Wednesday, July 30, 2008

"Financials Are Still Reeling".....

I recently wrote this post concerning what will need to happen to speed recovery in US fixed income and housing markets. In that post, I discussed the continuing damage that 'mark to market' accounting valuation is doing to investment and commercial banks holding untradeable CDOs and other structured finance instruments.
In its weekend edition, the Wall Street Journal published a piece by, entitled "Financials Are Still Reeling."
No kidding. And why not?
Merrill's recent capital infusion of yet another $8B to cover even more writedowns makes the point quite elegantly. Today's Wall Street Journal attempted to suggest, via its article's title, "Thain's Housekeeping Spiffs Up Merrill," that the ailing brokerage firm is on the mend.
Don't you believe it.
As the nearby Yahoo-sourced one-year price chart for Merrill and the S&P500 Index shows, the financial services giant's price has collapsed by over 60% in just a year. Yes, a little blip of a daily 8% or 12% pop will occur, but on a pitifully-low base price. The bleeding is just not going to stop.
You see, this entire financial services debacle is unique because it involves tradeable instruments. Whole loans could be valued at par so long as they were performing. But once magically transformed via financial engineering into CDOs and their ilk, market price became the dominating valuation metric. And, as I and others have noted for some time now, markets for structured instruments can vanish in an instant. Thus, zero price.
There is no ability for anyone to know how much is a sufficient writedown of an asset with no trading market, except 100%. And who wants to do that?
Thus, over the past five years, as the nearby Yahoo-sourced price chart for Merrill and the S&P500 Index displays, the brokerage is down nearly 50%. Any outperformance managed through 2006 evaporated beginning in mid-2007.
Yes, financials are still reeling. And it won't stop until all the CDOs are basically written off. Totally.
Or, short of that, a vibrant market suddenly erupts all at once as a few hedge funds and private equity groups, like Paulson's ,written about in yesterday's Journal, swoop in and briefly create a market in the instruments for pennies on the dollar.
The holders will get to value the instruments, though probably at lower values than they wished. But above zero.
As I've written elsewhere, these private firms will then enjoy a spectacular rise in value of these structured instruments which are mostly still performing assets.
But for publicly-held companies, there's absolutely no reason for any investor to take a chance on what has become a blind pool of assets which are valued based upon non-existent markets for complex instruments.

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