There will be some scary times for Wall Street firms in the months ahead according to Business Week writers David Henry’s and Mathew Goldstein’s September 8, 2008 article “More Trash Than Cash.” The writers portray a scenario that could result in tremendous chaos for both Wall Street firms and the capital markets. Christopher Whalen of Institutional Risk Analytics (a consulting firm) summarized the situation saying, “It’s really an ugly time, and it’s only going to get worse.”
The writers focus on the financial results Wall Street firms are expected to report, in the coming weeks, for the third quarter of 2008. JP Morgan Securities has estimated that banks worldwide will suffer an addition $200 billion of losses during this period. This is in addition to the $500 billion of losses that the banks have already taken. Such losses would require that many banks replace lost capital. While obtaining additional capital from investors would be desirable, unfortunately, the available sources of outside investment are drying up and much harder to find. Therein lies the problem. Unless the banks can replace lost capital from investors, they have to resort to liquidating assets in order to maintain adequate capital for regulators and creditors. Under such circumstances, banks could be forced to unload roughly $2 trillion of assets.
If the banks are forced to unload assets, the markets may see a domino effect. Assets sold at substantial discounts from reported valuations would force a bank to realize additional losses. Moreover, such sales would establish “market values” for instruments that had previously been valued at “fair value” (based on a firm’s assumptions and internal projections). Such sales could also force other banks and customers to have to write down their portfolios as true market values of their holdings could be more objectively determined. The whole situation is fraught with danger.
The situation could become even more serious because there are only limited buyers for such assets and many of them are “vulture” investors. These investors are likely to remain on the sidelines until prices hit rock bottom. In summary, the Wall Street banks are facing liquidation of large blocks of assets into a weak market with limited demand. For example, in July, 2008, Merrill Lynch was forced to sell $30.6 billion of collateralized debt obligations for $6.7 billion. Moreover, Merrill had to finance 75% of the purchase price in order to consummate the transaction.
Meredith Whitney, star bank analyst for Oppenheimer & Co., joins the BusinessWeek writers in believing that the banks are facing much bigger credit losses than they’ve reported so far. “What’s ahead is much more severe than that what we’ve seen so far,” Whitney says. Whitney believes that the banks have failed to properly value many assets on their balance sheets. She urges that the banks need to “get real” about valuing their problem mortgage-related debt. The day of reckoning may be closer than ever she thinks.
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