The Fall of Lehman and The Terrible Lessons of Bear Stearns

By: John Mauldin | Mon, Sep 15, 2008
Print Email

The weekend has brought us events that can only be described in large, over-the-top terms. The Fed agreeing to take equity on its balance sheet? How bad can things really be? Clearly much worse than most people thought last Friday. Moral Hazard has been re-introduced as Lehman is allowed to go down. I will admit to being surprised. I thought Paulson and Bernanke would put it in the too big too fail category. I think they did the right thing by refusing taxpayer money for a bailout, but it is clearly going to roil the credit markets for weeks and months. It will be interesting to see how long it lasts.

I am in La Jolla today, working with my partners at Altegris, and looking over their shoulders while they monitor the performance of some of our managers. Interesting times. But I have had the time to read two short but very interesting commentaries on the current crisis. I will have more to say on Friday, but for now let's read old friends (to Outside the Box readers) Michael Lewitt of Hegemony Capital Management (www.hcmmarketletter.com) and Barry Ritholtz of Fusion IQ (www.fusioniqrank.com).

As I send this, credit default swaps spreads are simply blowing out. I have been writing about how we would see significant problems in the CDS markets for almost two years. This is something that you could see coming yet nothing was done. I know we are now in crisis, but let's hope that the authorities learn some lessons and put in place some sensible regulations of the CDS market soon. And for the love of Pete (insert your favorite expletive here) put these (more expletives) things on a regulated exchange.

And I agree with Michael below. This is not a time to try and catch a falling knife. That time will come, but not yet. And remember things will get better and we will get through this. As I just said to Barry, "We do live in interesting times."

John Mauldin, Editor
Outside the Box

 


 

The Fall of Lehman: How To Fix It - Part II
By Michael Lewitt

History has a funny way of humbling men. So do markets. Perhaps the most disturbing aspect of Lehman Brothers' fall is that it comes almost seven years to the day after 9-11. That day was supposed to teach us humility, and the fall of Lehman, coming six months after the collapse of Bear Stearns and coupled with Merrill Lynch's disappearance as an independent company, are the result of a complete lack of humility on the part of those executives charged with leading the world's most important purveyors of capital in the post-9-11 world. For all the talk of pulling together in the wake of the terrorist attacks that shook America to the core and that supposedly set our priorities straight, Wall Street rushed headlong back to its mindless pursuit of profits and speculation without consideration for the consequences of its actions. Now the chickens have come home to roost.

In April 2008, HCM published a controversial essay entitled "How To Fix It," in which we outlined our (unsolicited) recommendations for how to correct the excesses that led to the credit crisis that began in mid-2007 and brought us to this historic day. We are republishing that issue of the market letter by attachment for those who did not read it the first time. Our key recommendations, which seemed much more radical in April than they do today, were the following:

Finally, we made the point that too much economic activity in the United States was aimed at speculation rather than production. For example, the equity markets are increasingly dominated by quantitative investment strategies that are driven by considerations that are totally divorced from considerations of fundamental value. At the same time, the credit markets are increasingly utilized to finance change-of-control transactions for private equity firms that are done simply because low cost financing is available, not because a project is going to add to the productive capacity or capital account of the nation. As we wrote in that April issue, "[a]t some point, society has to figure out that the way an investor earns his money is even more important than the amount of money he makes. This is why human beings were vested with moral sentiments, so they could distinguish the quality of human conduct from the quantity of its results."

These changes cannot and will not be effected simply by legislative fiat. It is incumbent upon the gatekeepers of capital - the fiduciaries that make the decisions about allocating capital - to bring discipline to the system. This will require a rethinking of their priorities and a willingness to add to their investment calculus considerations that exceed their own narrow interests about short-term investment returns. Our system requires a new concept of fiduciary duty that encompasses systemic as well as single-firm interests, and that focuses to a greater degree on risk-adjusted returns than raw numerical returns. Obviously the forces that led to this weekend's events have been building for many years, and the changes needed to fix the system will not be made overnight. But we should not let this occasion pass to reflect on what has occurred.

Imagine You Are On the Deck of The Titanic (Because You Are)

It is clear to us that the Federal Reserve and United States Treasury are not underestimating the enormity of the crisis. Continuing to write checks to bail out the private sector would have been the wrong decision, but the fallout is going to be severe. The next domino to fall may be the insurance giant, American International Group, Inc. (AIG), which is facing credit rating downgrades that will force it to post more collateral (that it doesn't have )on a large volume of credit insurance contracts. AIG is a much larger systemic threat than Lehman Brothers ever was, so this situation is profoundly serious. In HCM's judgment, investors should not try to pick a bottom in today's or this week's market. The market is going to experience extraordinary volatility today and over the immediate future. Play the market at your own risk and only with money you can afford to lose. The indices are heading significantly lower, as we have previously forecast. Gold, short-term U.S. Treasuries, short-term Swiss and German government paper, the Swiss franc, and certain Asian currencies like the Singapore dollar are the safest places to park your cash for the moment. The U.S. dollar continues to be debased (less against the Euro, which remains compromised, than against Asian currencies and the Swiss franc), particularly by the startling and historic decision by the Federal Reserve to accept equity securities at its discount window. If nothing else, that decision alone suggests the enormity and depth of the crisis we are facing. We never thought we'd live to see the day that the American central bank would accept equity as collateral for loans. We have to admit that took us by surprise and made us very nervous.

 


 

The Terrible Lessons of Bear Stearns
Posted by Barry Ritholtz on Monday, September 15, 2008 | 07:09 AM
http://bigpicture.typepad.com/comments/2008/09/the-terrible-le.html

As Lehman Brothers (LEH) turns into a single digit financial midget on its way to zero, as Washington Mutual (WM) works its way towards a buck, as Wachovia (WB) drops more than 80% over a year, as Fannie Mae (FNM) and Freddie Mac (FRE) become divisions of the United States of America, and are now priced in pennies -- we need to reflect upon the ongoing lessons learned from all these interventions by Treasury, Congress and the Federal Reserve.

The lesson from the Bear Stearns' bailout -- $29 Billion in Federal Reserve bad paper guarantees -- are quite stark:

Unfortunately, Moral Hazard has created terrible lessons in 2008 -- via Bear Stearns (BSC), Lehman (LEH), Fannie Mae (FNM) and Freddie Mac (FRE).

 


 

Your wishing I had not been so right analyst,

 


 

John Mauldin

Author: John Mauldin

John Mauldin
Frontlinethoughts.com

John Mauldin

Note: John Mauldin is president of Millennium Wave Advisors, LLC, (MWA) a registered investment advisor. All material presented herein is believed to be reliable but we cannot attest to its accuracy. Investment recommendations may change and readers are urged to check with their investment counselors before making any investment decisions. Opinions expressed in these reports may change without prior notice. John Mauldin and/or the staff at Millennium Wave Advisors, LLC may or may not have investments in any funds cited above. Mauldin can be reached at 800-829-7273. MWA is also a Commodity Pool Operator (CPO) and a Commodity Trading Advisor (CTA) registered with the CFTC, as well as an Introducing Broker (IB). John Mauldin is a registered representative of Millennium Wave Securities, LLC, (MWS) an NASD registered broker-dealer. Millennium Wave Investments is a dba of MWA LLC and MWS LLC. Funds recommended by Mauldin may pay a portion of their fees to Altegris Investments who will share 1/3 of those fees with MWS and thus to Mauldin. For more information please see "How does it work" at www.accreditedinvestor.ws. This website and any views expressed herein are provided for information purposes only and should not be construed in any way as an offer, an endorsement or inducement to invest with any CTA, fund or program mentioned. Before seeking any advisors services or making an investment in a fund, investors must read and examine thoroughly the respective disclosure document or offering memorandum. Please read the information under the tab "Hedge Funds: Risks" for further risks associated with hedge funds.

If you would like to reproduce any of John Mauldin's E-Letters you must include the source of your quote and an email address (John@FrontlineThoughts.com) Please write to info@FrontlineThoughts.com and inform us of any reproductions. Please include where and when the copy will be reproduced.

John Mauldin is president of Millennium Wave Advisors, LLC, a registered investment advisor. All material presented herein is believed to be reliable but we cannot attest to its accuracy. Investment recommendations may change and readers are urged to check with their investment counselors before making any investment decisions.

Opinions expressed in these reports may change without prior notice. John Mauldin and/or the staffs at Millennium Wave Advisors, LLC may or may not have investments in any funds cited above.

PAST RESULTS ARE NOT INDICATIVE OF FUTURE RESULTS. THERE IS RISK OF LOSS AS WELL AS THE OPPORTUNITY FOR GAIN WHEN INVESTING IN MANAGED FUNDS. WHEN CONSIDERING ALTERNATIVE INVESTMENTS, INCLUDING HEDGE FUNDS, YOU SHOULD CONSIDER VARIOUS RISKS INCLUDING THE FACT THAT SOME PRODUCTS: OFTEN ENGAGE IN LEVERAGING AND OTHER SPECULATIVE INVESTMENT PRACTICES THAT MAY INCREASE THE RISK OF INVESTMENT LOSS, CAN BE ILLIQUID, ARE NOT REQUIRED TO PROVIDE PERIODIC PRICING OR VALUATION INFORMATION TO INVESTORS, MAY INVOLVE COMPLEX TAX STRUCTURES AND DELAYS IN DISTRIBUTING IMPORTANT TAX INFORMATION, ARE NOT SUBJECT TO THE SAME REGULATORY REQUIREMENTS AS MUTUAL FUNDS, OFTEN CHARGE HIGH FEES, AND IN MANY CASES THE UNDERLYING INVESTMENTS ARE NOT TRANSPARENT AND ARE KNOWN ONLY TO THE INVESTMENT MANAGER.

Copyright © 2003-2015 John Mauldin. All Rights Reserved

All Images, XHTML Renderings, and Source Code Copyright © Safehaven.com