Stress ? to the whole world

When no suitors line up to buy a bank or broker-dealer whose stock falls by 95%, it usually reflects a lack of faith in how positions are marked, rather than a comment on future business prospects. There are signals of price confusion everywhere (a). One solution to this impasse is a more violent form of price discovery that takes place when entities fail, and assets are sold en masse to willing buyers. With visibility on what large blocks trade for, investors in smaller size would finally get a better sense of the clearing price. The de-leveraging virus claimed its first victim in June 2007 with a mortgage hedge fund that was leveraged 25 to 1. It spread to other entities, whose leverage is noted in parentheses: structured investment vehicles (11 to 1), stat arb hedge funds (10 to 1), monoline insurance companies like AMBAC (100 to 1), Swiss banks (65 to 1), publicly traded stocks mimicking mortgage hedge fund strategies (32 to 1), entire brokerage firms (30 to 1), and then more recently, Fannie Mae and Freddie Mac (75 to 1). Leverage in insurance company financial products subsidiaries is sometimes unknowable; one firm with close to a half a trillion in exposure was leveraged over 200 to 1 right before the credit markets turned in June of 2007.

The Fed does not have the inclination nor the ammunition to prevent such entities from falling short of capital. So, what lies ahead may be more business failures, and more selling pressure across equity and credit markets from today's levels, perhaps more than we anticipated a couple of months ago. I don't know how long it will take for over-leveraged assets to find a new home, and a new price. Sovereign wealth fund injections appear to have been premature, and serve as a cautionary tale for bottom-fishing too soon. But the wall of cash is indisputably rising on many fronts

quoted 16th Sep 08