'Approaching a Solvency Crisis'

Ever since the financial crisis began more than a year ago, one question has repeatedly popped up: "When is it going to end?"

The answer is: nobody really knows (including me).

I will say, however, that my 25 years of experience in financial markets have taught me one thing (among many others, of course): bear markets -- and bull markets, for that matter -- usually don't end until most people stop asking that question.

Nonetheless, for what it's worth, I believe we are still in the early stages of this unfolding disaster, as I've indicated here and based on the progression of events I detailed in my book, Financial Armageddon (which was published just before the bubble burst).

And apparently, so do a few others. In "Too Big to Fail? We'll See about That," Tom Petruno, the Los Angeles Times' markets columnist, highlights the views of someone who believes things are going to get uglier.

The calamity in the financial sector will be remembered for the household names it damaged or took down.

The mess in the U.S. financial system is making me nostalgic for the dot-com collapse of 2000-2002.

That, too, was a cataclysmic bursting of an insane market bubble.

But, as we are painfully learning, it's one thing for the economy to lose Pets.com and a few hundred, or thousand, similar start-ups; it's another thing entirely to watch the market bet on the demise of, say, the nation's two largest providers of mortgage money.

The U.S. credit crunch turned 1 year old this month, and the situation clearly isn't improving. Major financial companies continue to reel from huge losses on defaulted home loans. Barring a dramatic turnaround in the economy, commercial real estate loans could become the next black hole -- although the banks will say, as they did initially with home loans, that commercial losses should be "manageable."

The unwinding of any market mania takes time, of course, and produces many casualties. That's the ugly side of capitalism at work.

But the casualties of the tech bubble mostly were little companies that weren't important in the greater economic scheme of things. Titans like Cisco Systems Inc. saw their stock market values plummet from 2000 to 2002, but there was never a danger that Cisco would go kaput.

By contrast, the enduring memory of the financial bubble's collapse will be the number of marquee companies either swept away or forced to shrink drastically to survive.

That issue was a key element of a speech that Federal Reserve Chairman Ben S. Bernanke delivered Friday. The central bank chief focused on how regulators might deal with "future systemic shocks" within the financial industry -- company failures or near-failures so large they could trigger chain reactions with potentially dire consequences.

We've already lived through several such systemic shocks this year. Countrywide Financial Corp., brokerage Bear Stearns Cos. and IndyMac Bancorp are history, the first two rescued just in the nick of time by larger rivals, the third seized by the government.

Now, shares of mortgage titans Fannie Mae and Freddie Mac trade for less than a fast-food lunch as the market bets that a government takeover is inevitable, if not imminent.

This week was another rumor-fueled ride on Wall Street. Fears of an impending failure of another major financial company were stoked by a speech early in the week by Kenneth Rogoff, a former chief economist at the International Monetary Fund and a historian of financial crises.

"The worst is yet to come," he said of the U.S. financial system. "We're not just going to see mid-sized banks go under in the next few months. We're going to see a whopper, we're going to see a big one, one of the big investment banks or big banks."

By late in the week Lehman Bros. Holdings Inc., long on the list of the most at-risk institutions, was said to be shopping itself to potential foreign buyers, including a state-run South Korean development bank.

And shares of Washington Mutual Inc., the biggest U.S. thrift institution, on Friday fell to their lowest level since mid-July on renewed jitters about the Seattle-based company's viability.

U.S. regulators are in a trap. They'd prefer to simply allow ruined banks and other financial companies to fail, thus purging the system.

But the list of potential victims now includes too many of the biggest institutions, which in turn have financial ties to countless other players in the business. Every huge tree that falls can take down a lot of other trees.

Even so, Bernanke said Friday that regulators would have to be more disciplined in how they handle future shocks, with the goal of "reducing the range of circumstances" in which a threat to the financial system's stability "might be expected by markets to prompt government intervention" -- i.e., a bailout.

For Fannie Mae and Freddie Mac, a bailout of some magnitude already is baked in the cake, thanks to the authority Congress gave Treasury Secretary Henry M. Paulson Jr. last month. "Too big to fail" is synonymous with Fannie and Freddie, given that they own or guarantee nearly half of all U.S. home loans.

But if regulators are ready to play tougher with other financial companies in jeopardy, they are likely to have plenty of opportunities to demonstrate their resolve.

That's because the banking and brokerage businesses have entered a second phase of the bad-asset workout, according to one large hedge fund manager whose views circulate on Wall Street but who doesn't seek or want publicity.

The first phase, the manager says, involved attempts by loss-ridden financial companies to raise fresh capital from investors. Some were successful, some were not.

The second phase, now underway, involves fire sales of assets by banks and brokerages that have no choice but to shrink themselves because there isn't enough willing and able capital out there to buttress every damaged balance sheet that needs it.

And as assets are dumped at fire-sale prices, that will trigger markdowns of similar assets, further weakening the finances of banks and brokerages across the board.

"We are approaching a solvency crisis that we think is about to result in an avalanche of asset sales," the hedge fund manager says.

Good luck, Chairman Bernanke.

Comments

[Steve Gelmis]

I greatly value your perspective, and perhaps this may seem like splitting hairs, but I want to take issue with how you've framed this post with respect to the differences between this bust and the previous one.

The implosion of companies like Pets.com may have been what gave the emblematic color to the last bust, so we call it the dot-com or dot-bomb bust. However, just as this bust is nominally about housing, it's not being driven by the failure of the homebuilders themselves, but rather the established and much larger finance industry's excesses. The dot com bust was all about excesses arising from telecom deregulation (including the commercialization of the Internet). It was the damage done to Lucent (IPOed as a split-adjusted $6.75, run up to $100 and then back down to $3 before being finally sold off to Alcatel), Nortel, the dozens of deeply-funded failed CLEC start-ups, Sun Microsystems (up to $200 and today under $10), and hundreds of other large companies which were structured for excess (Qwest, Worldcom, anyone?) that constituted the real damage of that era.

My point is that you weaken your case about the present disaster (which I agree is will be a larger problem) when you minimize the previous bust as a shortcut means to apply comparative magnification.

As to whether I'm personally likely to be nostalgic for the previous one, probably not. This time around I know how to make money in a down market.

[roger]

When is it going to end? don't know.more worrisome is HOW is it going to end? (usually don't end until most people stop asking that question.)this puzzles me Micheal is to intelligent a person the believe this statement so I presume he has a good sense of humor

[Independent Accountant]

How will this end? With much higher inflation. We'll be calling "Him" Zimbabwe Ben before this is all over.

We really are in a credit crunch. It is easy to see in mortgage financing, but it is starting to affect the broader business community. Small business can't access the funding it needs to grow, which is okay because the consumer has no money to buy anything with.

Our big mistake goes back about 30 years. We exported our primary jobs, preferring to naively believe that we could survive on service jobs in the "information economy" Now it has come back to bite us.

No lending, no spending.
No spending, no growth.
No growth, contraction.
Contraction, unemployment.
Unemployment, deflation
Deflation, deflationary spiral.
Deflationary spiral, depression

Connect the dots. It ends in depression, which is a contraction of all aspects of the economy....lending, spending, asset values, employment.

[Unscripted Thoughts]

Perhaps I am stating the obvious here...but wouldn't a forced asset sale put a value to all those Level II/III assets the banks have been hiding on their Balance Sheets? Based on the multi-billion levels reported for several of the largest players, that could easily turn into a free-fall of FUGLY proportions. Or am I missing something?

[roger]

"We" exported our primary jobs.NO manufacturers,industrialist & the retail sector went on the hunt for cheaper labor WE the consumers contributed by always shopping for the cheapest.The basics of economic activity:Financial sector: This sector manages & supplies the medium of exchange.Industrial,
Manufacturing & farming sectors are the sources of real wealth.
Retail sector: buys sells buys for profit only. This sector is the primary source
for the accumulation of money witch in turn is entrusted to the finance sector.
This sector is not satisfied with just managing it also sells money (interest)
and creates new money (credit) A wonderful machine for creating BUBBLES
the source of DEPRESSIONS
Consumers (this is all of us) produce absolutely nothing no wealth of any kind.But don't mind me I nave a simple mind always locking for simple answers

[Black Star Ranch]

....enough of the pre-game hype. Let's let the games begin. My garden's in, the cow is producing, the wood's cut, and most things are canned. The well now works with solar panel backup and the John Deere has plenty of diesel. Besides, even though I voted for both Father & Son, I'd find it fitting that the "house of cards, lies, and deceptions" falls apart before the end of the son's watch. The only trouble with that though is he'd enact martial law and we'd have them in for much much longer.

You mean I shouldn't take much stock in, ".....this may be an indication that we are nearing the bottom of the long downswing, and we believe the market is due for a turnaround soon......" ?? (ref: typical verbal bovine fecal matter originating from DC and parts of NY)

And lastly, is there anyone for instructing our esteemed legislators on the art of "reading the damned bill" BEFORE signing any more "giving away the farm" economic stimulus packages?

I'm glad we had the talk, I'm feeling MUCH better.....

[Tom]

Nice article.
Has some useful info in it.
Maybe I will link to this.

[Tom]

Nice article.
Has some useful info in it.
Maybe I will link to this.

[Tom]

Nice article.
Has some useful info in it.
Maybe I will link to this.

[Tom]

Sorry for double posts.
I used the back button.