Tuesday, 16 September 2008

Forget the Broker Dealers, Bigger Problems Loom

Away from the noise of Wall Street, ordinary citizens are going about their business as usual. However if you are in any way connected to or interested in financial markets, these are indeed interesting times.

6 months ago there were five large independent broker dealers in the US. Today there are only two. How many will there be in another 6 months? Nouriel Roubini thinks none of them will independent.

Does it really matter? Do we really need them? I would argue not. What benefit have these institutions brought to the economy? They have proved themselves incompetent by losing every dollar they have ever made. And this is not the first time.

What good are institutions that leverage themselves to the hilt, slice and dice dubious pieces of paper in the name of financial innovation and then infect all corners of the financial markets with their toxicity? Absolutely nothing and good riddance to them.

Besides, there are bigger problems out there in the form of AIG, Washington Mutual and Wachovia - and they are just the ones we know about. Citigroup itself is hardly out of the woods and it is doubtful if they survive in their current form.

The latest on AIG and WaMu is that their ratings have taken another hit. From marketwatch.com:

WaMu, AIG downgraded

Washington Mutual shares (WM) stumbled 9.4% to $1.82 after Standard & Poor's late Monday cut its ratings on the company and its Washington Mutual Bank unit because of increased market turmoil. S&P cut the counterparty credit rating on Washington Mutual Inc. to BB-/B from BBB-/A-3 and the rating on Washington Mutual Bank to BBB-/A-3 from BBB/A-2. The outlook is negative....

....Fitch on Monday evening downgraded AIG's rating to A from AA-, and said the company has an "extremely limited" ability to raise capital for its holding company

That doesn't sound good for AIG. from Bloomberg:

AIG's Ratings Cut by S&P, Moody's, Threatening Quest for Funds

American International Group Inc.'s credit ratings were downgraded by Standard & Poor's and Moody's Investors Service, threatening efforts to raise emergency funds to keep the company afloat.

The ratings reductions occurred after two people familiar with the situation said that the biggest U.S. insurer by assets is seeking $70 billion to $75 billion in loans arranged by Goldman Sachs Group Inc. and JPMorgan Chase & Co. to replenish capital.

$70-$75 billion, jaysus! On the weekend it was $40 billion. Also an AIG failure would not be good for anyone it seems:

"I don't know of a major bank that doesn't have some significant exposure to AIG," said Kenneth Lewis, chief executive officer of Bank of America Corp., in a CNBC interview. An AIG collapse would "be a much bigger problem than most that we've looked at," he said.

Why is that?

"The bigger problem here is that AIG is a bigger balance sheet, the tentacles go further and we don't have the same relationship between the Fed and an insurance company as we do with some of the others," said Liz Ann Sonders, chief investment strategist at Charles Schwab & Co. in a Bloomberg Television interview.

That's about it in a nutshell. Isn't this wonderful world of interconnected global financial markets marvelous? Hank containment Paulson was careful not to rule out government intervention. My bet is that AIG will qualify for the 'too big to fail' doctrine if it does indeed come to that.

How about Australia? There seems to be almost eerie silence form our banks and other financial institutions. It would be wishful thinking to assume our banks will be unscathed. We already know ANZ has CDS exposure to some major US corporate names. I think it's safe to say that BNB and all it's satellite companies are toast. MQG will find it tough to stay in one piece and there have been some rumblings about SUN's portfolio of assets.

But forget about the sideshow surrounding the Broker Dealers. The main event is the main street banks and insurers. If a couple of these go belly up in short order, we could be in for some real fireworks.


Dean said...

The majors all came out today stating their Lehmans exposures - think the largest was 150 mill. I agree BNB are buggered, but probably were before the events of the last few days unfolded. Im still undecided on MacBank, their share price has been mauled lately, especially the last couple of days. When your whole business model is based on gearing to the hilt then thats fair enough. However the usual defense wheeled out to explain how they are nothing like the US broker houses is ' they are far better capitalized'. Whats your view on MQG?

The Fundamental Analyst said...

No doubt MQG is better capitalized. They only have about half the leverage of the US Investment Banks. They have $10 billion in shareholders equity compared to $167 billion in assets. I notice they carry $21 billion in derivatives and $57 billion in debt.

Are MQG marking all their exposures to market? I don't have a clue. MQG is and has always been somewhat of a blackbox. I think they can survive but probably not in their current form. As you said, their business model is broken.

dean said...

article on MQG in today's Australian


The Fundamental Analyst said...

Thanks for the article Deano,

Here is the most important sentence in that article IMO:

"In these uncertain times the worst thing a company can do is have too much debt, hold a portfolio of declining asset values, lack transparency and fail to provide earnings outlooks."

Spot on, US brokers are getting absolutley slaughtered tonight. Another nasty day in stor for MQG tomorrow.