The most economic volatile week in history?

Was last week the most economic volatile in World history?

Following from my last post on Monday, we have witnessed even more extraordinary events this week.

- After Lehman Brothers filed for bankruptcy (the biggest in US History), AIG, the world's largest insurer was bailed out of potential bankruptcy by the US Government.

- British bank Lloyds TSB agreed to buy rival HBOS to create a 28 billion pound ($63.9 billion) mortgage company. HBOS was
Britain's largest home loan lender

- Current speculation is that Morgan Stanley and Wachovia are in talks to merge, and that Washington Mutual, the USs' largest savings bank is in trouble.

- Gold had its largest one day (*market*) spike in history, up a lazy 8.9%.

- Over the weekend, the United States Treasury unveiled a $US700 billion ($A871 billion) rescue plan for the troubled US financial sector. With the stroke of a pen, this would be equivalant to the US increasing its money supply by about 7 to 8 percent! (assuming M3 money supply is currently about US$14 trillion).
The US GOvernment will aquire up to US$700 billion in home and commercial mortgages from US-based banks over the next 2 years. To do this, the U.S. government's debt limit would rise to $11.315 trillion from $10.615 trillion.


Short Selling

On Friday both the the U.K. Financial Services Authority and the US Securities and Exchange Commision (SEC) took action to prohibit some short selling practices and to require much greater disclosure of short-shorting selling positions. This had huge implications for the world markets on Friday.

On Friday:
* The FTSE was up 8.8% for the day.
* The Dow Jones was up 3.4% for the day.

The main reason why the FTSE and Dow went so strong is because short sellers were closing a lot of their positions! To close their position they must buy. (its opposite to going long. They sell high first then buy low to close position, as opposed to buy low, sell high).

United Kingdom:

On Thursday the UK Financial Services Authority halted all short-selling of financial companies, which would be in effect until 16 January 2009 (but may go longer).

United States:

On Friday the SEC announced, effective immediately, that 799 financial companies would be protected from short-selling practices until 2 October 2008. There is talk congress may even put a bill together to constrain short-selling altogether.

Australia:

The Australian Securities Exchange (ASX) on Friday said that it would prohibit naked short-selling from tomorrow on all securities, while covered short selling will require greater disclosure.

This, along with the surge in world stockmarkets on Friday, will likely lead to big gains on the ASX tomorrow. Banks and financial stocks in particular should do very well, along with any stock which has been short-sold heavily in recent months such as Fortescue Metals. (ie. stocks which have large amounts of debt!)


Investment Bank Model Dead?

For now it appears the only large investment bank left in the US is Goldman Sachs. Bear Stearns and Lehmans are gone. Merrill Lynch has merged, and Morgan Stanley is believed to be on the cusp of merging. This is a huge turn around inside 12 months! The following graphics show how the US financial scene has changed so quickly for 29 (now 26) of the biggest financial firms.

Source: http://www.nytimes.com/interactive/2008/09/15/business/20080916-treemap-graphic.html

Chart 1: Market cap of 29 selected financial stocks as at 9 October 2007

Chart 2: Market cap of 27* selected financial stocks as at 12 September 2008
Result: These 29 companies have lost almost US$1 Trillion in market capitalisation, with the total financial sector loosing about US$4 trillion in market capitalisation so far.

Macquarie & Babcock to follow?

All through this weeks turmoil Australia has largely been untouched (so far). However, concerns of Australia's two investment banks made Macquarie Bank (MQG) plummet 23 percent on Thursday, before rebounding 37 percent on Friday. Babcock and Brown (BNB) hit a low of 68 cents on Thursday. BNB was over $30 dollars per share in November 2007. It has now fallen 97% in only 10 months!

In my opinion Babcock and Macquarie will not survive - its a matter of timing. Macquarie today is in a lot better shape than Babcock of course but it too will not be able to weather the global economic crisis which will progressively get worse in the next few years.

The investment bank model is built on debt and expectations. Assets are geared with a lot of debt on the basis that the assets will continue to appreciate in time and that revenue streams would appreciate in time. Some of the world's largest investment banks have gone under because the cost of debt (and the loss of liquidity) has gotten out of hand. Macquarie and Babcock own long-life assets which used to be owned (or provided) by governments. Airports, ports, roads, power stations etc. Expensive assets which have large sunk costs and require substantial maintenance.

For example, the toll-road model is flawed, and there are a number of toll road floats on the ASX in the last couple of years. They are built on over inflated expectations of usage. These expectations are used to finance the equity and (mostly) debt to get the roads built. Governments know exactly how expensive roads are to build and maintain, investment banks are only now waking up to economics101. Economies have booms and busts, but the investment bankers believe we will always have booms.. The big global boom is over, and now we are heading for one of the biggest busts in world history. Its all a matter of timing.

Right now though, We are currently experiencing first hand the worlds worst financial crisis since the last Great Depression. The populus (in the US, Australian and the rest of the world) still has a tremendus amount of confidence in Government and their ability to print their way out of financial demise. This won't and can't last forever. The more money they throw, the longer they put-off the inevitable collapse, and the more money there is to fuel inflation. I predict hyperinflation will eventually come into play and this will be the catalst to bring about a loss in confidence in Government (whom backs our currency, our money supply).


Until next time,
Scott