MS is down 37% right now. The market is giving its assessment about the "safety" of that company right now.

http://finance.yahoo.com/q?s=ms

I am back...

if the mkts fail you and all the clever ones that made millions on the right assesment that everything was overvalued will not have anywhere to put their cash.

In fact I will take it to the extreme... if the system fail all the money and profit that you are looking to make will not be paid to you because your counterparty is gone bankrupt.

This is what it seems you fail to understand. Right now the authorities are not trying to save Dick Fuld or whatever rich banker has lost lots of money....

If AIG goes down all the firms that had a position with them that was making profit will have to write the position down to zero.

Don't you understand that we, the little people, are the ultimate creditors to the financial markets with our deposits? Where do you think all the money comes from? Central bank reserves and deposits....

And my friend the bill would be a little bigger than a $138bn credit line...

Anyway it looks like we are imploding right now. Today T-Bills were yielding negative! People were paying to keep money with the safe US treasury.... this is the extent of the crisis

A general market collapse does not result in all economic activity stopping. It results in shifts of capital. Those new capital holders reinvest that capital, quite probably in different enterprises than the former holders. The "wealth" of the overall economy does not "evaporate" in a market crash, it just changes its focus.

A collapse should have happened in August of 2007 or March of this year. I was burned so badly when the government stepped in to prop things up then, I don't have much left to work with. The "incompetent" and "criminals" using the government's gun, have already confiscated billions which should have been paid out to traders who were short when the market forces, left to their own devices, would have resulted in the markets tanking.

Even if the counter-parties had gone bankrupt (for example, if Bear Stearns was a counter-party to some of my put option positions back in March) I could have, through my broker, become an effective creditor in that bankruptcy.

With the government bailout, I'm not only "screwed" by having options, that I should have made money on expire worthless, but I'm also screwed as a taxpayer, being forced to pay for the losses Bear Stearns investors (primarily bondholders) would have been forced to take in an actual bankruptcy.

Again, I cannot stress this enough, these bailouts are keeping wealth in the hands of those with "political connections" and those willing to use the "government's gun" to force market direction.

It represents a massive theft of wealth, through the use of government force, from the (relatively) free market.

(You do understand what an "investment bank" is? When the government bails out an investment bank, they are bailing out a group of private investors. Such action is not helping "the general public," it is only helping those with positions that are benefited by the investment banks' continued existence. If I make a wrong trade, I have to suffer the losses. The investment banks have made massive wrong trades, but rather than allowing them to take the losses, the government is stepping in -- which represents effective violence -- and preventing the counter-parties to those trades from being paid their gains.)

It seems to me that you are a little bitter and are blinded by this in your assessment of the situation.

First Bear Stearn and Lehman Bros stock price went virtually to zero. Leh lost 98.7% from 9/5 to 9/13 and BS lost nealry 90% in the last 2 weeks of trading.

To me this does not ring as a bailout for the private investors that lost 98 and 90% of their money.

I have little simpathy for the speculators that sold Leh and BS in the last week.

When I am talking of the mkt collapsing I am not talking about the Dow or the S&P. I was referring o the capital markets. Specifically the money markets.

It seems to me that you do not understand how these works.

As per the traders who did not make billions they are either too greedy, silly, or they made their money. As I said both companies lost more than 90% in the last 2 weeks... this is enough for any put holder or short seller to make a good return.

For the people that were left out (i.e. the ones that sold leh at $1 or similar) it should be a valuable lesson.

These markets are regulated and the authorities will do anything to prevent the financial system to size.

We are very close to that right now, despite the intervention of the Fed.

I am sorry that you think the govt used taxpayers $$ to save some rich banker.

I am not an investment banker and I have never held a position in BS or LEH...

Bear market rallies are sharp and violent. Look at the market from 2000-2003 and see how many days the NASDAQ rallied >5% in one day. Too many shorts crowd in, something positive happens, and they all stampede to cover. When market is at extreme oversolds (overboughts), it is very risky to be short (long).

Some rallies will be triggered by govt action. Can't assume the govt is going to stand by and do nothing as the markets fall. Doesn't matter what you or I think "should" happen, or what is "right" or "wrong" as a matter of morality or economic theory.

Trading is a pragmatic business, no-one cares if "its not fair".

In times of crisis, I guess you could say the same about govt.

During WW2 the govt was not worrying about whether it was "fair" to drop the A-bomb, they were trying to win a war. Right now the govt is not worrying about whether it is "fair" to seize FRE/FNM or force sale of BSC or take control of AIG, they are trying to avert disaster.

I'm "a little bitter" -- now that's an understatement!

My assessment of the situation is done with a cold, rational mindset (I've been studying the economy and markets for decades); my anger follows because I understand exactly how the thieves are ripping people off.

I am not "blinded" by my anger; my anger is a justifiable response to what I see from examining the situation with my eyes wide open!

There is great injustice when the Federal government steps into private markets to bail out, prop-up -- or whatever you want to call it -- certain transactions and market participants, to the detriment of other market participants.

A "market" represents the combined actions of millions of individual participants. When government officials step in and "dictate" certain market actions, counter to the market forces, those government officials are either saying that they think they are "smarter" than the combined efforts of the millions of individual market participants, or they are acting corruptly, manipulating the markets for the gain of certain participants (their "friends" or "political base").

Bear Stearns was acquired for $10/share, because the government guaranteed all the bad debt. Shareholders would have likely received nothing if Bear had been allowed to fail. Of course, it is the bondholders who are the primary beneficiaries in these bailouts -- the bondholders would have received some amount of cents on the dollar if the government had not "volunteered" the taxpayer to guarantee the debt of these firms. (You also need to look at some of the severance packages the executives have walked away with after the bailout -- AIG's CEO left with $7 million after just 3 months on the job!)

I understand that the stock market is a capital market -- the fact that you apparently do not understand this, tells me you have little understanding of the capital markets!

(And subsequently, you do not understand how these bailouts are protecting certain "politically connected" participants in the capital markets.)

Let's leave the personal attacks out of this. I am sorry if I ofended you first. I apologize for that.

Now let's go back to the markets.

Let's make it really simple. Let's assume 5 players in the market.

1) The Government/Fed (G)
2) Lehman (Leh)
3) Morgan Stanley (MS)
4) Any commercial bank (B)
5) the public (P)

P applies (and gets it) for a mortgage to bank B.

Bank B sells the mortgage to Leh who repackages it into a portfolio of bonds (for easiness of the analisys we assume they keep them on their balance sheet).

These bonds yield quite a lot more than where risk free interest rates are. So L borrows money from B and tells B to increase the mortgages. B opens te gates and more bonds are created. L buys the bonds with the money they borrow from B.

P buys real estate with the money obtained. Real estate goes down. Some members of P go bankrupt.

B is happy to have offloaded its mortgage to Leh.

MS enters normal financial transactions with L. Maybe buys some bonds, maybe just trades with L.

Leh having bought the bonds are having trouble. There are defaults on the pool of bonds. L tries to sell the bonds but MS are not stupid and know they are toxic. B is also not interest in buying them. L has to devalue them.

All of a sudden B and MS are a little nervous. Leh is taking a hit on the stock. It makes sense. If the only asset they have is the bonds and they go down they need to pair down their liabilities. On the liabilities side of the balance sheet there are the debt (loan taken from B) and equity.

As they cannot compress the loan equity starts to go down.

Because L is forced to mark its position to mkt they value their portfolio of B very low. The stock takes a hit.

MS is worried because they had sold some protection to P on Leh. If Leh goes bust MS might be in trouble.

B is not much happier. B as lent L some money. If L goes down they will have to write their loan to zero.

Now L can't really find a buyer of these toxic bonds. The liabilities are worth much more than the assets. L goes under.

B is scared that MS is the same situation and decides that they are not lending any money to any financial istitution.

MS has very little exposure to the bonds. But they need to finance their operations (B has closed the tap).

P is not lending money to MS (no CP, no CD, no underwriting of bonds issued by MS) coz they are scared about their exposure to the bonds and who knows what else.

On top of the troube with the bonds MS has now lost any profitable position they had traded with Leh as they went down.

The money mkt is seized. MS calls the Fed and asks them to lend them some money, otherwise they will go bust.

Now you'd say let MS go.

Here is what would happen.

If MS go then bank B will have it's asset shrink eveen more. They will start being in truble themselves as no other financial institution is there to lend them money to mantain its operation.

Ultimately as asset go down (they needed to write down Leh and MS) their liability will go down. Stocks get hit, but eventually even their debt needs to go down.

In our simple examble the only other debt the bank has is deposits from P.

You draw your conclusions on who is going to get screwed.

Is it Leh CEO? Naah he paid himself $22m last year, he'll be fine. MS CEO? Naah last year they did not think this would happen, they drank champagne all Summer. The bank management? Naaah, they were haveing a great year with no bad risk on their books....

Sorry pal but it's the little ones that get screwed.

Now rewind a little bit.

The Fed looks at MS and says: you know what? all those bonds are not THAT bad. yes you had some defaults, but at these level if only 15% of them matures at par (gets paid in full) you are golden. So let me issue a guarantee on your debt.

All of a sudden B is more happy to extend credit to MS again, P is lifted in their spirits and attracted by the good yields MS is offering on its bonds. There will be sacrifices but hopefully we will have avoided melt down.


I see where you are coming from with your "let the market decide, avoid any manipulation" position.

In theory I would not disagree with you. That is what capitalism is all about.

But our capitalism has always had a dramatic flaw. Free (until now that is) movement of capital was not met by free movement of labor.

It's clear that in the US, Europe and any other modern society we are not allowing the labor market to follow market laws.

Let's not make this political please. I am just stating facts without taking an view or making judgement.

For instance we close the borders to immigrants. In a free market they would be welcome as a cheaper input for the labor market. Capital can go to China for investments, but Chinese workers cannot come here to work.

This is just an example of how our society works to protect the common good. Employment is important and even if the labor market is not really a free market it does not matter and we accept it in order to preserve out community.

The same can be said by the action taken by the Fed/Govt in these last few days.
Letting the banking system go down to let the mkt sort itself out is not an option right now.

Would it be the best thing to do? YES.

I am with you in principle. I have already told you. But this is not applicable in our current situation.

Yesterday 1m Treasury Bills were trading at negative yields. This means banks were more willing to lose a little than to lend money to each other.

Think about it. No good can come of this.

Again the equity investors in BS and LEH and AIG have lost everything (or nearly everything in the case of BS).

The Bond holders were bailed out. Yes that is true. Is that market manipulation? You bet!

Why BS and not Leh? Leh bond holders were left with nothing.

And now why AIG?

All good questions. But again the situation is changing daily.

I am sure you'll concurr with me that we cannot allow the system to freeze.

You said that the rest of the economy will go on. I have doubts that without credit anything in this world can be accomplish.

Yours is a world where we'll go back to having a cow and a goat in our backyards, we'll grow our veggies and drive 30 year old cars as we cannot afford to buy new ones.

Actually I Like that. I have got some cash stashed away (I sold everything 17 months ago). Let's hope the real estate and equity market really take it on the chin... I am talking about 70-80% drop.

The I'll buy my little plot, build a track on it, grow veggies and feed the animals.

A much simpler world....

Either that or a war.... what do you think the more plausible outcome will be?

As usual I totally agree with your analysis.

I like your explanation.

One thing to note: For those that are bothered by the AIG bailout.... AIG is not simply a 'regular person's' insurance company (car/home owners insurance/etc.). They had (have) a huge part to play in the economy due to their large credit default swap portfolio and the role that plays in the lending environment.

Nothing I said was intended to be a personal attack. My point about you "not understanding the capital markets" was not any attack -- it was an observation about your thinking which indicated that you do not think the stock markets are capital markets.

As for your analysis of the "credit situation," I think the best way to correct your errors, is for you to take a minute and look at this:

http://www.telegraph.co.uk/money/main.jhtml?view=DETAILS&grid=&xml=/money/2008/03/26/bcncrisis126.xml

When the government bails out a Fannie May, a Bear Stearns, or an AIG, using the above linked explanation, who is being bailed out?

I am sorry I just didn't want you to think I was being rude towards you.

I will read the above later... Out with the missus right now...

OK I read it...

Seems pretty good to me... So whats your point?

- The borrowers were stupid to take out mortgages when they could not afford it.
- The morgage lenders were just greedy.
- The banks were even more stupid in agreeing to lend money to people with no credit worthiness.
- The system is screwed up to allow banks to keep CDOs and CMOs off balance ssheet.
- The investors were stupid/greedy in buying these collateralized bonds just because they returned double digit figures (AAA returning 12-15% over Fed Funds? Cmon!)
- The regulators (fed/govt) didn't do anything to stop it.

Everybody has part of the blame. Fine. But now what?

What you seem to imply is that because these institutions were the ones that took the risks (and possibly the fat returns in the past few years) we should let the market take its course and make them fail.

It's their own fault, they should deal with it.

Whilst I agree with that in principle I am just saying that right now if we let the market forces act free we'll end up much worse. And it's not going to be just the bad banks that will be punished, but the whole system.

We seem to disagree on that. U think (correct me if I am wrong) that the economy is stronger than that and we can do without a few banks.

I am saying that if the money markets (the way companies/banks manage their short term liquidity) size up then companies will find it impossible to access the capital markets.

Anyway it seems that a legislative solution is approaching.

We are going to get out of the crisis by ring-fencing the rubbish at the local Fed dump until it can be recycled...

We'll see.

My g/f's sister works for AIG, and her b/f works for MS. They were just getting into the market to buy a house - in SF no less. Talk about screwed!