Financial Black Hole: Close To Nationalization?
A: Ok, things are getting a bit serious now that RBS seems to be a test subject for nationalization. The government already stepped up and rescued Bank of America & Citigroup recently. Yet the shares are trading as if both companies will be nationalized, go the way of the GSEs, and see equity shareholders wiped out. I just get the feeling that something big will happen in the next month or two. I don't know if the system is prepared? I'm sure that this is a major aspect of talks right now. We saw the nuclear weapon test with the failure of Lehman, and learned that letting BAC or C go that same route simply can't happen. When we saw Fannie/Freddie get nationalized, it seemed to go more orderly than I original thought. I wonder if a similar path will be taken again.
Look at this image showing the bottom half of my trading screen; it shows you the bid/asks of JPM - BAC - C as of 2:30PM:
Focus more on BAC & C! It's fairly clear there is absolutely NO CONFIDENCE in the common equity of these two ginormous institutions. It's not that these firms are expected to fail, but rather, that the common shareholders are likely not going to survive what lies ahead. With these big boys' stock price trading at such distressed levels, there are few to no options available should a cash crunch come in the near future. The government will have to step up again, which they could do using 2nd half of TARP, or something more drastic will occur. RTC?
I think we are reaching the point where something more drastic is likely to occur. Like the GSEs, I think we are very close to the point of no return, the black hole, where a decision needs to be made and what better way to do it then in the first few weeks of a new administration ---> clean the slate!
If they are going to do it, JUST DO IT ALREADY, and might as well do it to both BAC & C at the same time! Heck, I wouldn't be surprised if Wells & JPMorgan won't be down this road in another 3-4 months - do them too! It has been a busy path that has decimated investment banking and wall street as we used to now it. I can hear the cries of 'privatize the profits, socialize the losses' already, and they are growing louder! Free market capitalism? I think not.
A nationalization would trigger a credit event, and that means all those pesky holders of credit default protection would have to be paid out. Chances are, this has been discussed prior to any announcement and the process could be more orderly than some doomsayers think. This is the tangled web of finance that we have woven; the interconnectedness of the global banking system. This also is what played a large role in taking down AIG, a big issuer of CDS protection on the wrong side of some very big trades. Who issued protection against a credit event for BAC and Citigroup, and on the hook should either one go under government control? Who knows, as this market trades OTC and is largely unregulated. DTCC has a page showing you gross notional, net notional, and contracts on CDS for the Top 1000 entities.
Can the system absorb a chain reaction of events from such a large credit event? This is what the top dogs fear and probably are discussing. It started when the party just went on and on and on, then the music stopped, many were left without a chair, and there was nothing that could be done for those left holding highly toxic balance sheets when bids for structured credit assets disappeared and the housing/credit boom went bust. Picture a black hole with its fierce event horizon (the point of no return). I feel like Citigroup and Bank of America common shares are caught in the gravitational tidal forces sucking it closer to the point of no return.
If it happens, the common shares will be wiped out and prob open at like $0.50/share. But the credit event that is triggered and the domino effect of that is the situation to watch! Orderly Liquidation or Fear Based Selloff? I think the biggest test is very near and I wonder if the world has been preparing to handle such a storybook ending to this banking saga?
Posted by truthteller
Tue Jan 20th, 2009 03:43 PM
Noah, did you see what Roubini is saying?
Very scary.
Roubini Predicts U.S. Losses May Reach $3.6 Trillion
http://www.bloomberg.com/apps/news?pid=newsarchive&sid=aS0yBnMR3USk
Hello brokers, the banking system is insolvent.
Yes, Noah, prices will go to 1995 levels, we're in big, big trouble.
Posted by Noah
Tue Jan 20th, 2009 03:48 PM
yep, included a section of it in the previous discussion.
Im hearing that any nationalization will not have the severe domino effects that some are talking about. One CDS trader tells me that if C is nationalized, a credit event will be orderly. I wonder about that but this guy is brilliant!
Posted by mh23
Tue Jan 20th, 2009 04:06 PM
Noah:
Great post. Do you see a potential run on the banks, or at this point are we merely witnessing common share holders running for the hills? I sold all my BAC at 9, a far cry from the 28 where I averaged in at. That being said, once the dividend was wiped out, I could see the writing on the wall. I have no idea why these banks are not already trading at close to zero.
Posted by Noah
Tue Jan 20th, 2009 04:15 PM
C just cut dividend to 0.01/share AFTER how many statements that dividend is safe! Go MER WHITNEY!
Posted by Noah
Tue Jan 20th, 2009 04:24 PM
mh23 - actually, no I dont. Maybe some forced selling to raise cash by HFs, and other big funds, but I dont see any bank runs. This is prob going to be less powerful because of when it is occuring, what we already been through, and the warnings we have seen already.
With that said, stocks could certainly plunge again, and they are. But I dont see any bank runs because I think as events unfold, we will be able to absorb it rather well. Lets see if Im right. I need to be positive somewhere!
Posted by anonymous
Tue Jan 20th, 2009 05:00 PM
Noah - slightly OT, but what do you see as the risk, if any, of having significant financial assets in an account at a place like Fidelity or Schwab?
Posted by Noah
Tue Jan 20th, 2009 05:07 PM
over the 250K mark that is backed by FDIC? If so, I would consider diversifying although for me, it would be for peace of mind to stay under the govt insured level.
I would also make sure a small portion of significant assets is in gold as a hedge against inflation/fiat destruction/end of world scenario where it wont really matter how much paper money you have. I dont see end of world coming, again, for personal peace of mind. Def have some hard assets outside of real estate/land
Posted by anonymous
Tue Jan 20th, 2009 05:24 PM
Actually, Noah, I believe the SIPC protection applies to brokerages, including Fidelity and Schwab. That limit is $500K, not $250K.
That said, I'm wondering if you or anyone else on this board can comment knowledgeably on the risk of a Fidelity or Schwab actually folding. Being more custodial firms than risk-taking banks/brokerages, I would think they pose less risk. But I would welcome any and all thoughts on the subject.
As for gold, I would never suggest someone invest a significant portion of their wealth in gold, for many reasons. But that's just me.
Posted by truthteller
Tue Jan 20th, 2009 05:30 PM
I think places like Fidelity, Scwab, Vanguard, Dreyfus are reasonably safe.
Posted by Noah
Tue Jan 20th, 2009 05:32 PM
anon - oops sorry about the mistake of 500K, yes you are right regarding brokerages coverage.
BUT, as I check up on this again, SIPC is NOT insurance like you may think! It is a fund setup by member brokerage firms in case a firm fails! The govt does not back up SIPC. If your broker is stealing from your account but the firm is up and running, SIPC coverage doesn't come into play. And, it only covers losses due to theft or proven unauthorized trading. Losses due to fraud are not covered.
Basically, it protects customers whose securities were misappropriated, never purchased, or stolen. Commodities or futures contracts are not covered.
http://en.wikipedia.org/wiki/SIPC
If you are covered, and you owned stock, it may take time for you to file a claim and get stock certificates back, during which time you cant trade out of the position. So the coverage is a bit different from say FDIC coveraged of 250K per account in insured banks, that I erroneously referred to last comment. Enough to warrant being safe in my mind.
But, please notice that I said: "a SMALL portion of significant assets is in gold"
...NOT a significant portion of ones wealth; always diversify! And I would have said the same thing in 2007 and in 2008, and chances are it would have performed well for you. I still say it now. Keep a small portion, maybe 5-10%, depending on your own research and risk tolerance of course, in precious metals at these levels.
And like I said, if it were me, I would transfer funds if you are over the 500K insurance for peace of mind even though I too consider those names safe.
Posted by Thisson
Tue Jan 20th, 2009 07:23 PM
What use is gold? Even physical gold?
If the dollar becomes so worthless, then is the corner bodega going to sell me my milk and frosted flakes for krugeraands?
Are they going to give me change in pieces of silver?
Seriously, there isn't enough physical precious metal to meet the currency needs of trade if (when?) the dollar fails.
Posted by Noah
Tue Jan 20th, 2009 07:32 PM
Thisson - VERY TRUE! But that wont stop gold as an asset class from out-performing the broader market! if it comes to what you said, Id rather have bread, water, and wheat.
Call it capital preservation.
Sometimes NOT losing money is a great investment!
Posted by lars
Tue Jan 20th, 2009 08:26 PM
Places like Vanguard, Fidelity and even Schwab are not in the business of taking principal risk the way an investment bank or commercial bank is. Therefore, the risk is very small that you would have a problem. Indeed, the main risk (which isn't a risk IMHO) is fraud.
Even at places like ML, money market assets are ring-fenced so only if management "borrowed" money from the MMA and used it elsewhere would you have a problem. Of course, YMMV.
Posted by anonymous
Tue Jan 20th, 2009 09:25 PM
Lars - that's my take as well.
Also, suppose you have cash in a treasury money market mutual fund, isn't it also true that if the mutual fund holdco goes under (i.e., Fidelity, Vanguard...), the mutual funds themselves are still intact as separate companies. And, since mutual funds are regulated entities which hold in trust (and don't mingle) their underlying securities, the only concern again would be fraud?
Posted by lars
Tue Jan 20th, 2009 10:42 PM
anonymous 9:25 pm
Yes.
Posted by lars
Tue Jan 20th, 2009 11:24 PM
I should add to my yes that I am not an expert in bankruptcy. Hence, YMMV. But am putting my own money in the Vanguards of the world and, notwithstanding I don't sleep well at night given the current mess, it has nothing to due with Vanguard risk.
Posted by Noah
Wed Jan 21st, 2009 09:14 AM
Thanks for the comments about those two firms LARS!
Just curious, why is it then that you have trouble sleeping? Just the overall situation?
My money is in Schwab, Etrade, Lightspeed Trading, and HSBC personal / business accounts. Etrade is the only one I worry about and I only had my account there before I re-opened my trading account. Likely will cash out there and move to Schwab.
Posted by lars
Wed Jan 21st, 2009 12:03 PM
Noah,
I worry that the dollars I have so carefully accumulated are going to become worthless as the FED and Treasury debase the dollar's already debased value.
We seem hell bent on easing this crisis by printing money to save the day for having printed too much money. The only saving grace that I see at this point is that every nation is on the same path (debase currency by printing way out of mess, though this raises concerns as to the likelihood of success). So the dollar decline may not prove to be as bad as I think (obviously so far this has been the case with thw $). Still, I am very fearful the FED pushes the presses too far, the rest of the world finally gives up on the US as reserve currency, and then we, and my measly stash of dollars, are in serious trouble.
Posted by Noah
Wed Jan 21st, 2009 02:24 PM
Lars - yes that is why I own gold. Ive been thinking about this alot recently and the more I research the more I think any destructive dollar debasement may not come.
For one, in a deflationary environment the us dollar should strengthen. As it did before the quick reversal a few months ago. Now its strengthening again.
Second, the printing that the fed is doing is to fill a hole that has occurred in the shadow banking system that saw asset values completely wiped out. So that spike in adjusted monetary base and excess reserves I think is a bit misleading. That money is not entering the system, whereby you would have a huge multiplier effect. In fact the opposite is occurring. Cash is being hoarded as the recapitalization process continues and M1 multiplier is actually diving. Again, symptom of deflation.
Now, the quantitative easing the fed recently started, IS creating money out of thin air and depositing that into primary dealer accounts as they buy up agency MBS and treasuries. That is inflationary but I dont think it is anywhere at levels that could cause a hyperinflationary environment or complete dollar destruction.
As you say, everyone is doing it too. This is how I understand it right now. Im trying to learn more as I go about this confusing situation in terms of printing, mutliplier effect, surge in monetary base, and what it all means. For now, I think the fed is printing LESS than the amount that has been destroyed in shadow banking system.
I know credit is contracting and that certainly is not inflationary. But in years to come, of course that is different story the effect of all this.
I worry too, and I am trying to understand the best I can. Thanks for comment
Posted by BrokerMan
Wed Jan 21st, 2009 02:32 PM
Noah, considering the dire straits of these banks, is it conceivable that a bank like Citibank or JP Morgan Chase may not show up at the closing table with the money they committed to lending to a borrower? Is that a legitimate buyer concern for someone closing in the next month or two?
Posted by Noah
Wed Jan 21st, 2009 02:43 PM
Well Im not a mortgage guy so I will ask mortgageman to comment on that
Posted by Fred
Wed Jan 21st, 2009 03:00 PM
over $2 billion has flowed into the XLF today alone. clearly, the banks going wallpaper is not a widely held sentiment - at least for today LOL!
Posted by faustus
Wed Jan 21st, 2009 03:11 PM
Noah, even though I've been saying the same thing you just said for some time (as we know), I am also still occasionally up at night on the dollar/inflation front.
That said, we should all watch how inflation/deflation plays out in the UK. They may be the first litmus test of the effects of wildly aggressive monetary policy and nationalization in an industrialized country - since I expect it to play out worse there.
Btw, is your inventory widget stuck?
Posted by lars
Wed Jan 21st, 2009 06:01 PM
faustus,
I find your comment interesting about the UK. Moreover, it was very much on my mind when I made my comments about beggar thy neighbor monetary policy. The decline of the pound against the dollar has been near incredible. It seems to be showing some resistance at the 1.38-1.39 levels for now. Personally, I expect it to continue its downward plunge. The UK is in far, far worse shape then even the US.
Posted by Thisson
Thu Jan 22nd, 2009 01:28 PM
Of course they are in worse shape. They've had central banking longer. haha.
Posted by Fred
Thu Jan 22nd, 2009 01:49 PM
it just occurred to me that a better comparison for the current decline is not relative to other declines' percentage loss of index value but rather as a percentage of nominal GDP during each time period. any one have a chart that shows decline in total market cap as a percentage of GDP? i guess you could inflation adjust both data series or just take the unadjusted resulting index. i am just wondering if what we are missing here is the liquidity factor - its just easier to pull money out today than it was in '87 or '32, etc.