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) -- What makes a Lehman? What makes it so it's not


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, which could be saved by capital infusion, or Wachovia, which could be saved by merger, or Washington Mutual, where some securities are saved and others aren't?

The answer?The brokerage business. The way a brokerage business works.

Which brings me to


. We have heard endless denials that anything is wrong with SocGen. Yet it keeps going down.

What does that mean?

I think it means something is wrong. I do not think it means something is right and people don't want it to be right. I do not think it means that the shorts are just spoiling for a fight to take it down. I think there are fundamental problems having to do with SocGen that are

sui generis

-- meaning the other guys don't have them, as it is isolated to SocGen. And, like Lehman, I am not sure that the people running SocGen really get the gravity of the situation.

Let me explain. Most banks here borrow money from depositors or borrow money in the markets and from each other and lever it. Many banks in Europe do the same, but they also buy sovereign debt and lever that. If you are buying U.S. debt and borrowing against that, then you don't have too much to worry about. Maybe some interest rate risk. Not default risk.

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Many banks in Europe bought sovereign debt from EU members. They levered against that. Now, just substitute "subprime debt" for "sovereign debt" and you can see the problem with levering against it. As long as the stuff's at par, you have no problem with capital. When the stuff falls like subprime, then it is dangerous to lever against. Europe's very loose with the rules about how much you can lever up on sovereign debt.

Our rules are tougher; our regulators are tougher. We have to presume that many banks there, particularly French banks, are valuing subprime sovereign debt as par so they are vastly overlevered. Left to their own devices, these banks are all Citigroup, meaning that they need to have capital injected and equity watered down. If it is really bad, then you have an RBS situation on your hands, a real dilution that makes it basically a government-owned bank.



Lehman. That's not the end of the world. In fact, at a certain point that will lead to a much-needed resolution to the problems.

Put frankly, it is not what people are really worried about. The government has a plan, it executes the plan, the institution's equity is crushed. We move on. If the bank is smaller, then it is bought -- Wachovia-like if good, Bear-like if OK and WaMu-like if really awful.

All workable. All where we are clearly headed despite all protestations.

Again, none of these is Lehman.

What's Lehman?

A brokerage house with many derivative positions sold to hedge funds that are worried about getting their money back because of a bankruptcy that the authorities either let happen or don't know it is about to happen because of endless management protestations that are taken to heart and believed in.

That's the worst case.

What bank looks the most like Lehman? SocGen. This is the bank that is the principal maker of the derivative book in the world. Consider it the world's largest bookie. It makes odd and strange markets, proprietary trades that are unlisted, with many, many hedge funds.

Those hedge funds know that if SocGen is Lehman'd, those contracts will be caught up in bankruptcy and it will be years if they get their money back (if they ever see any money at all).

These hedge funds are watching the ratings agencies and they are getting really nervous. They are thinking, "Unwind these trades before it all goes bad." I am willing to bet that some are taking action right now. SocGen often has to take the other side of the trade to unwind these positions because they either laid off the risk to an account in a long-term contract that can't be undone or they actually own the other side.

In either case, the bank would have no choice but to position the close out to live up to its obligations of making a market, and that means it is long much more than it thought. Given that it is long these unwound trades against sovereign debt, it could be a loser on both sides.

It is possible that soon no one will want to lend it money because it will be an open secret that this derivative book might be choking them. They could, already, be long tons of really-hard-to-understand positions and, even though they would most likely be buying them back at a considerable haircut to what they are worth, the hedge funds are so afraid of a Lehman scenario that they would be freaking out and whacking any bids.

Ultimately, there would be an insurmountable capital need and, in this case, an AIG-like bailout would have to occur.

Is all of this happening now? I don't know. I am simply searching for reasons why the market seems not to be appeased by any of the denials, including very public TV denials, that nothing is wrong and no capital is needed.

But the possibility of not being able to explain to investors that you saw a Lehman coming? I believe that's weighing heavily on this bank, certainly more than others, because the others "just" have the sovereign lever-up problem I described, a miserable institution-killing situation but something the authorities are most likely ready for.

Of course, the Europeans have castigated us for being moralists and letting Lehman fail. They should be sophisticated enough to know this scenario could happen.

But how can we be bullish ahead of it possibly happening?


I wrote a piece about how the next Lehman could be there in Europe. People freaked out that it was a new position for me. Actually, this has been my view for some time, and I even had a fight about it on air. I have said over and over again a Lehman there will not be as bad for us as a Lehman here. Given, though, that U.S. hedge funds do a ton of business with SocGen, there could be some heavy fallout if this situation becomes a reality -- and that, plus the obvious credit crunch that comes from bank failures, as well as the deflation that Jean-Claude Trichet, the Bernanke of Europe, doesn't seem to care about, is what's behind this endless torture.

So, know your enemy. It's all about two kinds of collapses, Non-Lehman, totally workable. Freakout, but workable, with ultimate impact on the horizon. And Lehman, justified freakout that is buyable but takes out the lows for the year.

None of this has to do with the euro. An end of the euro would be well received by investors even though the policymakers would hate it. The end of the euro would make it so all of the above still happens, but we would have a nasty resolution to all countries and a dramatically lower standard of living for the people of those countries that get the boot.

The fact that all of this is on the table is what made me write here yesterday that you need to either brace yourself with a diversified portfolio of high-yielders, some growth high-yielders and cash, or, if you are a hedge fund, you should be shorting rallies, particularly with financials.

That this is odd, that this is revelatory, is quite frankly ridiculous. It is Hedge Fund 101. It is why you should bother to read me.

And be ready.