The black holes, oh the black holes. One by one, they are getting filled, but that's only the good news. The bad news is that we added a new one this week, and amazingly, another previously impervious financial institution has gone gray.
Let's analyze where we were a month ago vs. where we are now.
Back then I isolated seven companies (one was a pair) that I said could bring down the financial system if they failed. They were
. We have made remarkable progress in filling these black holes, although I'm not crazy about the way some of them were filled. Let's review them.
- Fannie/Freddie got filled in pretty horrid fashion. In fact, the way they were filled remains the trigger for the latest wave of threats that could take our financial system back to the Stone Age. That's because it showed the government as a weak entity without resolve when it comes to financial instruments. One part of the government was telling us that these two companies' capital was OK, no matter what the stocks were saying, but another part of the government was leaking to Barron's that the companies could be seized and then seized them. Somehow a buy of mortgage-backed securities by the Fed or Treasury (issuing one-year notes and buying $200 billion of mortgage paper had been my plan) never happened. Instead, in one day, the U.S. government lost all credibility in its message to financial markets and destroyed confidence, perhaps for years.
- Lehman Brothers was just a terrible blow because it didn't have to go down like this. We now know there were multiple buyers, but one man, Dick Fuld, Lehman's chief, turned them down and was not pressured to accept their offers. (He will no doubt be reviled for as long as he lives and then some.) That left a series of enhanced margin accounts, actual cash, left overseas as part of the ridiculous unregulated offshore shenanigans that brokers have been conducting for years. The inability to access that cash, which was something the Feds might not even have known about, triggered waves and waves of selling everywhere as frantic hedge funds couldn't access capital. This was a totally botched black-hole fill from which we are still trying to recover. Like Fannie Mae/Freddie Mac, it was avoidable. Lehman suffered from the vicious hedge funds-media-ratings agency circle that can bring down pretty much any institution: Short the common stock relentlessly, buy puts relentlessly, buy credit default swaps on the black market -- that's really what it is -- at any price for any amount to mark the bonds as losers, take money out of the prime brokerage and tip off the media. That spreads panic, which then causes the stock to decline further, which then triggers ratings agency downgrades, which then cause people not to deal with the firm. Then it's all over. The speed with which this can occur also brought down a better capitalized firm, Merrill Lynch (MER) , from $28 right through what I thought was a sacrosanct line -- but which turned out to be a Maginot line -- of $22, where 300 million shares were offered. Capital in stock can't equal the selling vortex that I described. It is really what I would call a Kesselschlacht by the shorts. That's German for a decisive battle of encirclement (literally, "cauldron battle.")
- AIG was bound to happen ever since that company fooled itself into believing it wasn't on the hook for subprime mortgages. It had tremendous exposure in both its investment accounts and its insurance division. (I bet this will total more than $200 billion in global obligations and losses -- far more than the $85 billion loan the company got from the Fed.) Rank incompetence and overconfidence doomed this one, along with an absolutely ridiculous end-of-September disposal plan that was too late to stop another short-selling Kesselchlacht.
- GM. Along with Ford, this is probably going to be the next front, as GM has now drawn down its credit line. We need to have that credit line last until after the Congress passes the Resolution Mortgage Trust bill. If it doesn't, I see bankruptcy on the horizon for GM.
- Ford's mum, but it is probably in just as bad shape; loan guarantees are totally necessary. These companies are black holes that should be filled by bankruptcy because they need to start over. But political interests most likely will fill them for now with the loan guarantees.
- Incredibly reckless lender Washington Mutual is a likely save if the Resolution Mortgage Trust bill is passed. That's because an acquirer could dump all the horrible loans into a package and sell them to the government for 30 cents on the dollar for first mortgages and 10 cents on the dollar for home equity lines of credit, although I would split the vintages and pay more for non-Cal 2007 and less for Florida 2006 and the like. I could work out a schedule, but they will most likely figure this out only a year from now after mucho dinero. The only solution here is an acquisition, because Washington Mutual could not handle the hit to capital that would come from the writedowns that would accompany an offloading of assets to the Resolution Mortgage Trust. Even so, this black hole will be filled if the government plan passes.
- The best news of the week was that the short-selling ban gives Citigroup breathing room to get the money in from the German sale, perhaps sell to Japan and issue new equity to tidy things over until the Resolution Mortgage Trust allows it to dump whatever problem loans it has. If I were Citigroup and knew that the bill would pass, I would buy Washington Mutual and then offload all of the bad loans and take the charge and get forgiveness from the government, or at least have officials look the other way. That would eliminate this black hole once and for all and would make the bank very profitable, provided the Resolution Mortgage Trust allows Citigroup to move its structured investment vehicles off the balance sheet (although I am not smart enough to figure out how that would work).
- The bad news of the week was that, amazingly, Morgan Stanley (MS) - Get Report became a black hole. That means it's going to require an immediate merger or the shorts will figure out how to conduct a Kesselchslacht there, too. Meanwhile, Goldman Sachs (GS) - Get Report turned gray. It should be able to go it alone at least as as long as there's the short-selling ban. The firm would be wise to tie up with a commercial bank even as we all know the truth: A commercial bank is a lot riskier than Goldman. But the shorts are determined to wage Kesselschlacht against these guys, too, no matter how careful they have been.
So, overall, almost all of the black holes are filled or being filled, and that will certainy ease the crisis, although not in any way that makes me confident.
In the new world we will have
JP Morgan Chase
Bank of America
as the two major banks, while
will acquire the deposits of failed banks from the FDIC, which will at last have an entity to which it can sell the failed banks' bad loans. Citigroup could survive, even thrive, but it will have to issue equity and buy someone to get out of this mess. As for
, if it doesn't buy Morgan Stanley this weekend it will have to wait until it can sell off its bad loans to the Resolution Mortgage Trust. Then it will live to play again and be the most profitable bank of all. Without its purchase of Golden West, Wachovia would already be a dominant player, if not a Wells or a US Bancorp.
That's this weekend's scorecard. Sorry about the German, but as far as I know there is no other single word that means a successful battle of encirclement and annihilation by a superior enemy.
is just too elegant not to appreciate.
At the time of publication, Cramer was long Goldman Sachs, JPMorgan Chase and Morgan Stanley.
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