Somebody pinch me. Am I dreaming? Are there really only two remaining independent Wall Street investment banks? Did all of this really just happen?
Sadly, I'm afraid so
This weekend will go down as one of the most spectacular unravelings in financial history. In a nutshell:
- The financial crisis just went supernova.
- Talk of "Too big to fail"? Please. That was so two days ago.
- The Federal Reserve's balance sheet will be doubling as a garbage dump until further notice.
Breaking news is coming in by the second, but here's the latest on Sunday's unprecedented blizzard of events:
In response to the cacophony of news, the Federal Reserve opened its arms to ailing financial firms, now accepting nearly any financial asset a firm can scrape together -- including stocks -- as collateral to borrow against its emergency discount lending window. While this should inject liquidity and make it easier for firms to unwind their entanglements with Lehman, it does so at taxpayers' risk -- and taxpayers are already pulling their pockets inside out over this year's other bailouts.
Madness. Absolute freakin' madness
A few notable points: Whether Lehman will be able to dismantle its balance sheet without sending the market into an orgy of forced selling will be the center of attention in the coming days. When so much leverage is employed on investments that are so intertwined with other financial firms, you get a situation where selling begets even more selling. If Lehman has to dump assets at fire-sale prices, that could cause other investors to mark down the value of their holdings, which could force them to sell assets to raise cash, causing even more selling ... the whole process feeds on itself like a cat chasing its tail. In fact, that kind of "feeding-on-itself" phenomenon is partially what caused the market crash of 1987, where the Dow Jones lost more than 20% in one day.
Another question is why Merrill was suddenly and unexpectedly thrown into Bank of America's arms. While everyone knew Lehman had it coming, Merrill's last-minute sale has many wondering if it too was teetering on collapse. As word emerged that Lehman wouldn't be bought by another firm, it's possible the shock waves of its collapse posed too great a risk to allow Merrill to stand on its own. You can take that as a positive (at least Merrill is off the table) or a negative (it shows that the vulnerability of financial firms is nowhere near over).
Buckle up, grab a drink, and stay calm
This is a good time to remind yourself of a cardinal investing rule -- it's never a good time to panic. Lehman has ended -- the world hasn't. Nonetheless, it is also important to realize the severity and ramifications of these events. It's perfectly healthy for excessive speculation to get purged out, but in this case, the purging went into overdrive. The chickens tried to come home to roost ... they just got slaughtered by a mob of paranoid investors along the way.
Stay tuned. We'll have more coverage of these historic events throughout the day.
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