Bloodbath on Wall Street, implications everywhere

February 2, 2010

Dear Mayne Reporters,

when the October 1987 crash hit Wall Street, the Dow Jones industrial average plunged 508 points or 23% in a day. Last night the Dow fell 504 points to 10,917 but this only represented a drop of 4.42%.

That said, it was still the sixth largest points decline in history and the biggest since September 17, 2001, the first day of trading after the terrorist attacks, when the Dow lost 685 points.

AIG the biggest story of all

The victims are everywhere with the world's biggest insurance company AIG shaping up to be the first $US1 trillion collapse. As the HIH failure showed, insurance collapses are very messy and AIG shares plunged 61% to $US4.76 last night, meaning its $US1 trillion in assets are now only supported by $US12.8 billion of equity. No wonder it is asking The Federal Reserve for $50 billion and is even exploring borrowing funds from its own reserves, something akin to raiding the staff super fund.

AIG's big problem is that 70% of its investments are in property or mortgages and the US financial system is desperately short of capital courtesy of the collapsing housing market. The collapse of Lehman has literally tightened the noose around the whole system and AIG looks most vulnerable at this point.

A few dinosaurs will try to blame hedge funds for this crisis when in fact that particular sector will be one of the biggest victims given that they rely on leverage provided by that soon to be extinct business model known as the independent investment bank.

We've seen such a fundamental fraud perpetuate by wholesale providers of investment banking products that investment banks will only survive if they are part of a bigger commercial bank that can rely on steady deposits from punters, rather than wholesale funding. Don't expect Goldman Sachs and Morgan Stanley to remain independent and the Bank of America CEO this morning predicted America's 9000 commercial banks will halve in number over the coming years.

Even America's most diversified conglomerate, General Electric, saw its shares plunge by 8% last night as it has 25% of its assets in property and mortgages.

By the time Asian markets close today, we will have seen the greatest one day destruction of financial institutional value in history. This is what happened to the big seven on Wall Street last night, including links so you can click through and see for yourself.

Ranking the Not So Magnificent Seven by market capitalisation

1. JPM Morgan-Chase: slumped 10.13% to $US37. Year high $US53.25 and current market cap $US127 billion.

2. Bank of America: slumped 21% to $US26.55 after Merrill takeover. Year high $US54.21 and current cap $US121 billion.

3. Citi: slumped 15.15% to $US15.24. Year high $US55.55 and current cap $US83 billion.

4. Goldman-Sachs: slumped 12.13% to $US135.50. Year high $US250.70 and current cap $US53.36 billion.

5. Morgan Stanley: slumped 13.54% to $US32.19. Year high $US75.50 and current cap $US35.7 billion.

6. Merrill Lynch: up 1c to $US17.06 after BoA rescue. Year high $US98.68 and current cap $US17 billion.

7. AIG: slumped 61% to $US4.76. Year high $US76.13 and current cap just $US12.8 billion.

All up, the big seven are only worth $US450 billion after shedding almost $100 billion overnight. When you throw in the likes of Bankwest owner HBOS, which plunged 18% on the UK overnight, the global financial destruction will clearly top $300 billion by the time the dust settles.

Was Lehman too big to fail?

We're starting to discover whether Lehman really was too big to fail as 5000 staff in the UK were told last night that $100 million in wages due this week won't be paid. Australia's industrial laws will see local staff do better, but it will be incredibly messy and the churches, charities, councils and super funds that bought $2 billion of dodgy US mortgages from its subsidiary Grange Securities will now just be one of thousands of creditors around the world.

Ian Roger's from the excellent banking ezine The Sheet scored some good early insights on the workout issues with the following item this morning:

ANZ managed to make itself into the list of the top thirty unsecured creditors of Lehman Brothers Holdings Inc, which filed for bankruptcy protection in the US yesterday afternoon, Australian time.

Lehman, somewhat surprisingly, opted for the “chapter 11” route that caters to the reorganisation and even the potential recovery of the firm.

ANZ's two unsecured loans and one letter of credit add to just US$82 million, which is chicken feed by the standards of Lehman's largest creditor.

That honour belongs to Citigroup, owed approximately US$138 billion according to Lehman's bankruptcy petition.

The Bank of New York Mellon Corp is second, owed around US$17 billion, followed by a number of Japanese and European banks (including Azoro, BNP, Mizuho, Sumitomo Mitsubishi and UFJ), though each of these is owed only several hundred million each.

National Australia Bank scrapes into the list of Lehman's top unsecured creditors with a letter of credit for US$10 million.

Lehman has not, yet, published any details on secured creditors.

Other market responses: oil plunges, official interest rates to fall

Stand by for a cut in official US interest rates from the Federal Reserve tomorrow after almost $200 billion of liquidity was pumped into the system by central banks around the world.

And hold onto your hats today because Australian resource stocks will be heavily sold off today after commodity prices crashed overnight, with the oil price at one pushing towards just $US90 a barrel. It's all part of the same deleveraging stories. There's a global fire sale of assets going on to pay back debts to the world's stricken banking system.

Corporates that want to raise big licks of debt will find it difficult, and that even applies to BHP-Billiton it is wants to add a big cash component to its Rio Tinto bid.

Finally, check out Alan Kohler's 6am column on Business Spectator which provides some interesting historical background along with his usual cutting commentary. There's now absolutely no doubt that George W Bush will go down as the worst President in history and Alan Greenspan isn't looking too flash either.

A debt-funded war, grossly irresponsible tax cuts, massive financial deregulation and ridiculously loose monetary policy have combined to create this enormous global mess and a huge loss of prestige for the US.

Barack Obama will no doubt be expressing concern, but after a flat couple of weeks he'll be relieved to have the debate back on the economy.

That's all for now.

Do ya best, Stephen Mayne

* The Mayne Report is a multi-media governance website published by Stephen Mayne with occasional email editions. To unsubscribe from the emails click here.