Wall Street

Wall Street

I don’t know about you, but I find the news from Wall Street a tad unnerving:

“The American financial system was shaken to its core on Sunday. Lehman Brothers Holdings Inc. faced the prospect of liquidation, and Merrill Lynch & Co. was close to a deal to sell itself to Bank of America Corp.

“We have never seen anything like this,” said analyst Glenn Schorr, who covers the investment banks for UBS AG. “There have been tough situations like Long-Term Capital Management and the crash of 1987, but the problem here is there is leverage in the securities under the microscope and in the banks that own them. And to try and unwind it all at once creates a one-way market where there are only sellers, and no buyers.”

The convulsions could lead to even tighter credit, higher borrowing costs and moribund capital markets, as securities firms and commercial banks try to further limit risk and preserve capital. Those moves could cause the U.S. economy to slow further.”

And that’s not even the latest news: since that article was published, Merrill has decided to sell itself to BofA, Lehman Brothers seems to be about to file for bankruptcy, AIG has asked the Fed for help, though the WSJ adds that “it wasn’t clear what (the Fed) could do”, and the Fed, for its part, has expanded its lending facilities, prompting Yves Smith to comment:

“I guess it is now official. We no longer have functioning trading markets, at least in terms of serving their alleged purpose of giving companies access to capital.”

Nouriel Roubini is generally pessimistic, but he’s also generally right. Here’s his take*:

“It is now clear that we are again — as we were in mid-March at the time of the Bear Stearns collapse — an epsilon away from a generalized run on most of the shadow banking system, especially the other major independent broker dealers (Lehman, Merrill Lynch, Morgan Stanley, Goldman Sachs). If Lehman does not find a buyer over the weekend and the counterparties of Lehman withdraw their credit lines on Monday (as they all will in the absence of a deal) you will have not only a collapse of Lehman but also the beginning of a run on the other independent broker dealers (Merrill Lynch first but also in sequence Goldman Sachs and Morgan Stanley and possibly even those broker dealers that are part of a larger commercial bank, I.e. JP Morgan and Citigroup). Then this run would lead to a massive systemic meltdown of the financial system.”

I very much hope he’s wrong. But it looks to be a wild ride.

* Ken Houghton at AngryBear adds a caveat:

“But the effect of LEH going out of business would not be so severe as the effect of BS going out of business for one reason that Roubini, for some reason, appears not to have mentioned.

Lehmann has no clearing business.

Had Bear gone out of business, about 30% of the hedge funds in the country would not have been able to execute virtually any transaction for the following thirty days. Not a payment. Not a redemption. Not a trade on a listed exchange. Not a receipt. Not a de-leveraging. Not a swap payment, not a CDS payment, not fulfilling an option exercised against them.

There’s not just a “maybe” about financial collapse in such a scenario; P probably well in excess of 0.9944. $30 billion is a “bargain” in such a situation.”