Wall Street Contagion: The Blowback Begins

Let’s all join hands and circle to the left
Break that ring and swing with the girl you love the best
Then you promenade back home with the cutest gal in sight
There’ll be a hot time in the old town tonight

Back in the day, square dancing was taught in elementary school. Hot Time in the Old Town Tonight was my favorite. As a grownup, the lyrics took on new meaning because it embodies the modus operandi of the securities industry so well.
The Economist: A good time for a squeezeLast night, Wall Street was hot as hell, sweltering with rumour and speculation as to what happens next week.
Less than two weeks after “U.S. securities firms added 10,000 staff in June, pushing employment levels in the industry to 848,300, higher than the previous peak of 840,900 in March 2001” [CNN Money], the game appears to be up.
The de rigueur slaughter of sacrificial lambs has begun:
“Bear Stearns Cos., the manager of two hedge funds that collapsed last month, plans to oust Warren Spector, chief of bond and stock trading, the Wall Street Journal reported, citing an unidentified person familiar with the matter.” [Bloomerg]
The inevitable comparisons to past disasters are being made:
“The rapid unravelling of the US subprime mortgage market reminds us of the adage that history repeats itself: many of the sad excesses of today’s subprime market are but an echo of the costly savings and loan crisis of the early 1980s. Perhaps history will have taught the American taxpayer to resist vigorously picking up the bill, which this time around could prove even more costly than the earlier S&L meltdown.” [Financial Times]
Collateral damage surfaces in unexpected, far-away places…:
“At the start of the week, IKB startled markets by admitting it had racked up vast losses on its credit portfolio — a move that prompted KfW, the German state bank, to underwrite around €8bn ($11bn) of IKB-owned securities. But, on Thursday, it emerged that IKB’s exposure to the subprime sector had somehow ballooned to €17bn — many times the total market capitalisation of the group.” [Financial Times]
… big time:
“The rescue of IKB, a specialist lender based in Düsseldorf, began on Sunday when Peer Steinbrück, German finance minister, called top banking executives to discuss a bail-out. According to people who took part in the conference call, Jochen Sanio, head of Germany’s financial regulator, is said to have warned of the worst banking crisis since 1931.” [Financial Times]
Deals in the pipeline are D.O.A.:
“The leveraged debt pipeline is still at high levels, but few of those deals are coming to market. The leveraged loan pipeline, which is full of offerings designed to finance the year’s largest buyouts, includes over $203bn of deals. Among those are an expected $19bn offering for Clear Channel, a $16bn offering for First Data, a $15.5bn loan for Alltel and a $12.5bn loan for Sallie Mae.” [Financial News US]
Lawsuits are filed as former high-fliers go belly up:
“A law firm has filed an arbitration claim against Bear Stearns alleging the company misled investors in two leveraged hedge funds, as the funds filed for bankruptcy.
Zamansky & Partners, a New York law firm which specializes in securities arbitration, filed the arbitration claim on behalf of a Wisconsin man, saying the bank misled investors in its leveraged hedge funds. Attorney Jake Zamansky expects to file up to $100m (€73m) in claims against Bear Stearns on behalf of hundreds of investors.” [Financial News US]

The Economist: A good time for a squeeze

BANKERS and investors might not agree, but the recent sell-off in financial markets is good news. It may, at last, have brought people to their senses. For the past few years, too much money has been lent too cheaply and too easily to too many people, whether it was speculators trying to make a fast buck in Miami condominiums or private-equity groups financing their latest multi-billion-dollar takeover. This wake-up call came too late to save the American housing market from frenzy and subsequent bust. But it may have arrived in time to stop the takeover boom getting out of control–and when the world economy is strong enough to cope with the consequences. — The Economist

Bad as it may be on Wall Street [Cramer Goes Apeshit], the fact is that turmoil is part of the Darwinian Circle of Life in the capital markets.
Things get overdone. They go to hell. Eventually, it starts all over again with a new cast and crew. It has been less than seven years since the dotcom bust. You would think that the experience would have left an impression for a lifetime on anyone over 18, but instead of learning about the common denominators of each cycle — leverage [How Leverage Undermines Traders] and speculation — they just avoided NASDAQ stocks and moved to real estate. Sigh.
Schumpeter called it Creative Destruction: “Every piece of business strategy acquires its true significance only against the background of that process and within the situation created by it. It must be seen in its role in the perennial gale of creative destruction; it cannot be understood irrespective of it or, in fact, on the hypothesis that there is a perennial lull. . . . But in capitalist reality as distinguished from its textbook picture, it is not that kind of competition which counts but the competition from the new commodity, the new technology, the new source of supply, the new type of organization (the largest-scale unit of control for instance)—competition which commands a decisive cost or quality advantage and which strikes not at the margins of the profits and the outputs of the existing firms but at their foundations and their very lives.”
These days, the process feels instantaneous.