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Requiem for investment banks?

The shorts got squeezed with a vengeance on Thursday morning as rumours began to circulate that Helicopter Ben was about to morph into Stealth Bomber Ben and an imminent Fed easing could halt the death spiral of the markets, the proverbial classic Minsky moment that precedes monetary Armageddon. When the Nikkei Dow plunged by 5 per cent and the Japanese yen rose 10 per cent against the Aussie dollar and the Kiwi, I was certain that the panic unwinding of the carry trade could mean certain Black Friday on August 17, 2007, a ghastly Dow plunge of as much as 3000 points. This was the scenario that would have haunted Bernanke and shaped his legacy, as Black Monday was Greenspan's baptism of fire and the anti-inflation crusade / Third World sovereign debt made Chairman Volcker a legend.

So I began aggressively buying the shares and call options of Goldman Sachs and Bear Stearns on Thursday, positions that rose by 20 per cent in the next twenty four hours. Sometimes it takes a global financial crisis to set up a mother of all money making trade on Wall Street I-banks. As a long/short equities manager whose mandate is both macro and global, I have also been trading risk aversion in the foreign exchange market, mainly yen options, volatility swaps and Aussie/Sing dollar/Russian rouble NDF's. Bliss it was that dawn (of a rate cut. Forgive me, William Wordsworth, for butchering your poetic fantasies to make my point) it was to be alive but to be long high beta Wall Street brokers and in the money, high delta September call options on the CBOE was pure heaven. Interestingly, Merrill traded exactly at my worst case scenario at 67, pinpointed in my short Merrill recommendation six weeks ago at 90, when I was pooh-poohed on my call at a DIFC party to welcome the Merrill President by some of the top bankers in town. Institutional thinking can lull the witness into being long and wrong even if iconoclastic, independent, what-me-worry type of financial thinkers are a royal pain in the derrière to the hold and the bureaucratic of UAE finance. As a trader, I cannot forget Lady Caroline Lamb's description of Lord Byron, my hero since boyhood. Mad, bad and dangerous to know, exactly like the schizo financial markets I love beyond all else in the money world.

The Fed's discount rate cut will do little to address the subprime meltdown or the trauma in the corporate bond, leveraged loan, high yield, CDO and credit default swap market. Sure, it makes a FOMC easing inevitable in September but even a 4 per cent Fed Funds rate is not going to save the US from recession. Sure, the pinstriped poms poms who advise private clients in the UAE (the professionals need no advise other than the flutter in their gut or the Eureka moment in their statistical equation, both equally respectable ways to lose money) now going to go into serious hand holding mode. But Chandababa aint gonna go to sleep that easily, not if he is leveraged to his eyeballs, a fate most financial geniuses on commission payouts ensure for their clients.

So what's the real story? The Fed did not bail out the asset markets, it acted as the lender of the last resort, as it did in 1998 when Merriwether's LTCM went ballistic on 1984 when it nationalised Continental Illinois Bank in Chicago. The default rate will surge as home prices continue falling and almost a trillion dollars of adjustable rate mortgages (ARM) reset in the next twelve months. This means recession is inevitable. Note that the price of nickel has lost 50 per cent of its value in the last month and oil is down $8 during prime Gulf of Mexico hurricane season. Real interest rates are far too high in the US as financial distress will take down hundreds of subprime lenders, hedge funds, CDO investors and insurers, international banks. There is no way the repricing of risk or the spike in volatility has reached its peak. Sure, the Street is meant to soothe and sell. But this humble column consistently proves the big boys of Gulf finance wrong. Who called the end of the UAE stock market bubble in summer 2005? Who called an international global emerging market crash in New Year 2007? Who recommend a Merrill Lynch short at 90? Who predicted a plunge in dollar interest rates in 2007? Who lost his shirt in Citigroup call options? A trader who does not love his losses in doomed because I know I will bleed but never, ever hemorrhage my cash.

The credit crunch has exposed the Darth Vader netherworld of the global capital markets. Hello, the Black Death in CDO will spread financial cancer to not just Citi or Morgan but the entire international banking system. The credit default swaps and mortgage derivatives market is an accident waiting to happen. Funding risk for banks, rollover risk for borrowers, credit risk in the commercial paper and Euromoney markets will haunt the world of finance. Remember, jumbo deals will not get done at a higher price, they will never get done at all Period. Price discovery and issuance in the debt market is doomed.

This is seriously bad news for Wall Street investment banks. While subprime origination, trading and syndicate exposure is a mere 3 per cent of global revenues, this credit crunch is no longer just about trailer trash unable to pay back inflated loans. Volatility in the CDS market has jumped fivefold for Bear Stearns, threefold for MS, MER, GS. Fixed Income inventory risk will mean billions in losses as hedges proved useless for net long credit dealers. While price/book multiples for investment banks are the lowest since Enron/Worldcom, there is no immediate light at the end of the tunnel. Sure, fear creates lovely trading opportunity, as my Merrill short and Goldman long proves, because only Chicago School egghead finance professors believe financial markets are efficient (ever visited the floor of a Third World exchange?) Current prices suggest a 20 per cent hit in sector earnings.

Spreads will go wider in high yield and emerging market debt. Debt Issuance, IPO, convertibles, secondary offerings will plummet, if not end. The buy side has turned risk averse. A Congressional witch hunt against the rating agencies and the Wall Street banks has just begun. High yield bond issuance has plunged 50 per cent, as has mortgage backed securities and asset backed Eurobonds. A major German bank in was bailed out by its Grossbanken big brother in Frankfurt run by Emperor Josef Akermann. The Private equity bubble is over, as one fourth of all M and A deals were financial sponsors. The LBO pipeline is $240 billion. Who will finance it? Not shell shocked banks. Hedge funds were buyers of the last resort for Wall Street's toxic waste deals and I expect several thousand hedge funds to go bankrupt as clients redeem in panic. The only silver lining on Wall Street? Borse Dubai has offered a 230 Swedish kroner all cash offer for Sweden's OMX. This is a 17 per cent premium to NASDAQ cash /paper offer of 197. This means a bidding war is inevitable. Will Dubai Borse bag OMX? Doubtful. The Wallenbergs are patriotic Swedes - Ericsson, Saab, Alfa Laval, Investor. Peter Wallenberg was a Wharton classmate, his cousin Freddie a dear friend. OMX and NASDAQ management envision a global footprint, something Dubai Borse cannot ensure. DFM and DIFX are not exactly global exchanges. A white knight? Possible. A higher counteroffer from NASDAQ despite dilution risk? Yes. In any case, the most juicy money making opportunity on a Dubai deal since the P and O bidding war with Singapore. Stay long Sweden's OMX!