Resolution? Trust? A Jedi seeks not these things!

I hate to say it. But we need this. There needs to be massive government intervention to create some degree of confidence. It would be one thing if Lehman and Merrill and WaMu and AIG all went under (or were taken out under duress). But now they are coming for Morgan Stanley and Goldman Sachs.


That just can't happen.


Look, the financial world is a confidence game. Even simple trades involves confidence. You put your money into a Merrill Lynch account and buy a stock, you assume they're holding that stock. Hell, you assume the money market fund they use is safe. You assume your bank will be able to cash your checks. Etc. Etc.

Once that confidence is lost, the system can't continue. Everything will break down, and I mean everything. Our whole economic system would collapse.

Spare me the moral hazard arguement. What about the reverse? Should Goldman Sachs pay for the sins of Bear Stearns? Should Morgan Stanley pay for the sins of Lehman Brothers? Look maybe no one is completely innocent here, but it seems to me that Morgan Stanley is petty theft whereas Bear Stearns was a serial killer. Should we execute both?

Its sad that its come to this. But I don't know what else we were supposed to do. I want to live in a Libertarian/Capitalist paradise as much as anyone. But if we waited for the market to figure all this out, we'd be left with no capacity to finance anything. Our economy just won't work like that. No capitalist economy could. Its called capitalist for a reason. We need capital to make it work.

Bonds are highly illiquid right now. Even Treasuries are showing unusual bid/ask spreads. There are many many many players who are going to be caught on the wrong side of this thing. On top of that, there are many players who are going to (quite reasonably) want to flatten their positions and wait to see how this plays out.

In corporates, especially Goldman and Morgan, potential sellers have disapeared so as far as I can tell, little is trading currently. CDS are gapping tighter of course. There will be a serious short-squeeze in CDS before things stabilize.

Some hedge funds are going to get crushed. I mean, anyone who was leveraged short financials may wind up getting busted out. That will result in some weird trading in seemingly unrelated instruments. Hence, I think you would be wise to not chase this move too aggressively. If you can find stuff that's lagging merely because it isn't getting any attention, fine. But don't over play it.

Personally (not professionally) I'm looking to reset a dollar short I've had. While this may be the right move for the economy, it isn't good for our currency.

Lehman Brothers: Bounce too close to a supernova

I have nothing to say about Lehman itself, except to say that I really and truly believe they could have remained solvent in a more normal market. I'll also say I'm surprised no deal emerged as it seemed to me like there were enough parts worth buying. But deep down, I think Barclays in particular was scared that if they bought "Lehman" assets, the market would have seen it as nothing more than "Lehman" assets. In other words, Barclays might have gotten away with buying the same assets from someone else, but the very fact that they were Lehman's would create a special stain. What would then stop them from coming for Barclays? Ultimately, it was too risky.

On the market overall, it should be lower. Goldman and Morgan Stanley are going to have to merge with a bank. Period. Even if its a bank that's smaller (say a U.S. Bank), it will have to be done to diversify their funding sources.

This also pushes back any kind of recovery for the economy for a long time. I was thinking 3Q 2009, but now I'm thinking at least a year beyond that. I could be convinced to move off that either way by incoming delinquency figures, but for now I'm thinking year-end 2010 before any improvement in the economy.

So I've further reduced my credit underweight and increased Treasury exposure. The risk on Treasuries is the dollar. Most of the Treasury rally in September was dollar related up to today. For the moment we're getting a big rally on fear, which makes sense. But if the dollar starts to get pushed around, the Treasury market won't hold up.

Right now I'm willing to bet on Treasuries because I don't think Europe is any better off, and in fact I'd expect interest rate differentials to favor the U.S. on the margins (i.e., Europe will cut rates). But the situation is fluid enough to where I'm watching everything very closely.

This is truly uncharted territory.