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Banks on the Verge of a Nervous Breakdown
by: Stock Lobster posted on: September 16, 2008 | about stocks: AIG / BAC / CIT / LEH / MER / SKF / UYG / WB


"October. This is one of the peculiarly dangerous months to speculate in stocks. The others are July, January, September, April, November, May, March, June, December, August, and February."
~ Mark Twain, (1894)

Operating Principles cube: It's a cool cube made of smaller cubes that opens up in different ways and you can read all the different principles like... "Demonstrating smart risk management."
~ From current Ebay auction of a genuine, shrink wrapped "Lehman Operating Principles" cube

The boys of summer are in their final innings, political candidates are brewing up new batches of curare, God is in the heavens, and all is well with the world, at least as well as may be expected during a $1.5 trillion dollar global credit crisis. Alons, mes enfants, are we having fun yet? A behind the scenes effort to roust Hedge Funds and Pension Funds out of oil and commodities has borne fruit in the shape of $100/barrel oil and $750/oz gold. However, an improbable rally in financials triggered by the SEC's "No Crappy Bank Left Behind" shorting rule is but a distant memory.

Shorters, both naked and clothed, have ignored the 2 child per couple guideline, and are proliferating like black flies at a Maine rest area. Reports of continued billion dollar losses at premiere banks are fomenting a short-position feeding frenzy amongst traders, still bruised by the indignity of having been forced to cover their shorts on financials, which after all, really were that badly off.

Let's check the latest developments in our late summer banking debacle:

* This weekend, following the kind of furtive deliberation and consumption of double espressos which normally precedes the election of a pope, the emperors of the banking world gave Dick Fuld (who wasn't even permitted to be present at his own sentencing) the thumbs down, and threw Lehman (LEH) to the lions. The stock becomes the latest of former Wall Street blue chips now trading below the value of a first class U.S. postage stamp. The stock, which had closed at $3.65 on Friday, opened at 25c, and quickly plunged to 17c. Dick Fuld, who had hardly been heard from in preceding weeks, and which rumor had it was hiding under his desk, is said to have scheduled session one with a Reality Readjustment coach. Meanwhile, former employees of Lehman are busy auctioning off memorabilia from the defunct firm. No word if Neuberger Berman and other Lehman assets will be found there as well, but Lehman Brother investors can find some merriment in a t-shirt which proclaims "I Invested My Life Savings in Lehman, and All I Have Left is This Lousy T-Shirt."
* Sharp-eyed pedestrians below 70 Pine Street last week had reported that AIG (AIG) was seen standing on the ledge of a high floor: smoking, listening to Nine Inch Nails, The Smiths, and Depeche Mode on its iPod. This sighting immediately led our traders to load up on SKF, XLF and AIG puts. Word is that AIG, like LEH, IMB, and BSC did before, has been running up its cellphone talking to old girlfriends and psychics, as well as checking on its bank balance. Meanwhile, the morbid, the curious, and the short are checking on the iPod selections and cellphone bills of Washington Mutual (WM), Citibank (C), Wachovia (WB) and even Morgan Stanley (MS). Something about billions of dollars of credit derivative exposure and bill collectors starting to call on weekends.

(Click to enlarge)

* As I write this, all eyes remain on AIG as it steps closer to the edge, threatening to take its $441 billion in derivative counterparty risk with it and causing credit spreads to "blow out" to levels last seen during the dark days of BSC's swan dives, according to JP Morgan's Sally Auld, despite the fact that last year we were reassured that the same indicators confirmed Lehman to be no Bear Stearns. Hank Paulson is said to be one of the growing throng of spectators watching AIG with binoculars and walkie talkies, but no word as of yet whether the Federal reserve is going to send in a SWAT team to get AIG back inside, or whether it is present merely to measure the size of the hole which AIG will create when it hits the ground.
* Merrill Lynch (MER) was sold over the weekend to Bank of America (BAC) for a purported $29/share, and yet Mr. Market refuses to bid the stock anywhere near that price (when last seen, MER was skimming near $20.50), and so far BAC is hardly acting like the euphoric winner of a valuable prize. Of course we know that Mr. Market is confused lately, eagerly awaiting the Treasury's yet to be announced "fresh assessment" or what we might mistakenly believe to be a financial crisis, but nevertheless, you'd think he'd be snapping up a bargain when he saw one. The fact that the bride is ugly and the groom rumored to be behind on his child support payments, should have nothing to do with it. Nevertheless, Harvey smells a rat, or at least an untended hamster, and won't have anything to do with either MER or BAC for the moment.
* Jefferson County in Alabama, was seen drinking brown liquor in public and throwing something, maybe CDOs, off the Tallahassee bridge. Security Capital Associates (SCA), Ambac (ABK) and MBIA (MBI) deny they were anywhere near the bridge at the time.
* Ben Bernanke, aerial acrobat of the U.S. Federal Reserve, is apparently heeding his doctor's warning and avoiding any encounters with stray microphones or press stenographers. Rumors that Ben has been invited to play bridge under Dick Fuld's expansive desk at 745 Seventh Avenue are yet to be verified.
* Hammering Hank Paulson, the purported secret identity of mutant Xmen Professor Charles Xavier, has been surprisingly reluctant to extend the Treasury's catering facilities or financial largesse to Lehman Brothers. Perhaps Lehman signaled its distress too far in advance, giving Treasury officials plenty of time to put their numerous phone numbers on "ignore", or perhaps Hank, recently exhausted by the return of adolescent prodigals FNM and FRE, is reluctant to take on any new market orphans. LEH was left to spend the night outside, and became the latest in a sad string of U.S. financial bluechips to now trade at the price of first class U.S. postage. Meanwhile last week, on Traders' Asylum (our own refuge from analysts who repeatedly declare that financials have seen 'the bottom'), Harvey was recommending NJSUZ (LEH September $2.50 puts) as a long term lotto ticket at 10c. The joke is on Mr. Market, because Friday, LEH printed $3.66 after hours and those puts closed at 70c. The unthinkable has become the probable. Of course as a sensible trader, I never would have suggested such an extreme play, but Harvey, market cynic that he is, said there was a particular odor around Lehman, a powerful scent reminiscent of untended litterboxes.

Now, none of this should take anyone by surprise. In June, perma bear and perennial cassandra Nouriel Roubini forecast much of this on Tom Keene's invaluable Bloomberg show, and in July he stated that Lehman would be the next to go 'belly up', the FDIC would run out of funds, and other cheerful revelations which surely make Mr. Roubini the life of any realtor's party in Manhattan, but which neverthless I posted for readers who by now are used to party pooping news (RTT: NYU Professor Nouriel Roubini Says Lehman Brothers Is Next To Go Belly Up).

Personally, I'm still not sure why, after 5 years of consistently winning forecasts, that traders who desire to make (rather than lose) money are not glued to the next words of Mr. Roubini and Mish Sheldrake; but there's the market for you. I guess some people feel that knowing what's going to happen in advance might remove some of the thrill, and diminish the casino-like allure of the mirage known as the stock market. To each his own.

Me, I'm old fashioned. I like money, and I like keeping it. I sold my house in Connecticut in 2005, after I took a quick look at the number of borrowers making $50,000 who had bought houses worth $500,000 with interest-only ARM mortgages. Handicapped as I am by a profound resistance to creative advanced finance, I was forced to rely on basic mathematics, an unloved tool on Wall Street which nonetheless shows a surprising ability to predict impending disaster. I hear Harvard Business School is considering adding it to its curriculum in 2010.

Armed with similar Stone Age analytical tools, we've been been recommending shorting financials for over a year, with the brief exception of a period beginning July 16th, when the rules of gravity and common sense were temporarily suspended by a direct order from the chairman of the SEC, a period I will call (with a nod to Jacobins) the "Humidorian Reaction." However, it seems the powers to suspend reality are, sadly, limited to a period no greater than 30 days, and so honor, grace, and the law of physics have once again returned to Wall Street. Woe to those who thought that flying pigs were a new genetically modified product engineered by Genentech.

40% daily swings and 30 minute rallies have become the norm, and the sight of the cream of US financials plunging 75% in a week has become another ho-hum event. What's a trader to do? We are holding steady in our XLF $18, $17 now $15 puts, AIG puts returned 300% gains overnight, WM an easy double and we are also in SKF, QID calls, in addition to shorting just about every financial this week. (WB, BAC, CIT, and UYG puts the obvious candidates). QQQQ and SPY puts are also a natural choice as the markets begin to reflect the red in the leaves. Prudent traders may also add to this list tins of canned food and at least one steel umbrella to prevent additional brain trauma from all of those falling shoes and knives.

In addition, in the interest of public safety, I have compiled short guidelines of 10 Safety Tips For Times of Extreme Market Turbulence:

1. Never borrow money to buy a stock. If you have a death wish, it is far easier and faster to take a bath with your toaster. Borrowing money to buy stock is, however, more convenient than the seven day waiting period required for purchasing a handgun.
2. Never recommend a stock to friends or family members, unless you like the thought of receiving death threats for the next ten years, being ignored at Holiday festivities, or forever being known as "the schmuck" who recommended they buy Fannie Mae at $15.00.
3. Do not frequent single ticker message boards. Single ticker message boards are unfortunately often stealth distributors of cyanide laced Koolaid, and recruiting stations for brain eating stock cults. Such cults, while mesmerizing and strangely addictive, often end up with bizarre rituals of group financial suicide. In addition, cult members are often missing a chromosome rendering them less than ideal mates. Should you find yourself inadvertantly trapped in a stock cult which is on a well planned collision course with the earth's core, or SEC regulators, please identify all exits ahead of time for an emergency escape, and consider a 50% loss as Mr. Market's way of telling you that 'they trade best who trade alone'.
4. Be extremely cautious of "no brainer" picks recommended on such boards. These are recommendations for people with no brain. Truth.
5. Anytime you hear a "boat" or "truck" reference in the same sentence as buying a stock, be alarmed. 'Loading the boat' and 'backing up the truck', should immediately conjure images of martime disasters, refugee flotillas, stolen merchandise, and traffic accidents covered by a news helicopter.
6. Practice 'safe speculation' (an oxymoron I know), and never put all your eggs in one basket, unless you like the idea of a big, runny omelette with bits of eggshell and wicker in it.
7. Contrary to a popular 19th century belief, the best time to buy is not when blood is running in the streets, unless you like the idea of owning a mangled corpse. These concepts do not apply where the the stock may have been attacked with the lead PIPE of dilution or due to be demolished as a public health hazard due to billions of dollars of ABS having been found rotting in the basement. In such cases, the blood can run for weeks, leading to the stock's agonizing demise trading in the range of first class U.S. postage. Think of those sharp investors from Kuwait and their "fire-sale" purchase of MER from a few months back.
8. In the event of a sudden sharp loss of buying pressure, keep the aisles clear, an eye on the escape hatches and remember that at these times market orders are your friend.
9. Should extreme market volatility cause you to become suddenly ill, do not put your computer at risk. Professional traders keep a copy of the Wall Street Journal near at hand for these occasions. Investors Business Daily is also quite absorbent.
10. Remember that bears make money, bulls make money. Pigs with dreams of a $1.00 financial stock returning to $80 in our planet's lifetime, get a complimentary ride through the Cuisinart, and generally end up as a side dish to breakfast.

http://seekingalpha.com/article/95926-banks-on-the-verge-of-a-nervous-breakdown