Posted by: donmihaihai | March 17, 2008

“Yes, and I have cords of them, gentlemen, cords of them.”

The current financial crisis in US financial system is turning into ugly situation where there are runs everywhere, from runs in Auction rate bond to run in Hedge funds and now bank run occurred in Bear Stearns. At this period of liquidity crisis, the only way to get out of the crisis is confidence but well, I don’t think the market is getting any. In the panic of 1907, while JP Morgan run the salvage operation with high degree of confidence and authority, there was John D. Rockefeller, the richest man at that era, which I think no one ever has that kind of wealth after him, announced that he would give half of his wealth to support the financial system if necessary. And it could be the only time he ever boast his wealth by saying, “Yes, and I have cords of them, gentlemen, cords of them.” That instantly injected confidence when it was printed in the front page of all major newspapers. From my personal view, the current crisis lack of confidence come in 2 parts. 1st, while there was JP Morgan running the salvage operation, digging into securities and bank accounts ascertain that those are solvent are to live and insolvent are to fail in 1907, no one is putting up with high degree of confidence that despite having making write-down and losses, all major financial institutions are actually with adequate capital and no risk of insolvency. 2nd, everyone seen to be worrying using tax payer money to bail out the banks.

Any student of finance will know that what bank run is. It is ok if the run happened to a bank that is insolvent but it is NOT OK if the run spread and turn into panic causing run in any bank because of the lack of confidence. When that happens, it doesn’t matter whether the other banks are with adequate capital or not, due to the inherent nature of financial intermediation, even the strongest bank can fall. When that happened, total financial system stalled(not just the market, think about our deposit, salary payment, etc). This is why they always label a financial institution too bad to fail if they are big enough. As we had witness, even if the central banks have no money to do it, they will print money. It happened to Asian countries 10 years back, Japan(?) and now seen to be happening in US because there is a run on Bear Stearns, a big securities firm. While I don’t know how it can happen to a securities firm, it is being reported that $17 billion of cash was taken within 2 days due to rumors that Bear Stearns is shortage of cash. While I don’t know whether Bear Stearns is already insolvent before or after this withdrawal, I am certain that this $17 billion plus what withdraw before that and more going to withdraw after that cum the huge drop in share price at last Friday pushed Bear Stearns into the road of no return.

Bear Stearns deserve that, many would say. They are one of the biggest players in the CDO thing. Let it fail since it is causing market melt down around all markets. Reading news from papers since day 1, I still have not get the full picture but the only thing I am sure about is this kind of crisis can only happen with many players coming into a party that never seen to be ending, getting hot as it race toward midnight. Last year, someone wrote an article title “Risk, rest in peace”, I guess article like that are being ignored. Anyway bank failure and run is not the product of US capital system or emerging market due to their structure. It happened to Singapore too, not too long ago, 10 years ago, during Asian crisis as an ex-banker told me. Due to the operation of MAS and Keppel bank, Tai Lee was rescued before it was announced so it becomes a non event to many normal Singaporean like me. Tai Lee, one of the 6 local bank(smallest?) back then was pushed into insolvency with high concentration of loans in Indonesia as rupiah collapse. I don’t think the worries of MAS were that of Tai Lee insolvency but the whole financial system in Singapore, which include 5 other local banks with loans to Indonesia as well as other Asian countries. Thinking back, perhaps the only signal I get was UOB paying 5% for one year fixed deposit, well I did not read newspaper back then. I was very happy back then as that was my 1st time placing money on FD on my own but no bank ever offer me that kind of rate again. When bank is in need of capital, paying high interest on deposit is one of the ways they use. Personally, if the current situation in US is really that bad, I fully support this rescue operation of Fed and JP Morgan.

It is JP Morgan again, JP Morgan Chase to be exact and a totally different kind of House of Morgan compare to a century ago where they frequencies act as the banker of last resort in Wall Street. “Doing first class business in a first class way” was what JP Morgan Jr said in front of banking and currency sub committee of US Senate when JP Morgan was being question of unwanting practices while conducting their investment banking. While it was later found out that his bankers were indeed not doing business in the way he wants it, it show how JP Morgan was built. Does current financial institution being run in this way?

While I do not know the current situation of those big banks, will there be changes in accounting for them after these because mark to market kind of accounting show huge flaw as it is certainly not reflecting the real capital adequacy of bank by forcing them to keep writedown due to mark to market and it keep going round and round. Whatever it is, the real lost to any investment and loans is always amount of default – recoveries. That is the same for monolines like MBIA where so many are shorting them and asking whether they are really AAA rating. The main short actor is Walliam Ackman of Pershing Square Capital Management and lately Martin Whitman join in buy purchasing common shares of bond insurancer saying that they are having strong capital. I don’t know who is right but I strongly won’t bet again Martin Whitman and his group of right-left-many hands men. Willing to buy common shares with his cheap and safe approach on B/S and bet heavily on them mean something and like him said, the share price worth much more even if there are no new businesses for MBIA. Anyway, the shorting of MBIA by Ackman is not something new, Fortune magazine already run an article back in 2005(or 2006) on why he think MBIA AAA rating is a fake.

Let see how the current situation is being bought back to normal.

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