Why did Lehman really fail? The equity window is effectively closed for most financial services companies. This fact was the true trigger for the meltdown in AIG and Lehman and the problems at WaMu, HBOS and Merrill Lynch.
Moreover, it will be the trigger for a lot of the financial services bankruptcies going forward.
Rewind just a few months ago to June and you could remember a time when financial services companies were raising capital like mad. Below are just a few of the posts right here on my blog:
But, something happened between then and now. Slowly but surely, investors started to realize that the writedowns just were not coming to a halt. Financial services companies just continued to write down assets. Investors pulled back.
I first wrote about this in May in a piece called "Debt financing gone."
Another side effect of the credit crunch is the lack of availability of cheap debt financing for businesses. Companies have two alternatives: they can hold off on needed financing until the credit markets are more inviting or they can raise money through alternative means like convertible bonds and rights issues (equity offerings). According to The Telegraph, apparently, a lot of companies cannot wait because they are issuing equity right now to the tune of $100 billion over the next few months, $45 billion of it in the UK alone.
But, then the drumbeat of failed and under-subscribed rights issues and equity offers started to mount. The sovereign wealth funds began to become wary as well. In June, I wrote posts like these:
When July came around, the writedowns continued unabated. But, the capital window was a crap shoot for financial institutions. They began to sell shares at steep discounts to market value. They began to sell assets in order to raise capital instead. Anything to keep their capital base up. Rumors of bankruptcy started to swirl around certain institutions. One could sense the desperation, leading to these headlines in July:
So, as September rushes along, we should not be surprised that institutions are failing. The warning signs have been there for months. Writedowns were continuing while capital raising efforts were coming up short.
As far back as June 16th, I wrote:
When individuals, sovereign wealth funds and institutional investors stop giving these institutions more capital, the bottom will fall out of the financial services sector, and we will reach capitulation. As a result, some institutions will fail. But, at that point, the surviving institutions will be very cheap. Then, the financials will be screaming bargains and that is the time to buy.
The reason we have not reached bottom is that investors refuse to believe that more writedowns are to come (see link here). I have said time and again that the level of writedowns due to mortgage credit losses will continue to be underestimated because so many do not understand the magnitude of the bubble which has created this problem. The losses will not be limited to subprime RMBSs (residential mortgage backed securities). They will encompass Alt-A and some prime loans as well. These losses and writedowns have yet to occur.
Moreover, there will be a negative feedback loop with the real economy from the balance sheet deleveraging. This will actually create more writedowns. The full measure of real economy-related credit losses have yet to be realized. Other areas where writedowns may occur include CRE (Commercial Real Estate), Construction Loans, Leveraged Loans, Credit Card and Auto ABSs (Asset-backed securities), High Yield corporate debt and sovereign debt.
The Lehman Brothers debacle began the second writedown phase. Most commentators assumed that the collapse of Bear Stearns and its rescue by JP Morgan Chase spelled the end of turmoil. However, financial institutions are carrying significant exposure to other asset classes on their books.
This is one reason regional financials in the US, especially in the Midwest among institutions like KeyWest, Fifth Third and National City have been hit. This is also why UK banks and house builders have suffered of late. Investors are waking up to the international nature of the crisis, understanding that writedowns in the UK, Spain and Ireland have yet to occur. Whether Canada and Australia’s bubbly markets join suit in due course remains to be seen.
So, my advice is to sit tight and wait for signs that the bottom has finally fallen out of these stocks and that investors have capitulated. Then, there will be a lot of companies worth buying.
So where are we now in September?
We are at a point where capital ratios at financial institutions are deteriorating while most of the negative real economy effects lie ahead. There are many more writedowns to come.
But no additional capital is forthcoming. This has led to the weakest institutions being on the verge. With Lehman and AIG, we finally went over the edge.
We have not yet hit bottom. There will be much more to come.
European banks: still undercapitalised