Making the Headlines

The speed at which the financial markets have gone from one crisis to the next is simply stunning. Rather than try to lump all the events into a single update, we’re going to split them into multiple updates spread out over several days. There are just too many things going on to wrap into one message.

In short, we’ve had four major events:

Fannie Mae and Freddie Mac were bailed out by the US Government:

Put succinctly, this was one of the most botched government actions I’ve ever witnessed. While protecting some debt holders completely, others were sacrificed. It would have been just as easy, and cost far less, to protect all the constituents. As you will read in a subsequent update, I suspect there is more to this than has been disclosed. One theory is that certain foreign governments demanded a bailout (namely China), which may have turned this into a foreign policy matter as opposed to domestic economics.

Lehman Brothers declared bankruptcy:

In the same way that Bear Stearns fell to hubris and greed, Lehman Brothers fell into bankruptcy this weekend because of heavy bets in the mortgage market. The circumstances are simple – they have assets supposedly worth $600 billion that are likely worth far less, and liabilities of $600 billion. Cash is king, and if you don’t have enough, then you will fail. That is the oldest axiom of finance.

Merrill Lynch sold themselves to Bank of America:

In order to avoid the same fate as Lehman, Merrill ran into the arms of a better capitalized, deposit-based bank. It seems that Merrill was in much better shape than Lehman, and might have survived on their own. But in this market, that is not a risk they were willing to take.

AIG is on the verge of collapse:

The insurer to the world is running out of dough. With a trillion dollar balance sheet, AIG is about to report tens of billions in losses on insurance contracts against mortgages. While a bailout is possible, we’re all waiting for news on this one.

Outlook and Perspective:

However you choose to frame these events, the conclusion is the same – we are in extraordinary times. Never before in the history of the markets have institutions of this size faced such dire circumstances. The GSEs alone represent $3 trillion in assets – that is a 3 followed by twelve zeros. The magnitude is astounding. When these markets move, nothing can get in their way.

For perspective, this is all about finance firms. The rest of the economy, while going slowly, is certainly going. Companies that make stuff are still making stuff, and there are plenty of long-term opportunities in these industries. In the world of economics, when the employer of the analyst, the person responsible for commenting on the state of the world, is in trouble the analyst tends to believe the world is about to end. Put another way, our financial news is governed by folks who are losing their jobs. This puts everyone in a bad mood.

While these events affect everyone in some way, we have managed to stay out of the storm with our investment strategy. In the long-term, these issues will resolve themselves and we’ll once again go back to business as usual. Unfortunately, that will be many months away with a few more headlines until then. If you have questions regarding your account, please do not hesitate to call. We are contacting people directly if there is something specific in these events that affects their account. Otherwise, rest assured that we are working through this with a level head and long-term focus.

Regards,

David