Traders,Yesterday's news was more confusing than the plot line of General Hospital. The market was down, up, down, up. It was a day of uncertainty, the Fed Fund futures were priced for a 90% chance of a Fed Cut happening yesterday. The reason, since everyone is going to the discount window and borrowing billions costs money - lower rates will help ease the burden of borrowing money of the short-term loans (now 84 days). The NY Fed injected another $50 billion into the market. The big news going into the morning was also AIG and their need to raise money.
However, the market started rallying after the opening - it seemed that Goldman and JP Morgan would bail out AIG, since the government would NOT bail them out (or so they said). Then the government decided to NOT cut the rates (I guess they are leaving some ammo in case they need to cut), the treasuries didn't know how to react. The market sold off hard and fast back to the morning lows. Rumors also came out that AIG could not survive the day and Goldman and JP Morgan were not coming to the rescue (let the government eat that pile of crud) – it was simply too much risk. Then it seems the Fed might come to the rescue of AIG by the end of the day, the market started to rally again.
No one had any idea what is going on - it was another day of sitting at the edge of the cliff - wondering if we would fall off. The Fed came to the rescue again! Hurray!
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AIG USA!
We just got two nationalized mortgage companies the other day and now we have a nationalized insurance company. Got to love General Planning - I even heard someone say, "Who said fascism is dead, it's alive and well!". My concerns isn't political as much as it is government debt and printing of money. I mean how much more can we print? I guess it's just paper, right?Late yesterday the government just didn't loan them $40 billion they asked for, they literally took them over and more than doubled the size of the loan - I guess it was really THAT BAD.
On Monday the CEOs of major firms met with the Fed and Treasury, they said we can NOT let AIG fail - it could mean a possible collapse of the financial markets. The Fed and Treasury said NO, AIG will need to raise money in the private market. See the Fed and Treasury just said NO to Lehman, so how can they say yes to AIG? Congress is getting a little miffed - since they opened the bailout door and told them - No More Bailouts unless you check with us first. But this isn't just a bank or even an investment bank - we are talking about the LARGEST Insurer in the WORLD! They ARE too big to let fail (or so the CEOs said) - but the Treasury and Fed stood pat, NO!
Goldman and JP Morgan eventually didn’t step up to the plate (Why? It was worse than expected!), it seemed from what AIG was saying they needed about $70-$100 billion or they wouldn't survive the day. Rumors on the street would be they would file for bankruptcy by Wednesday afternoon. Rumors going into the close was the Fed may just bail them out, the market rallied into the close. But after the close there was news that AIG would filing bankruptcy, the stock was down in the aftermarket and the futures started getting hit - but the story isn't over yet.
Then late last night the doors opened and the Fed appeared - "We now own a Insurance company!"
Here's the deal:
$85 billion loan - for an 80% stake.
2 Year loan - AIG must sell assets to pay back the loan.
So WHY did the Fed change their mind, if the CEOs of the US firms could not change their mind? My theory is simple, all you had to do was turn on the TV and watch lines of people in Asia looking to withdraw funds. CNBC and BLOOMBERG ASIA showed a run was starting – lines were long in Japan, Singapore, and Hong Kong. AIG stock was back down in the $1.50 range after the close. Bankruptcy was next. I am sure the phone rang off the hook as foreign governments started calling Paulson, Bernanke, and anyone who would answer. This is not just about an American insurance company or even a couple of US banks – this is a Global problem as the world’s banks and investments have a spider web relationship with AIG and if it would fail we could see a run. The decision came late last night – the Fed did not really have any time to review the balance sheets – they just pulled the trigger and picked a number. Now they have to sell it - Sell the Faith!
However the story is even more ugly than that. AIG as early as two weeks ago had NO IDEA how bad things were. They couldn’t even make heads or tails out of their own balance sheet. First it was $5-$10 billion they needed, then $20 billion, then $40 billion. Goldman and JP Morgan had spent a few days looking over the books, $75 billion seemed more like the number needed – but even that was questioned. Some say it could be 5 to 10 times more than that ($300 - $500 billion). So if Goldman and JP Morgan (as well as others), who had more time to review the books and balance sheets didn’t touch this (rumors where they needed more than the $75 billion) and the balance sheets were a lot worse than even imagined, what makes the Fed think in one late night review they could come up with any amount of accuracy of how much is needed. Some say $85 billion will not last the week and more will be needed to float it.
The government’s spin is that this might not cost tax payers any money and they could sell off assets and even make a profit. If that IS the case, why would not Goldman or JP Morgan (both smarter, better informed than the government, and had more time to review the balance sheets) jump at the chance? Because the deal sucks and there is a high probability that they will:
A. not sell off enough assets to cover the debt (who has the $85 billion to spend on debt obligations and willing the take the risk?)
and/or
B. smarter people say $85 billion is a band-aid. Remember, this is the same government that told us that Freddie and Fannie had more than enough capital and would be solvent – yeah right. It going to cost a lot more!
The stock has been volatile in the pre-market, no one really knows what the value should be - if the government owns 80%. Since we don't know the details (just the general ones) it will be hard to determine the share value, is it 20% of yesterday's close?
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Morgan Stanley to merge?
Now rumors are circling that Morgan Stanley (one of the remaining two large investment firms) maybe for sale or looking to merge with a bank for much needed capital. JP Morgan and B of A are fully bloated - they have gobbled up Bear Stearns, Countrywide, and Merrill Lynch. Who has any money to buy anything, other than the government printing money? Morgan is looking for a deal probably like Merrill Lynch - that could continue to give them access to the Discount Window (when it closes to non-members) and also those yummy deposits that banks have to capitalize their positions. The question is Who? Many of these banks look pretty ugly and are already using all their deposits to cover those nasty mortgage liabilities. Maybe Citi, they have been quite? Who knows at this point - however expect something in the future.
Looking back I heard the train of people paraded across CNBC and Bloomberg, "Countrywide would never fail!", "Bear Stearns has some of the best risk management on the street - they are a solid company!", "Fuld is well respected, Lehman is one of the few solid financial companies out there!", "Freddie and Fannie is well capitalized!", "AIG is a solid buy at $50 - they will be one of the few companies to survive this credit crisis!" - These people are selling nothing more than faith, obviously none of them reviewed the balance sheets.
Back to Morgan - their 3rd quarter numbers look better than forecast - however, there is still concerned about their liabilities. Morgan is revisiting their business models and the rumors about merging with a commercial bank, which would help with capital, is making its way through the street. Morgan looks good for now - but things can change in a day (we just saw that with Lehman and AIG) - when it happens it happens in a day, not weeks.
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The Fed saving ammo!
The Fed has moved from lowering rates to using the Nuke Option (Paulson's Bazooka) and is just buying out companies. Freddie, Fannie, AIG. Also they are using a dump truck at the Discount Window to dump money into the market - another $50 billion from the NY Fed yesterday. However, they need to keep the little ammo they have left as far as rates (200 bps - that is only 4 50bps rounds left.)Things are not looking good and the Fed needs all the ammo it has left. The Fed Fund futures had priced a cut at being 90%, those that are borrowing need a cut - the reason that 2% is still a massive fee on billions for a short-term loan. Any relief is much needed. However, instead of cutting they dumped more money into the system and just bought-out AIG (with a loan - that may or may not get paid back).
The Fed bailed out Bear, Freddie, Fannie and then let Lehman fail, but the next day bailed out AIG. So the big question - what is the litmus test that determines what is allowed to fail and what is not?
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Money Freeze!
The latest concern is a money market freeze - redemptions at many money market firms have been frozen. Lehman's debt (which is owned by many firms) was just marked to zero - no one is lending money and it is getting very tight. As more are going to the bank to pull out money, the more money gets tight. Add to that investments in corporate bonds (some failing - like Lehman) and we are seeing the trickle down to the consumers holdings.
One question that is not being talked about (YET) - is the pension funds, mutual funds, and state/local funds (remember my story about our local hospital? - they were a massive investor in corporate debt) - well those investments are going up in smoke. This story hasn't surfaced yet - but it will and it will get ugly.
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Futures Pre-market
Again the futures seem to be pretty volatile - they were up after the close, down hard when it looked like AIG was going to fail, then rallied after the Fed agreed to bail them out, and are now backing off again. I think many Arb traders will sit on the sideline rather than step up to the plate to risk taking a leg going into the opening. Futures are starting to get hit again going into the opening – still concerns about credit and money – specially after money markets have been frozen and losses now from Lehman’s bankruptcy is being realized.
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Support / Resistance
We got a good bounce yesterday after the morning looked to be a serious break-down. We have now created a short-term support area - the question is do we revisit them and do they hold. That is the question that no one can really answer - the Fed did give everyone some short-term relief by bailing out AIG for now...but what next?
INDU 11,000 / 11,275 (11,000 needs to hold, we just lost a Dow Jones component – GONE. There is going to have to be some quick replacement of that stock and it better be something good to keep the 30 stocks from falling. Today it’s really only 29 stocks – no one really knows what AIG value is right now – the numbers need to be crunched.)
NDX 1700 (1725) 1750 (1725 seems to be the pivot point – 1700 or 1750 is in the cards – faith will drive us higher and concern will drive us lower.)
SPX 1175-1200 / 1225 (We got a good boost into the close as rumors about AIG seem to calm the market – however 1200 is still in the cards and if that doesn’t hold then a lower visit. If faith returns to the market we could go higher – but I think we may be losing faith.)
RUT 700 / 720 (We were below 700 yesterday and rallied above it – it really comes down to 700 – not a place to get long or pick a bottom – but rather remain cautious.)
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Conclusion
An economist said late yesterday on Bloomberg, "It's amazing that the dollar has remain strong, China is no longer a lender, neither is many other countries, no one is asking the important question: Who is extending us the credit to bailout all these firms?" - I think that was rhetorical - the reality is that it is no one, we are just taking on massive amounts of debt and it will be the tax payer. We are leaving our kids and grandkids massive amounts of debt. Freddie, Fannie, AIG, will be forever government controlled entities (or fully fail and broken up) - they will not be able to pay back that kind of money. Not to mention the 100s of billions shoveled out the Discount Window. What is amazing - to a point of seeming like it makes little to no sense - why does the dollar remain strong?
The market still has not panicked yet. This is not like 1987 and the market just sold off - only to rebound. This is the fundamental solvency of the entire financial system. Major firms are failing, government is bailing out firms, and the credit crisis is in full swing. If I told you last year at this time that Lehman and Bear would fail, and AIG, Freddie, Fannie would be bailed out by the government - you would first call my crazy and if you did believe me you would think the market would of crashed by now. But it has remain very strong, VERY STRONG - and has sold off rather orderly.
We haven't had any panic yet - people are absorbing these massive losses and deleveraging very well. Maybe Paulson and Bernanke are doing a better job in selling the faith then I give them credit for. However, it is important that we are shifting these losses to the government, the liabilities still exist. We have now shifted our faith from the company to the Fed.
The printing press seems to be the mightiest of weapons. It's not like these bailouts and loans are really backed by anything, certainly not foreign investments. We burned through that a long time ago. Faith is a strong thing!
Take the time to think about this for a second - we are bailing out these firms with TREES!
Maybe it is time to get long IP?
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