Why a Merrill Bankruptcy does not Signal Market Bottom...

Discussion in 'Trading' started by achilles28, Sep 14, 2008.

  1. achilles28


    Consumer/business credit is too expensive.

    Street-level interest rates are too high to stimulate any lasting demand (FICO 650 rate - Fed Funds rate = 5% +)

    The culprit here is banks recapitalizing from mortgage losses.

    How long until banks pass on low rates to consumers/business? Could be years, like Japan...

    Inflation is too high for recovery. Energy and commodities are extremely high despite recent pullback.

    Further, endless Bailouts of the Financial sector pass losses on to the Consumer via dollar devaluation = inflation. Current tab for Johnny Q at 1.5 Trillion.

    Price inflation destroys consumption. More money is spent to buy less goods. 75% of US GDP is consumption-based = GDP contraction.

    The Consumer itself, is tapped. Most have splurged their re-financed home loan on a dumping market or junk toys.

    Others, bought new homes at market top only to see collapsing prices destroy what little equity they had and ARM-resets make home ownership untenable = mounting walk-aways and foreclosures.

    Is there any help from rising Wages? No. Wages are stagnating.

    The economy is hurting for reasons stated above. Job losses are mounting and few sectors are aggressively hiring let alone giving raises.

    This points to further foreclosures = more CDO losses = more Bank losses/failures = longer and longer until banks pass on low rates to consumers and business = longer until recovery from cheap rates.

    Even when Merill and Washington Mutual go under - along with 100-1000 small US Banks - will that mean market bottom and a soon-to-be recovery?

    My 2 cents, no.

    Failed banks will not mean those left standing are in the clear.

    It just means more lenders, banks, funds have failed.

    All large banks will have to clear their balance sheets of CDO debt (who will buy it??), or raise enough capital to offset losses through share dilution or angel investors (who will buy it??), or continue the liquidity trap until they've got enough padding to warrant risk exploration, cheaper business loans, and easier lending standards on mortgages...

    The economies fate rests on the shoulders of the criminals that created this mess - the Banks.

    It really is prisoners dilemma. The Banks life-line is recapitalization from the spread. But that liquidity trap is killing the Golden Goose (read: economy), that could buoy their underwater investments and toxic real estate securities.

    Their options are limited. If they don't take the spread, tons could drop like flies as precious operating cash needed to offset CDO losses evaporate.

    So they take the spread and lobby for Government bailouts and backstops to save their own ass.

    The derivative situation just adds to the Mutual Assured Destruction to all this.

    Each bank, besides taking on huge Real Estates losses, also wrote insurance on corporate debt on companies who are NOW ACTUALLY GOING BANKRUPT! Whoops.

    Now, they're on the hook for Tens of Trillions in insured debt, if the Government or Industry Syndicates don't step-in and bailout the laggards (a la Bear and Lehman) to prevent their debt value from going to zero.

    Even if it means billion in losses for *each* Wallstreet firm, as we're seeing with Lehmans CDO's under a shotgun purchase by its competitors. 3 Billion loss per firm is better than Wallstreet going under entirely....

    Very bleak.

    So whats needed for a recovery?

    1) Demand Side

    - Weak banks need to fail. This will stop major inflation as FDIC and FED backstops cease.

    - Standing banks need to recapitalize. Once thats done, Fed rates get passed on to consumer/business credit and demand stimulation can happen. Until then, its 30% down and 9% for the average Joe. This is the kicker. Could take many years. We simply don't know how long its gonna take because level 3 and 4 crap is off book. Exposure level is undisclosed so figuring the length of recovery is still an unknown.

    2) Supply Side

    - Inflation needs to stop to recapitalize the Consumers Wallet. That means constant dollar devaluation through endless Government backstops, bailouts and 1% Fed Funds need to stop.

    - Rates need to come up to reasonable levels after bank recapitalization or oils going to 200$.
  2. what makes you think MER is going the way of BSC ( a few months ago ) ?

  3. achilles28


    Merill has 15 billion more in level 3 than Lehman did = leveraged more than Lehman.

    The whole point of my long-winded diatribe was housing won't recover until banks recapitalize.

    Until then, CDO holders are screwed because theres nothing holding the RE market up (or the entire economy, for that matter).

    That means their level 3 will continue to see worsening losses on walk-aways and foreclosures. They've also got 44 billion in residential mortgages, of which some, will also go sour, foreclose, and become part of the level 3/4 heap they can't do anything about.

    Lehman went under cause they were too leveraged in CDO/subprime debt. Well, Merill is more leveraged then Lehman (as far as I can see), and the only thing that kept them going was the 34 billion influx in capital. Lehman got zero so they went first.

    Level 3 is an evolving figure.

    Its that volume of "junk" (subprime, arm, high-risk, default, foreclose, and walk-away) that can't catch a bid.

    As the economy and RE market worsen, more people go into delinquency, default, walk-away, foreclose and level 3 losses become:

    1) More Severe

    while the pool of Level 3 debt itself becomes:

    2) Larger.

    So, any House that is too leveraged in the RE market without enough drawdown capital is eventually going to go bankrupt save Government or Industry intervention.

    That drawdown period would be defined by the time it takes the less-distressed banks to recapitalize their balance sheets and end the liquidity trap. That could take years so who knows.

    Lots of these outfits are likely to go under. FDIC says at least 100 banks. We've only seen a few so far.
  4. but what about the benefits of free trade?

    all those consumers?

    i thought anyone who questioned free trade was an 'idiot'?

    free trade will solve everything

  5. achilles28


    Thanks for the laugh... :D

    Yea, Free Trade was supposed to save us.

    Instead, it just outsourced middle-class wealth overseas to build roads, pipelines and factories in China and India.

    That money could have staved off the severity of the housing crisis. More Americans would have had more savings/income to pay off that over-priced home on that over-priced mortgage = less foreclosures = less level 3 = less bank failures = shorter liquidity trap = quicker recovery.

    Also less inflation from Government bailouts.

    Oh well. Good thing we "Globalized" .
  6. Morgan Stanley's bankruptcy followed by Goldman Sach's bankruptcy will mark the "final bottom". Stay tuned. :cool:
  7. Cutten


    The market bottomed in 1932, 8 years before the end of the Great Depression. Numerous banks went belly up in 1933, unemployment soared into double digit percentages, the dollar went off the gold standard - but stocks had the best year imaginable.

    I bet back then people were bearish in 1933, 1934, 1935 as the market soared in a historic rally for the ages. This time will be similar.
  8. achilles28


  9. achilles28


    I respect the analysis. But the Nikkei never recovered after its protracted collapse in 1990.

    The Great Depression wasn't so much a liquidity trap, but a gigantic margin call. Rate hikes through the roof until the entire Country bled.

    The Depression cleaned out excesses. Government intervention supports them and hampers future growth.

    Incidentally, the recovery in 1933 onward never returned the market to its pre-crash highs. Not until 1955!

    What we need is a 1929 crash to clean it out then build back up.

    We're not going to see a meaningful rebound because we haven't seen a meaningful collapse.

    If we just let it slide and slide and slide, it'll take years before all the excesses are flushed, prices normalized to whatever they should be, and fundamentals back in line for another leap forward. I don't see it.

  10. Nonsense. The true bottom wont happen until SPY declares BK. Then I'm all in.:cool:
    #10     Sep 14, 2008