Blood on the Wall St.

Nostradamus and Co. certainly did not warn us of this coming. I might be paranoid comparing this to things like the Holocaust, but financial crises resemble wars in some aspects, they are both based on miscalculations and result in massive losses. But my head is still recovering from the way I have seen some of the biggest names in the financial biz, razed to the ground. It is fairly reminiscent of the LTCM fallout and the great bubble burst. And now I have a story to tell my grand kids (I remember in my time…..). And what a story it is. Before we go any further, there’s a Fools step by step guide to financial ruin (read previous post)

Sub-Prime fallout is passé ! or is it?
With no realistic idea of the how much more pain is left in the system, the market is headed for a tailspin. Skeptics have questioned the $700 Billion proposed bailout. Why? It’s the taxpayer’s money here, we are talking about. They clearly do not want to see that being used to bailout financial companies, who are clearly paying for their greed. Why not use this money to bail out the common man, who can’t pay up his mortgages? I wonder how the presidential candidates react to this. While this will definitely increase the deficit and inflation, what remains to be seen is if it opens floodgates to more companies filing for bankruptcy? And the Fed has already pumped in a lot of money to increase the liquidity in the market. But nothing seems to have helped the markets recover. Clearly it’s not a quick fix solution to the economy.

Another concern here is if the bailout is Okayed, it is pretty much the sole discretion of the treasury secretary, as to who gets rescued. These decisions will remain immune to any legal judgment. This has sparked fears of political lobbying for a piece of the pie, which may not be the best thing right now for America.

Over the last 2-3 weeks, we have seen the demise of some of the biggest names as we know them: Lehman, Bear Stearns. Fed Intervention in Freddie Mac & Fannie Mae, WAMU shotgun sale to JP Morgan Chase, BOA acquisition of Merrill Lynch, Warren Buffet’s $5 Billion bet on Goldman, AIG bailout keeping in mind “national interests”. And heads have rolled. Famed CEO of CitiGroup, ‘stepped down’ earlier this year. Wachovia I hear is looking for potential suitors as well.
I-Banker acquaintance of mine (yes I do have one!), “Nobody knows who it is next, too bad the bailout came late for Lehman. The work is ok. People know things have gotten oversold, but it’s too risky to take a contrarian call at this juncture...”

While the bailout may be a just a temporary shot in the arm, the doomsday sentiment is what is dragging the market downwards. What gives me nightmares is the un-regulated insurance market. If AIG and Co. go under, then it will open doors to Hell, as most of those securitized bonds are over insured and in some cases insured many times over using the same or a different insurance player. I think that’s one of the reasons the Fed, seized WaMu, and sold it to JP Morgan Chase, as they did not want FDIC to be paying out.


Indian Connection:
And no one has been spared. How these bankers work is by creating an element of leverage (Futures & Options). By this speculative trading, we can see due to the massive volumes, a false buying level emerges. When stocks start rising, the common man is lured in hopes of making a quick buck. When the banks have made their money, they pull out, taking the common investor down. And the cycle repeats. It was very well explained by someone “You invest $100, watch it grow to $110 -- you made a 10% profit. But you borrow $100, watch it grow to $110, and return $105 to your lender -- you made a 100% profit.”

Note: I did not use the term investing for the common man, as that is a longer term play and more profitable.

Seems perfect? No. If there are extensive investments in these kinds of financial instruments, then things start getting overvalued. And trading at future valuations and not fundamentals is a very risky ploy. The risk should be known and understood properly. With the India shining story being played out, Indian markets were on a roll, no one saw this coming. I remember very well how somebody told me seven months back, that Indian markets can’t come down. That whatever may be theoretically possible, it’s not applicable. We should have watched out for this when we saw things yen-carry trade happen mid last year. But no, we didn’t. With the markets inflated to 21000 levels everyone was happy. No one was complaining. And why will anybody? People are making money right. And then the collapse. It’s a lesson to those people who think India is immune to happenings in the world economies. Specially, its dependence on US has hit us n face so hard, that’s its almost crippling. With big banks pulling out our markets are down to 13000 levels, a more than 35% fall from the highs.

Dollar has crept up. Much joy for the IT companies who were facing a weak dollar? No. Because with the financial sector facing budget constraints, their customer base is going to take a hit and so are their profits. Many jobs will be lost. 
Personal perspective: My future education in US became nearly 25 % more expensive because of the dollar rising. Crap.

Who is to blame?

While we might need some accountability to effect a reform, unless we have thorough understanding of the crux of the problem, I am afraid we are not going to get far. Wall St. and the Bankers should take the fall? Why? Some say the problem is the competitive landscape, annual bonuses and the incentive system which drives people to lose sight of the fundamental principles and allow them to become more vulnerable to the impending fallout. You can’t run a business without putting a carrot at the end of the stick. That’s how everything works. In this case, it’s a juicier carrot. Also, we tend to ignore how the Wall Street came became so powerful in the first place. It is because they have key information and insight into market dynamics that the common man does not. (Remember Wall Street, the movie?) That’s why they bail out much before everyone else. It might be in their interest, not having a transparent system. But it’s certainly not malicious. However, it tends to give them a false sense of security and belief in the infallible mechanism using which they make money. Clearly they are proven wrong. Every time. There are too many financial instruments and clearly no one can map a perfect model of how the markets should behave. It goes against the basic fundamental unpredictability of the markets.

While they are certainly culpable, I would like to play devil’s advocate here. The greed has percolated down to the common man. I think that the common man would not be complaining if there was no sub-prime. He would not be aware. He would have happily sung his way to the bank, eager to get his piece of the pie. While not everyone wants to make a quick buck, most of us do. I do feel sorry for the people who were genuinely looking for investing options, hard luck!. So we should read the fine print more carefully and clearly understand the risk so that they can manage it. Putting all your eggs in the same basket was never a smart idea. There are banks for Fixed Deposits, who did perfectly well during this crisis. You have to take risk according to your risk appetite. And that’s the number one rule in the game. Yes, there will be skeptics and cynics, who will feel that how is the common man supposed to understand the opaque functioning of the street. He is not. He is supposed to look for safer bets. I am not proposing that trading should be an elitist activity. However, safeguarding the capital is of utmost priority for the common man as that’s his life savings. And that’s why this happens. We need to have people more aware about all their financial investing options. That’s the key to sound financial health. If someone chooses to place a risky bet, he should have worked out the pitfalls.

We did miss the early warning signs. Yen Carry on trading is one such example. Its fault of the regulatory body and the government, because of their oversight the scale of the mess is unimaginable. They are a bunch of incompetent fools. Everyone has suffered. And everyone is to blame.

Panic Selling was never a good thing, and I personally feel that in the Indian context things might be slightly better and we can go for value plays now, if you want. But with withdrawal of all the FII money, it will be a while before we see the highs of the yesteryear. So, yes I will go with the oversold sentiment for India, but only if you have the stomach to hold on for what is going to be a roller coaster ride, before we slowly climb to the highs again. On the global scale, with 4 out of the big 5 IB gone, and merger with banks which have lesser leverage available to them, we should emerge with a cleaner financial system. But for now, there is more pain in the system, before we start building Wall St. again.

Today we stand at an inflection point in our lives, where how (and if) the American Financial System recovers from this crippling blow, is going to determine a lot of how the world economy plays out in the coming year(s).