Risk Rap

Rapping About a World at Risk

Corporate Extinctions

A large meteor that hit the Yucatan peninsula 65 million years ago is considered one of the causal factors that led to the mass extinction of the dinosaurs. The theory gained wide acceptance after a photogemmetric satellite captured the image of the Chicxulub Crater centered just off the peninsulas northeast shore. The meteor theory seemed to solve the dinosaur extinction mystery of how a dominant species that ruled the earth for 200 million years can suddenly disappear. Apparently the theory suggests that the extinction happened more with a bang then a whimper.

Like the Chicxulub meteor, the economic crash of 2008 promises to claim a dramatic toll of corporate victims and drastically alter the landscape of the global capitalist system. The casualty list prominently includes some marquis corporate banking brands like Bear Stearns, Lehman Brothers, WAMU, Wachovia, Fannie, Freddie, Fortis, RBS, NorthernRock and threatens to claim the solvent souls of a UBS or Citibank. The State of California and the Sovereign State of Iceland are also endangered and the economic crisis may claim them as its biggest prize.

Hedge funds are quickly folding up shop. Morgan Stanley estimates that the AUM of the industry may shrink from $1.9tr to $900bn due to market losses and investor redemption and withdrawals. At its peak the global hedge fund industry was estimated to offer AIM products by over 6000 providers. By the close of the next year the size of the industry will be considerably smaller as capacity downsizes to serve less demand. Downsizing will also be the prevailing theme for community banks, RIA’s and CTA’s as excess capacity is worked out of the system through closures, consolidations and seizures. This contraction will effect industry service providers that sell services to the financial services market. Lawyers, accountants, IT providers and consultants will be hard pressed to maintain their book of business as the market for their services contracts.

Free marketeers and Social Darwinists may find it right and fitting that the financial services industry comprises the bulk of the corporate casualty list due to their culpability in nurturing this economic apocalypse and their proximity to the epicenter of the crash. The Hollow Men who led the US economic colossus to this dramatic self immolation however won’t have to fall on their swords. Their champion in the Treasury Mr. Paulson has swaddled them in a protective TARP so these masters of the universe can don superman capes to continue their selfless endeavor of saving the US economy from a total collapse.

Unfortunately the deadly meteor that almost liquidated the banking system is spreading outward to what some refer to as the real economy. Goldman Sachs’ indicates that the recession will shave a cool $1.3tr from the GDP. This will inhibit buying power by individuals, corporations and governments. Some economists fear that this will create enormous deflationary pressure prolonging the recession. Many see similarities with the Japanese recession of the 1980’s. That recession brought on by the burst of Godzilla sized real estate and equity market bubbles lasted for over a decade. Japanese central bankers cut interest rates to almost zero and the vicious downward spiral of the economy recovered as a result of SE Asian and North American market demand drivers that fueled tremendous export growth.

Retail is another sector that will be particularly hit hard by corporate failures. Industry statistics indicate that 14,000 retailers are expected to close their doors during the next year. US auto dealerships from the Big Three are expected to contract by 25%. The auto industry is a major hub of a large and intricate manufacturing supply chain and as such this sector will be hit hard with business closures as well. Construction, housing and domestic oriented leisure industries will continue to stagnate as the American consumer buying power evaporates. Not good news for an economy so strongly dependent on consumer spending.

Yesterday the National Bureau of Economic Research (NBER) announced that the economy went into a recession in December 2007. Its a bit funny that it took a year for the NBER to hear, feel and detect the Chicxulub Meteor that crashed into our economy. Today’s Employment Report from ADP indicates that the US economy shed another 250,000 jobs during the month of November. Now that the reality of the recession is upon us the corporate endangered species list will be a pressing problem and success metric that the Obama Administration will need to squarely address with any stimulus package he plans to enact to get the economy moving again. This actually bodes well for the passage of a rescue package for the Big Three Automakers. One thing is certain, urgent action is required or our economy will continue to go down not with a bang but with a whimper.

You tube video: Ranny Weeks and Orchestra: Out of Nowhere

Risk: recession, bankruptcy, solvency, rescue package, economic stimulus

December 4, 2008 Posted by | banking, bankruptsy, Bear Stearns, economics, Paulson, pop, unemployment | , , , , | Leave a comment

Hedge Funds Flight to Quality

Volatility in the equity markets, credit market dislocations and continued concerns about market liquidity are prompting hedge funds to seek out prime brokerage and custodial relationships with investment banks that boast healthy balance sheets.

JP Morgan’s acquisition of Bear Stearns has given hedge fund mangers pause to think about the financial health and balance sheet condition of their principal counterparties. The potential insolvency of first tier investment banks was once unimaginable. But the near bankruptcy of Bear Stearns due to losses in mortgage derivative and financing businesses, the persistent rumors concerning Lehman Brothers financial condition and the continued quest of Merrill Lynch, Citibank, UBS, AIG and Morgan Stanley to seek funding from Sovereign Wealth Funds to bolster capital adequacy is driving hedge funds to secure relationships with bank’s that have healthy balance sheets.

Risk aversion is a strong theme for all providers of credit. Hedge funds have a voracious appetite for credit. Many hedge funds require generous lines of credit to support highly leveraged and short selling trading strategies. If their prime broker becomes capital constrained these funds will not be able to execute their strategies. So the need to maintain relationships with healthy banks that provide consistent access to large lines of credit is critical.

The potential effect of market contagion in the event of Bear Stearns’ insolvency was the primary issue of concern that prompted the Federal Reserve to take its unprecedented action. Had Bear Stearns become insolvent the levered positions of its substantial hedge fund and correspondent broker clientele would create a wave of defaults that would cascade throughout the global capital market industry. Extreme market volatility and the negative effect on market liquidity in equity, futures, debt and foreign exchange markets could have been dramatic.

Hedge fund managers also require that banks have a product set, support infrastructure and market presence they require as trading strategies become more sophisticated to include numerous asset classes trading on multiple global exchanges. Cross-netting of product set positions and margin account requirements are important for hedge funds as well as the bank. Cross-netting of all positions helps fund mangers to gain preferential finance rates and transaction fees. Cross-netting for bank’s is a critical risk management tool to determine its aggregated exposure to the numerous investment positions of large sophisticated hedge fund complexes.

As the large money center banks struggle to integrate their global capital markets and investment banking businesses, capital adequacy in line with the requirements of the Basel II initiative heighten the need to measure and fund sufficient regulatory capital levels. The temptation of banks to arbitrage their regulatory and economic capital balances will certainly be put to the test as they seek to woo lucrative hedge fund business. The continually expanding global hedge fund industry may pose a competitive threat to the commercial credit side of these banking institutions as liquidity in the credit markets continue to be a pressing concern. It bears watching and it will be interesting to monitor developments to see if community banks can take advantage of its larger competitors capital constraints posed by its focus on capital markets business.

I can hear the frenzied flying now.

You Tube Video: Flight of the Bumblebee

Risk: capital markets, hedge funds, credit, commercial banking, regulatory, Basel II

June 5, 2008 Posted by | banking, Basel II, Bear Stearns, hedge funds, investments, regulatory | , , , , , , , , , , | Leave a comment

Paulson Carries the Olympic Torch

During last weeks US Senate Banking Committee hearings on the Bear Stearns bailout Treasury Secretary Henry Paulson had to send a deputy because he was in Beijing tutoring them on the finer points of high finance.

Paulson could probably call China his second home. He is reputably an avid bird watcher and China has some of the best displays of avian pomposity in the world. I have read estimates that he has visited China over 50 times under the guise of eco tourist, investment banker and now head of treasury.

I surmise that most of his trips these days concern how to manage the relationship between the largest economic superpower and the world’s fastest growing economic superpower. Mundane subjects like the sinking dollar, letting the Yuan float and reinforcing the message of America’s and China’s symbiotic dependency are topics of mutual concern.

You Tube Music Video: Olympic Theme

Risk: Political, Moral, Currency

April 13, 2008 Posted by | Bear Stearns, China, Paulson | , , , | Leave a comment

Too Big to Fail

Mini Me is Big Time

Last weeks Senate Hearings on the credit market crisis and the role of the Fed in the bailout of Bear Stearns produced some dramatic headlines, noteworthy quotes and an opportunity for politicians, regulators and big swinging bankers to come together to shed some much needed transparency on the situation.

People are confused, uncertain and fearful. How can the boom go bust so quickly and how can the American economic colossus be brought to its knees in such a pedestrian fashion? The talk on Main Street is big banks vs. sub prime mortgage holders and the political calculus of which class of debtors in default pose the greatest threat to the economic prosperity and political stability of the nation.

The emerging economic environment will reify a new political landscape that can potentially broaden the divisions of a divided nation. The to big to fail rationalization of opening the Federal coffers to bailout failing capitalist enterprises is perceived by many taxpayers as the rich and powerful taking care of the rich and powerful by robbing the poor to pay the rich.

To paraphrase Senator Dodd, “we can’t be perceived as if we are privatizing profit and socializing risk.” It is dangerous to arbitrage the nations economic and political default probabilities. Who is too big to fail? That will be a question that the voters should have some say on come November but the discourse thus far has been confined to Senate chambers and the hard to locate CSPAN channel. It has yet to come to the fore in any meaningful way in the campaigns of the political candidates running for office in this year’s election.

Give the Fed high marks for acting. Give some of the Senators credit for understanding that the actions of the Fed help both large institutional banking interests and the little guy concerned about the reset rate on his ARM.

Shame on the politicians that are trying to make hay by sowing divisions among interest groups for political gain.

Risk: Political, Banking, Class, Market

You Tube Video: Peter Gabriel, Big Time

April 10, 2008 Posted by | Bear Stearns, credit crisis, pop | , , , , , , , , , , | Leave a comment