The independent securities firm model comes under siege as Morgan Stanley and Goldman shares took a beating today. From Bloomberg:
Morgan Stanley and Goldman Sachs Group Inc., the biggest U.S. securities firms, tumbled the most ever in New York trading after a government rescue of American International Group Inc. failed to ease the credit crisis. The cost to protect against a default by the banks rose to a record.
Goldman fell as much as 26 percent on the New York Stock Exchange and Morgan Stanley plunged 44 percent, leading financial stocks to the lowest level in four years.
“They’re fish in the barrel, the short sellers have them targeted,” said William Smith, whose firm Smith Asset Management Inc. in New York manages $80 billion, including Goldman stock. “Morgan Stanley’s probably going to wind up doing a deal, it’s really a matter of survival.”….
Credit-default swaps protecting against a default on Morgan Stanley bonds rose 220 basis points to 900 basis points, and earlier today traded at 925, according to broker Phoenix Partners Group in New York. Contracts on Goldman climbed 110 basis points to 530 basis points, Phoenix data show. An increase in price for the contracts indicates a deterioration of the perception of credit quality.
The Wall Street Journal story on the Morgan Stanley-Wachovia talks very carefully uses the past tense to describe Morgan Stanley’s and Wachovia’s merger discussions but implies that the rationale for the deal remains live.
Frankly, I don’t get it. It smacks of desperation, and I don’t seen any benefits, save becoming too big to be permited to fail. There are few if any syergies between their businesses. And as one of my Japanese colleagues once observed, “Putting two sick dogs together does not produce a healthy cat.”
Note in particular the discussion at the end of John Mack calling Paulson, Christipher Cox, an Lloyd Blankfein trying to arrest the fall in firms’ stock prices. This again smacks of desperation. The belief (or one might even say hope) is that the investment banks are victims of evil short sellers. The fact that the credit default swaps market has also taken a very dim view of Morgan Stanley siys the decline in the stock is not the result of rumor-mongering or manipulation but a sea change in how major financial firms are viewed. The plunge is due to the perilous conditions in the markets and the questionable prospects for investment banks, which have become increasingly dependent on credit market products and proprietary trading.. Intervention (if it were even possible or permitted) works only if investors are behaving irrationally. It instead appears they may have come to their senses about how dangerous an overlevered financial ssytem is.
From the Wall Street Journal:
Morgan Stanley has held preliminary merger talks with Wachovia Corp. and at least one other bank…..
The investment bank, pursuing alternatives to shore up its falling stock price, has also reached out to regulators and large pension funds in an effort to stop short sellers from betting on the stock’s decline.
After Morgan Stanley’s precipitous decline in the last few days, its market value is only slightly above Wachovia’s….The Charlotte, N.C., bank has said it believes losses for Golden West’s “payment option” loan portfolio could eventually reach 12%.
But many analysts believe the losses from that portfolio may exceed 12 %.
“Is it going to be 20 percent? Is it going to be 30 percent?” said Nancy Bush of NAB Research LLC in Annandale, N.J. ….
The firm has said it believes it could stay independent because it doesn’t need immediate funding, but it has also recognized that confidence in an investment bank is a precious commodity that can wither quickly and must be preserved at any cost.
Wednesday, Morgan Stanley CEO John Mack called Treasury Secretary Henry Paulson and Securities and Exchange Commission Chairman Christopher Cox, as well as Goldman Sachs Group CEO Lloyd Blankfein, to discuss how to stop the rapid decline in the two firms’ share price. They didn’t discuss a merger, but mainly how to stop short-sellers betting on a decline in Goldman and Morgan shares, a person familiar with the matter said.
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Matthew Dubuque
Yes. Indeed these are desperate times. If there weren’t short sellers, there would still be more sellers of stock than buyers on a day like today. I thought that was what efficient markets were all about.
At any rate, perhaps another reason for the very recent suspension of the prohibition of commercial banks funneling IB subsidiaries is coming into view.
What we might see, if things get much worse, is a loosening of regulations limiting foreign holdings in US commercial bank holding companies. That would allow Chinese and Dubai entities to come into play.
Then some of those Chinese and Dubai assets could be funneled into IBs that had been taken over by a commercial bank, such as might happen to Morgan and Goldman in the more dire scenarios.
Whether it is in our national interest to have the Communist Party of China taking a dominant interest in our banking system is of course another matter. But debate will be quite hurried and shallow on the subject.
But this scenario seems to be a plausible inference supported by several recent developments as to an operational “master plan”.
Matt Dubuque
I don’t get why the fact Morgan Stanley’s stock price has been hammered would drive them into a merger. It’s not like they’re worried about a hostile takeover. Is the stock price drop likely to trigger a bond rating downgrade?
Low stock price means you can’t raise cash through stock or bonds. If you can’t raise cash to cover yur debts or you can’t roll over your debt it’s game over.
Why can’t they use the bonus pool to do a management buyout?
Like anon at 7:23 said. Why can’t the board and upper management just buy all the shares at $3 or whatever? Then when everything gets better, if Morgan Stanley is a good company, they can sell it at 10 times the price.
Take Washington Mutual for example. If WaMu is a good company and is not being improperly targeted by naked short sellers, then wouldn’t the higher ups buy it. Per MSN, its market capitalization is $3.43 billion. That’s nothing for an upper-crust pool of buyers.
(Idle thought: if there are naked short sellers, are there naked long buyers?)
Short sellers.
Are they not the perfect price discovery method?
If they lose they lose. Who cares? Why should anybody care. It’s their money. If they are wrong they are wrong.
Why are Wall Street and the Treasury & FED so concerned about price discovery?
Is it possible that (having had (how many?) weekend meetings) they already know the price (which the shorts are only guessing at), and that if this information (essential to an efficient market) were known to the market the USA would be known to be insolvent.
How soon will it be before the USA follows the (former) USSR and closes the market because the Treasury and FED don’t like the true price of their actions over the last decade?
With the CDS spread so high on both MS and GS… does this mean they are both going to stop doing business with Hedge Funds like they announced a month ago?
When hedge funds start failing en masse because they can’t get access to capital… here we go again…
Pretty soon there will be no one left to execute the trades…
Allow me to make an obvious observation: If the viability of your business is dependent on its stock price, you do not have a viable business. Period.
Eventually the markets will turn bad – as they are now – and you’re f*cked.
Second observation: If you’re spending your time as a CEO complaining to the SEC about short sellers – thinking that’s the root of your real problems – you deserve to be fired. Immediately. Because either your wasting your presumably valuable time, or you’ve built a business that’s not viable. In either case, you deserve to be fired.
RE: ““They’re fish in the barrel, the short sellers have them targeted,””
I don’t but the short mentality here, this is a matter of valuation and mark-to-market derivatives that have little value and thus bad bets made by these firms (for many years). If there is a shorting component and current exposure, it’s based on the accounting fraud that has placed these casinos into a vulnerable position — which can be blamed on poor regulation and years of accounting fraud linked to The Ownership Society and the anything goes mentality of The Republican/Bush Coup!
There's something I don't understand. I've heard numerous commentators over the past few days say "the independent broker/dealer model isn't viable anymore, they must merge with a large commercial bank" and "the market is saying it no longer supports the investment banking model."
WTF???
Broker/dealers have been around forever. And investment banks are no longer able to make money underwriting, doing M&A, wealth management, trading, etc?
I understand that securitization is dead, at least for the time being. I just don't get how these entire businesses can no longer be viable (or not viable without depositors funds to leverage out the wazoo).
I agree with Hu Flung about the inviability of a business that depends on a high stock price for survival. Another word for those is Ponzi schemes. Normally established enterprises like MS don't find themselves in this situation, which is usually reserved for fraudulent startups, Enrons, Tycos and the like. So how did MS come to be in this position? The rating agencies. They have totally lost their moorings. Shame on Fuld and Willumstad for not understanding how tenuous their hold on solvency was when it was held entirely in the hands of some punk analysts at S&P. If Mack is in that situation now, shame on him too. All the more shame for these people since they already had a chance to learn from the monoline experience, but chose to ignore it. Who woulda thought 6 months ago that MBI and ABK would outlive LEH, AIG, and MER. Ackman's whipping boys are turning out to be some of the most solid institutions on the street. They may yet outlast C, MS, and GS, too.
Short sellers aren’t the problem ‘naked’ short sellers are.
The rest of the discussions are just minor details, it’s the behind the scenes actions that are precarious. Any entity dealing in derivatives is pulling their hair out. The triggers have been hit, the switches have been met. The facade is about to fall and expose everything.
The bank consolidations are just stopgap measures. And it doesn’t look like they can prevent the snowballing effect, can’t even put it off until after the elections in November.
Spot gold is the precursor in times of panic, Paulson can’t wait to get out of Dodge soon enough and Congress is going to do what?
Jim Sinclair is one of the few that have grip on this and even he says there is no practical solution. (the debt is just to overwhelming)
Rue, its because broker/dealers aren’t just broker/dealers any more. If they were they wouldn’t need tons of capital, they wouldn’t have impossible-to-value assets and incomprehensible balance sheets, and their existence wouldn’t hang on a credit rating. They have gone far afield into some crazy stuff that was profitable for a while but now is killing them. If you want to write CDS contracts and do all kinds of crazy hedging and derivatives for your clients, you need access to capital and you need the protection of a real business that can’t collapse when it loses 1 letter from its credit rating.
7:23, lots of reasons: first, the bonus pool is nowhere near big enough even in a good year, let alone this year, when it is probably near empty. Second, no one would finance such a maniacal transaction.
Anonymous 8:57 –
That’s exactly what I was getting at. It’s not the broker/dealer model or traditional investment banking model that’s no longer viable, it’s the opaque financial engineering model that was reliant on never-ending funding at negative real rates, an appetite for big returns with the appearance of minimal risk, and a belief that the prices of certain assets (like houses) would always and forever increase that is no longer viable.
what if the short sale uptick rules just by “accident” or on purpose remain in effect all the time just in time to save GOLDMAN! TALK– ABOUT RIGGED!
ruetheday – exactly. The prime broker for my private equity fund (I also have some public positions) is a small regional broker/dealer. They do brokerage and investment banking and keep very minimal inventory in the stocks in which they make markets. The problem isn’t with the brokerage and investment banking, it’s with the internal hedge funds, esoteric financial products, and massive leverage of the large firms. Small brokerage firms that keep it simple have nothing to worry about and will continue to thrive. The large firms are abominations that deserve to fail.
A disturbing trend that we are seeing are “strong” banks being used to bailout the weaker banks. Imagine if Bank of America had never bought Countrywide. They would have the losses from their investment last year but now they have the whole pile. Now Merrill’s portfolio. If Wells is to take on Wamu that would serious drag them down. These initiatives are not helping. Let them fail or weaken the entire sector further.
Ruetheday
One could make the argument that the broker/dealer model is still viable but that it’s size (leverage) and growth would eventually have to be limited. New products (financial or otherwise) for any business is crucial to its future growth. In the future brokers will only be able to sell gov’t approved products and we will have a “product safety commission” for them. The new brokers will be about as sexy as the dairy industry IMO
7:23>> Why can't Morgan do a management buyout with the bonus pool?
8:59>> 7:23, lots of reasons: first, the bonus pool is nowhere near big enough even in a good year, let alone this year, when it is probably near empty. Second, no one would finance such a maniacal transaction.
0.1% downpayment with the Morgan bonus pool; 99.9% central bank financing. Presto Chango! MBO
Sy Krass said…
I’ve been thinking about an analogy to describe what is going on…the best I have come up with is this… think of the entire financial system as a body. The IB’s are diseased cells threatening to take down the whole system. The short sellers are the white blood and killer cells doing their job of excising the cancerous cells…
“The horror, the horror . . . .”
The issue with the stock price isn’t even access to capital. An investment bank may have all of the capital in the world, but it ceases to be viable if nobody is willing to do trasactions. If customers ask to pull their funds, and when the traders call around the street no other desks will do the trades to liquidate the customer’s positions (because they are worried they won’t settle), then they are toast. This extends beyond trading to underwriting, etc., with no confidence, no business can get done. Confidence can’t be measured in dollars of capital or risk adjusted ratios. Clearly, no financial institution can survive if ALL of their customers pull cash and nobody will by assets from them (a run).
Anonymous 11:46
Then perhaps these investment banks (and huge money center banks) shouldn’t be in businesses that are so levered and opaque that their lenders/depositors/customers/clients have no ability to understand their financial position. Transparency and a lack of leverage will generally lead to that confidence that everyone seems to want so badly.
No one seems to be doubting the strength of Berkshire Hathaway these days, and BH is largely a financial company itself at its core.
“stop short-sellers” = shoot the messenger.
What nonsense that this is caused by short-selling. Short sellers have to borrow stock, and if a bank wishes to protect itself can it not join the borrowers and keep hold of the stock ? Borrowing cost is low, about 1% p/a, and all the lower when market cap is low. Why don’t MS and GS simply outbid every other borrower for their own stock ? If they can’t legally do it themselves, an SPV could.
Or is it nothing to do with shorting…