The week Wall Street capitulated
"There’s a wildfire that the authorities are struggling to put out. We the market need a firebreak"
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Monday, October 6: Who? The man in charge of the Tarp is announced: Neel Kashkari |
After collectively asking ‘Who?’, faith that the US Treasury is getting a grip on the financial crisis is not enhanced by the announcement that Neel Kashkari, an assistant secretary of international affairs in the department, will oversee the $700 billion rescue plan. Few are surprised that Kashkari is a former Goldman banker but they are bemused to find he was a relatively lowly VP before he left.
The first meeting Euromoney had that fateful week was surprisingly upbeat. But that was because the banking official – an expert in financial institutions as it happened – believed that Paulson’s scheme to buy up illiquid assets was a big part of the solution.
"The Tarp will help the fixed-income markets. It will release capital and provide an additional avenue for the deleveraging of banks’ balance sheets. And it will help achieve the primary objective of boosting liquidity," he said. "Financial institutions are full of assets that they did not want to hold on a long-term basis. It is consuming precious liquidity and capital."
Otherwise this banker’s assessment of what was taking place was not pretty. "Investors are stuffing money under the mattress. Clearly not literally but metaphorically," he said. It’s an almost quaint image – one that is associated with a bygone age when people did not trust banks. Those times are back. There has been a run on the global financial system that is broad-based and debilitating. The run has taken place in a number of areas, starting with ABCP way back in August 2007, then depositors at banks, before materially deteriorating this September when money market funds broke the buck. The commercial paper sector has suffered a withdrawal of funds ever since. And after the dismal returns of 2008, mutual funds are finding that years of capital inflows are in reverse. The implications of this run are far from quaint, however. Backward-looking economic data are starting to show the impact of 14 months of restricted credit. What next? The disastrous impact on business confidence from two months of unprecedented volatility is certain to hit economic growth further still.
Lunch later that day with two experienced origination officials from a European bank was a sobering experience. First of all, the restaurant was half empty, which was unusual given its quality and proximity to the bank’s trading floor, but not surprising given the backdrop.
The bankers’ most pressing concern now is over the $95 billion drop in money market holdings of CP that the Fed reported had taken place the previous week. The new-issue market is shut for most corporates and all financials and the bankers do not see things changing in a hurry. It was noted how, almost exactly one year earlier, they and their counterparts were busy helping key investors fill their portfolios full of cheap credit in what was deemed to be a great buying opportunity. How times change. Of course it turned out that they could have waited and it would have been even cheaper.
They are not overly excited by the Tarp and cannot get their heads around the problems of how to establish a price. Buying at the market price could crystallize losses at other institutions. Neither would it resolve the lack of confidence – a pressing matter of concern given the precipitous price action in bank stocks. The market was in a spiral. Or, as another banker put it: "There’s a wild fire that the authorities are struggling to put out. What the market needs is a firebreak." It wasn’t clear at that point whether or not one could be created. Later that day the Fed announcement that it would buy asset-backed and secured CP was welcome but nowhere near enough to change the tone. The Dow fell 370 points, below the key 10,000 level, to 9956. At one point it was as low as 9526. Meanwhile, in credit markets the US investment-grade index widened to 188 basis points. A year previously it had been in the mid 50s. Other keenly watched indicators of market stress, such as the Ted spread and Libor, also rose.
Tuesday, October 7: Psychological barriers are breached
"If they didn’t let a bank fail, how were they going to prove there was a serious problem? You kill a chicken to scare the monkey..."
Wednesday, October 8: Looking into the black hole
"The financial structure has changed, ending credit-led financing and disintermediation, and into a funded model"
Thursday, October 9: It feels like capitulation
"Enough! Just sell my stock, sell me anything with credit risk and buy T-bills – at least I know I’ll get my money back"
Post-script: Washington DC, Friday, October 10 to Monday, 13
"Either we get a coordinated response from the world’s leaders by the end of the weekend, or we might as well give up and go home"