MarketView for September 17

Summary

  

Wall Street was pummeled again on Wednesday, with the major equity indexes falling to a three-year low as the rescue of insurer AIG failed to calm a crisis of confidence in global markets and banks radically reduced their desire to lend to each other. Basically, it was the worst day since the aftermath of the September 11 attacks in 2001 with the Street essentially playing musical chair and wondering who would be the next the next not to have a chair when the music stopped..

 

Of the two remaining major investment banks, Goldman Sachs stock suffered its largest one-day share price decline ever. Morgan Stanley had its worst day in at least 15 years as investors worried whether it would survive as an independent investment bank. Goldman Sachs saw its share price fall 13.9 percent to $114.50 and, at one point was down below $100 for the first time in more than three years. Morgan Stanley shares fell 24.2 percent to $21.75. The drop in Morgan Stanley's shares came despite the bank's posting quarterly results that beat Wall Street's estimates.

 

After the closing bell, reports on deal making among financial companies picked up pace. Morgan Stanley was discussing a merger with regional banking powerhouse Wachovia, the New York Times reported. There were also rumors that Washington Mutual, the country's largest savings bank, had put itself up for sale. Good luck!

 

The Dow Jones industrial average fell 449 points, or 4.06 percent, to its lowest level since November 2005. It was the blue-chip Dow average's biggest percentage drop since Monday, when it fell 504 points, or 4.42 percent, the most since the aftermath of 9/11.

 

The S&P 500 fell 57 points, or 4.71 percent, its lowest level since May 2005 and its biggest percentage drop since September 17, 2001, when the markets reopened after the September 11 attacks. The NASDAQ also fell the most since September 17, 2001. It shed 109 points, or 4.94 percent, to its lowest level since August 2006.

 

The White House defended government actions to shore up AIG, saying it was to prevent broader harm and noting it was "concerned about other companies." AIG is one of the 30 companies whose stocks make up the blue-chip Dow average.

 

Late Tuesday night, the Federal Reserve said the Federal Reserve Bank of New York will lend up to $85 billion to AIG in a plan aimed at saving the insurer from a "disorderly failure" that could wreak economic havoc. But on Wednesday, investors doubted whether the rescue plan would be enough. AIG shares sank 45.9 percent to $2.03 on the New York Stock Exchange.

 

The Fed's move was the latest in a string of bailouts, a bankruptcy on Wall Street, and central banks around the world flooding the financial system with money to prevent it from seizing up.

 

A break below important technical support for both the Dow and S&P 500 accelerated the market's slide, traders said.

 

The bank-to-bank cost of borrowing overnight dollars fell more than a percentage point on Wednesday, but the premium paid for the greenback and sterling over three months swelled, fanning fears that the supply of credit might be drying up in the global financial system.

 

Banks frantically seeking dollar funds have been stonewalled by others increasingly reluctant to lend amid uncertainty and nervousness following the collapse of Lehman Brothers and the bailout of AIG.

 

The SEC issued new rules governing the conduct of people who profit from stock declines as shares of major financial institutions plummeted on fears of a global credit crunch. The three SEC rules cover shares of all publicly traded companies and follow a brief emergency rule this summer that was aimed at curbing illegal short selling in 19 major financial stocks.

 

Morgan Stanley and Goldman Sachs Take It On The Chin

 

Morgan Stanley and Goldman Sachs on Wednesday where beaten up unmercifully on Wednesday, sending the shares of the two largest investment banks lower and boosting their debt-insurance prices higher amid rising fears over their ability to survive a deepening financial crisis.

 

Stronger-than-expected earnings from Goldman Sachs and Morgan Stanley on Tuesday failed to reassure the Street that all was going to be well. And despite assurances from Goldman and Morgan  that they had ample cash and capital, investors fled.

 

Morgan Stanley shares sank 42 percent, below the depths reached during the 1998 Asia debt crisis and the collapse of Long-Term Capital Management a decade ago. Goldman saw its share price fall as much as 26 percent to a three-year low. Goldman’s shares are down 53 percent this year, while Morgan's are down by two-thirds.

 

"It's very clear to me -- we're in the midst of a market controlled by fear and rumors, and short sellers are driving our stock down," Morgan Stanley Chief Executive John Mack told employees in a memo. "There is no rational basis for the movements in our stock or credit default spreads."

 

More ominously, investors bid up the price of protecting against a default by the banks, indicating concern that Wall Street's biggest companies are at risk and may seek some measure of safety by merging with a commercial bank.

 

Morgan Stanley’s bonds were also lower, with some issues trading at distressed levels. The investment bank’s 6 percent notes due in 2015 traded at 61 cents on the dollar, down from 94 cents a week ago, and yield 12.25 percentage points over Treasuries.

 

On Tuesday evening, Morgan Stanley rushed to release quarterly results, a day ahead of schedule, after investors sent its shares reeling 11 percent and increased debt-default insurance costs. Morgan out-earned larger Goldman, which posted a 70 percent decline in profit but exceeded expectations.

 

A growing number of analysts argue that investment banks, which tap capital markets to fund their business, need to combine with commercial banks and their stable pools of deposits to avoid a Lehman-like collapse when markets turn jittery.

 

Investors are also punishing investment banks because their extensive use of leverage, piling up debt to boost trading and investment returns, puts them at risk when markets tumble.

 

Goldman Chief Financial Officer David Viniar and Morgan CFO Colm Kelleher both said their companies performed very well despite unprecedented turmoil. They also contended they do not want or need to merge with a commercial bank.

 

Even so, many of the same market pressures that weighed on Bear Stearns in March and against Lehman last week are now turned on Morgan Stanley and Goldman. The cost of protecting $10 million of Morgan Stanley debt against default jumped to a point where sellers are demanding buyers make an upfront payment equal to 16 percent of the debt insured. That indicates traders view the company as distressed and at a high risk of default.

 

Morgan Stanley's credit default swaps earlier traded at an annual cost of $825,000 a year for five years, up $144,000 from Tuesday's close. Goldman's swap costs likewise surged, rising by $190,000 to $610,000 a year from Tuesday's close.

 

Housing Construction Falls

 

The Commerce Department reported on Wednesday that construction of new homes and apartments fell 6.2 pct. in August, the weakest pace in 17 years and far more than expected. However, lower mortgage rates and tax credits have given builders some glimmers of hope of a possible rebound. It was the slowest building pace since January 1991, but that should help clear out bloated inventories of unsold homes. Building activity is on track to slide below the 1 million-mark for the whole year, the first time that has happened in more than six decades.

 

Building permits, considered a good indicator of future activity, fell 8.9 percent in August to an annual rate of 854,000 units. Yet, the dramatic decline in mortgage rates that has occurred since the government moved to seize control over mortgage giants Fannie Mae and Freddie Mac should help provide a floor for home sales, keeping them from falling further.

 

David Seiders, chief economist for the National Association of Home Builders, indicated that builders are also optimistic that the new tax credit for first-time home buyers that was included in the recently passed housing bill will help push sales higher.

 

The two-year long housing downturn has pushed the country close to a recession, sent mortgage foreclosures to record highs and is now leveling some of the biggest names in finance because of soaring losses on their mortgage investments.

 

In the past 10 days, the government has seized control of Fannie and Freddie and late Tuesday night the Federal Reserve announced it was providing an $85 billion emergency loan to the country's largest insurance company, American International Group, which has also suffered major losses from bad mortgage investments.

 

For August, the drop in housing construction reflected a 1.9 percent decline in single-family construction which fell to an annual rate of 630,000 units. Construction of multi-family units fell by 15.1 percent to an annual rate of 265,000 units.

 

Building activity was down in all parts of the country outside of the West. Construction fell by 14.5 percent in the Northeast and was down 13.6 percent in the Midwest and 7.4 percent in the South. In the West, construction was up 10.8 percent.

 

Is WaMu Next

 

Washington Mutual  appeared headed toward a sale Wednesday after a major investor removed a potential stumbling block and nervous banking regulators began approaching the most logical buyers.

The New York Times, citing unidentified people familiar with the matter, said an auction of the bank was already under way, and The Wall Street Journal reported Wells Fargo and Citigroup have expressed interest in a takeover.

 

A concession by investment firm TPG, which injected $7 billion into WaMu five months ago, may have opened the way to a sale, or, failing that, made it easier for the bank to raise another round of capital. TPG could have stymied the process because of protection when it bought its stake in April. A clause in its agreement could have required a buyer or another major investor to pay TPG hundreds of millions, if not billions, of dollars in addition to whatever money was injected into WaMu.

 

But TPG agreed to waive the clause after concluding WaMu needs all the help it can get.

"It became clear that it would be in the best interests of Washington Mutual and our investors to waive the ... provisions," Fort Worth, Texas-based TPG said in a statement. "Our goal is to maximize the bank's flexibility in this difficult market environment."

 

The efforts to find a buyer, though, were being complicated by uncertainty about the magnitude of losses still lurking in Washington Mutual's home loan portfolio.

 

Citing unidentified sources, the New York Post said the potential buyers include JPMorgan Chase and HSBC Holdings, as well as Wells Fargo. Federal regulators would like to sell WaMu to a healthy bank, rather than risk a failure that would drain an already depleted deposit insurance fund. By some estimates, a WaMu failure could cost the Federal Deposit Insurance Corp.'s fund more than $20 billion. At $45.2 billion, the fund is already at a five-year low.

 

After losing $6.3 billion in the past three quarters, Washington Mutual believes it is slowly healing under a new chief executive, Alan Fishman, who will receive an $8 million bonus if he can keep WaMu alive through 2009.

 

The latest financial update that WaMu released late last week suggested WaMu's loan problems are becoming less severe compared to recent quarters, giving some hope that the company can still be salvaged. Nonetheless, it is still likely that the company will sustain a loss of about $1.8 billion in the quarter ending Sept. 30.

 

The company's stock fell 31 cents to $2.01 Wednesday, leaving the stock price with a decline of 85 percent so far this year. The erosion has left WaMu with a market value of about $3.5 billion — down from $43 billion at the end of 2006.

 

If WaMu either can't find a buyer or doesn't want to be sold at the price being offered, the thrift could raise more money to fatten its cushion against the losses that are still expected to come. Like TPG did, any investor would be betting that the slumping real estate market will bounce back, allowing WaMu to regain its financial equilibrium and return to the form that enabled it to pocket profits totaling $13.7 billion from 2003 through 2006.

 

Most of WaMu's branches are in the West, overlapping territory where Wells Fargo and Bank of America are the market leaders. WaMu's branches in New York and Illinois could be appealing to buyers if the company is sold in pieces.