Kudos to The Fed for finally refusing to bail out Lehman Brothers, Merrill Lynch and AIG. For too many years, the infamous “Greenspan Put” afforded “Wall Street” the luxury of betting the ranch on huge risks without any worries of what would happen if things didn’t work out as planned. This is called avoiding the stupid penalty.
The stupid penalty is the price you have to pay when you screw up. A simple example is when you bet the wrong side in a football game….you pay a 10% vig plus your original wager to the book. Well, for too many years, Wall Street didn’t have to worry about that since it was assumed (correctly as it turned out) that The Fed would backstop any losses with either a bailout or access to the Fed’s discount window.
Yesterday and into today, however, there seems to be a new set of rules. The Fed did not come to the rescue of Merrill, Lynch, Lehman Brothers and AIG. All three are in trouble due to the mortgage mess. Under the “new” rules, all three are left to fend for themselves.
The least painful was Bank of America’s takeover of Merrill, Lynch for about $50 billion in stock. While this will result in in some short-term disruptions, it will provide a long term solution for Merrill and BofA. BofA has long been rumored to be interested in Merrill and it makes a nice fit give BofAs huge branch network and Merrill’s ability to deliver at the retail level. Leaving aside the Glass-Stegal Act (separating banks from investment houses, and dating back to The Depression) it will be, after short-term adjustments, a good move.
Lehman is bankrupt and probably gone. Well, that’s what happens when you bet the ranch on the sub-prime markets. Maybe, if Fuld (Lehman’s Chairman) had owned up earlier to the problems, he might have been able to get caught up in the Bear Stearns rescue. Obviously, I wasn’t in the room when the decisions were made but I’d bet that the “Greenspan Put” was a part of the decision making process. Well, no Greenspan Put for Lehman and the stupid penalty goes into effect in a big way.
The final part of the news today, American International Group, (AIG) was caught up being a counter-party to the risks generated by the investment houses. Without the Greenspan Put, AIG will be forced to liquidate assets and/or seek a $20 billion infusion of new capital. It was reported that AIG turned downoffers from KKR among others and instead, sought $40billion from The Fed. No Greenspan Put for them, either.
So now, AIG is being forced to pay the stupid penalty. It may survive if it can raise the cash. It will be interesting to watch.
So what will happen?
Short term there will be some pain. Smart guys will short some positions and continue to grow. The Bulls will be hurt but, as value plays on cheap assets become attractive, the bulls will move back in and fuel a new growth cycle.
Long-term there’s going to be a lot of discounted stocks and assets which will be purchased by new firms and, most probably, some foreign funds. Small firms, unheard of now, will be big names in a few years and the cycle will continue. As long as there’s a stupid penalty, the system will be just fine.
