|
To print a copy, Set your printer to "Landscape mode." |
|
What Goes Down, Must Come Up "Storm shall pass" by Bill Newell
Anatomy of a crisis
Spreads on credit default swaps (derivatives used to buy protection
against defaults) widened for major brokers to levels not seen since the
Bear Stearns rescue in mid-March. By September 16 overnight LIBOR (the
The Fed responded to the crisis by broadening the collateral it would accept in return for providing liquidity to include non-investment grade securities and, for the first time in its history, equities. It also expanded its Treasury Security Lending Facility, which allows financial firms to swap bonds such as mortgage backed securities with the Fed for U.S. Treasuries that are more easily accepted as collateral for borrowing in the markets. At its meeting on September 16, however, the Federal Open Market Committee, the Fed’s monetary policy-setting group, left rates on hold and mentioned only that “Strains in financial markets have increased significantly” in its statement to the public. Many market participants had been hoping the Fed would cut rates, believing that such a move would have helped ease the crisis, even if only at the margin. One reason the Fed did not cut rates is that it was in talks with AIG that ultimately culminated in a $85 billion loan from the Fed in return for warrants that would give it an ownership stake in the company. This was unprecedented – a word that commentators would use over and over again during the week. The Fed likely thought that the loan to AIG would calm the markets. It did not – the Dow fell by another 449 points the day after the rescue of AIG was announced, and credit and money markets continued to seize up. By the morning of September 18 central banks all over the world were injecting hundreds of billions into global money markets in a coordinated effort to liquefy the system.
Implications of the crisis
Coming to the end of the first full week of the financial crisis equity markets are still jittery and credit and money markets are still not fully functional. Under these circumstances it might seem premature to draw any conclusions about the lasting effects of the crisis on the financial system. Still, some judgments are possible:
1. The current crisis, along with the bailout of Fannie Mae and Freddie Mac just a few weeks ago, makes it obvious that the liquidity and solvency problems in the financial system were far worse than most observers believed.
2. The unwinding of asset and derivative positions of Lehman and AIG is underway, and will be affecting prices for some time. How long that process will go on and who will bear the losses remains unknown.
3. The structure of the financial system will never be the same. The viability of the independent investment banking model has been called into question. This is not to say that some of the stronger investment banks will not remain as stand-alone entities. But efforts to merge investment banks into commercial banks suggests that commercial banks, with geographically diversified branching systems and a funding base of federally insured retail deposits, are increasingly being thought of as inherently more stable institutions. (This view seems well on its way to being the consensus, even though some commercial banks have had to write off billions of losses on mortgage related instruments.) The financial landscape will be populated by fewer, bigger firms.
4. More regulation is on its way. The federal safety net — notably access to the Fed’s discount window — has been widened. If the Fed or other government entities are backstopping risk in investment banks and insurance companies, it needs the tools to ensure that those risks do not get out of hand. Both presidential candidates have called for closer supervision and regulation of financial firms.
5. On September 19 the U.S. Treasury announced that it would be working with Congress to pass legislation that would create a Resolution Trust Company (RTC)-type entity that would buy shaky mortgage-related obligations from financial firms and warehouse them. (The original RTC bought the assets of failed thrift institutions in the early 1990s and managed their liquidation with a goal of obtaining the best value for taxpayers.) One major appeal of a new RTC is that it would be a “systemic” effort to resolve the financial crisis by addressing its underlying cause — mortgages that are headed for default and the securities that are based on them — rather than the piece-meal, firm-by-firm approach that has characterized the government’s approach to resolving financial firm failures so far. The stock market’s initial reaction to the announcement was positive, with the Dow rising hundreds of points. Separately, the Treasury announced that it would use $50 billion from the Exchange Stabilization Fund to insure money market funds, some of which had been experiencing a flood of redemptions.
Any silver linings?
It
would seem impossible to see how any good can come out of the current
financial crisis, other than mechanisms and regulatory changes to ensure
it will not happen again. But there are two causes for hope. One is that
the
What should you do?
My initial reaction to these events is to exercise caution. The government’s actions have gone far in preventing a meltdown of the financial system. We are however in the midst of a global slowdown, if not a recession, the effects of which have yet to play out fully. There is more market volatility ahead. I have not changed my stance on our equity, bond, and real estate allocations which have been in place since late spring.
Remember what has always follows a market decline is a market gain. The worst thing you can do is panic -- this storm shall pass. My recommendation is to hold your positions. It will take time for markets to adjust, even so, we do not want the near–term stormy seas to throw us off our long term course, and neither should you.
Hopkinton resident William C. Newell, CFP is President and Senior
Financial Advisor at Atlantic Capital Management, Inc., located in
Holliston,
Above is a letter from Mr. Newell to his clients. |
|
|
|
The Hopkinton News TM online only at HopNews.com ©2008 HopNews.com All Rights Reserved. 508-435-5534
|
I
was still on vacation when the news began to creep out about troubles
and capital shortfalls at several large financial firms. Lehman Brothers
had been unable to find a buyer. Its holding company would file for
bankruptcy, making it the largest casualty to date in the credit crisis
that began in the summer of last year. Merrill Lynch was acquired by
Bank of America for $50 billion. American International Group (AIG),
meanwhile, had been seeking capital without success. The markets were
shaken by this news, and the Dow Jones Industrial Average fell by 505
points — its largest single-day loss since 9/11.