September 22, 2008
This past week has seen an unprecedented events happening on Wall Street and a major rollercoaster ride in the stock market. This past week shook the foundations of the world financial system. A sharp slide in U.S. housing prices and a subsequent rise in delinquencies on home loans is the root cause of these massive losses on mortgage-backed bonds that in recent years have spread across the global financial landscape.
The financial crisis that began 13 months ago has entered a new, far more serious phase. Hopes that the damage could be contained to a handful of financial institutions that made bad bets on mortgages have evaporated this past week. Now increasingly big cracks have appeared in the system beyond the original problem -- troubled subprime mortgages -- in areas like credit-default swaps, the credit insurance contracts sold by American International Group Inc. and others. This led to a crazy week last week on Wall Street:
Here is a rundown of some of this past week's wild series of events:
1. Lehman Brothers declared bankruptcy on Monday.
2. Bank of America (NYSE: BAC) said it has agreed to buy Merrill Lynch & Co. Inc. (NYSE: MER) in an all-stock deal worth around $50B.
3. The Fed bailed out American International Group's (AIG) with an $85B infusion giving the government 80% ownership of the company.The Fed said if AIG were to topple, interest rates would have risen, lowering consumer buying power and stifling the already weakened economy and potentially inciting a panic by consumers.
4. The government activated a fund to protect money-market funds. President Bush authorized up to $50 billion that money-fund managers who pay a fee can tap into to prevent investors from losing principal.
5. On Thursday, the Fed joined other major central banks around the world to inject up to 180 billion dollar into global money markets. Meant to boost investor confidence and tighten the reigns on the crumbling credit crisis, the cash infusion did little to boost Wall Street’s mood.
6. Treasury Secretary Henry Paulson and Fed Chairman Ben Bernanke hatched a plan with congress members Thursday night to buy illiquid mortgage securities and auction them off later. The Bush administration asked Congress on Saturday for $700 billion to bail out firms burdened with bad mortgage debt, seeking extraordinary authority as it seeks to prevent meltdown in the global financial system.
7. Senior Bush administration officials pressed counterparts in Japan, Germany, Britain and other nations to set up similar plans for their own troubled financial firms
8. The SEC issued a temporary ban on short selling on 799 financial stocks. The ban runs through October 2 but the SEC may extend the ban if they feel it is necessary.
9. The SEC also eased rules to make it easier for companies to buy back their own stock shares. The idea is that buybacks can be an important source of liquidity during volatile times.
10. The Federal Reserve extended emergency lending procedures to allow commercial banks to finance purchases of asset-backed paper from money market funds. It also said it would buy short-term debt from Fannie Mae, (FNM) Freddie Mac (FRE) and the Federal Home Loan Banks.
11. Friday's volume was mixed. Bulked up by quadruple witching trading, NYSE trade swelled 14.7%. Nasdaq volume dropped 1.8%.
12. Gold has benefited from a wave of risk aversion that has hit the markets after U.S. investment bank Lehman Brothers filed for bankruptcy. The impact of the U.S. government's unprecedented $700 billion plan to bail out bad mortgage debt is expected to significantly weaken the dollar, and that means higher oil and gold prices. Bullion gained nearly 2 percent on Friday, but it was well off a high above $900 reached on Thursday when safe-haven demand for the precious metal heightened.
13. Oil tracked the stock market. It finished at $104.55 a barrel, up from $101.25 last week. But on Wednesday, it closed at $91.02, its lowest since February. Crude is now 29% off the high of $147.90 in July. Like gold, expect oil to rise due to the effects of a weaker dollar
To boil things down, the U.S. financial system is in a pretty pickle right now, and deleveraging is continuing to happen and will continue to happen for a while yet. Democratic lawmakers, who control both houses of Congress, said they hoped to approve the bailout quickly but wanted changes such as more oversight, limits on executive pay at participating firms, and assistance for homeowners.
On Monday investors will focus intently on testimonies by Federal Reserve chief Ben Bernanke, U.S. Treasury Secretary Henry Paulson and a speech by European Central Bank President Jean-Claude Trichet. Their comments will be scrutinized closely.
Also this week data is expected on the U.S. housing market, the euro zone services sector.
A sharp slide in U.S. housing prices and a subsequent rise in delinquencies on home loans is the root cause of these massive losses on mortgage-backed bonds that in recent years have spread across the global financial landscape. The problem is that the $700 Billion bailout does not really fix the root problem including falling real estate prices, foreclosures, and a glut in the housing market and credit so tight that most normal consumers won't have the credit rating and down payments available to start buying homes again to soak up the excess housing inventory and get new building going again. Oil is likely to go up again with the flooding of the market with U.S. dollars to fight the liquidity crisis and likely weakening of the dollar.
We are not out of the woods yet. Congress and the Bush administration and the Federal Reserve have not hammered out the final details of the $700B bailout plan. We will have to watch this week and see what the markets think about the Fed's bailout plan and if it instills confidence and calms the market. If not, it could be another ugly week.
