The haemorrhaging of hedge funds continued to dominate the action overnight as they dumped stocks to meet redemptions and margin calls and turned the global credit crunch into a stockmarket rout - until the last hour of trade.
Any tentative emergence of buyers on markets is usually being hit by a wall of hedge funds trying to raise cash to survive, but the big rally towards the end on Wall Street this morning in anticipation of a G7 deal was sustained almost until the close. But as we saw the hedge fund selling makes any rally fragile.
And the ghost of Lehman Brothers added to the air of crisis last night with the dreaded auction of $US400 billion worth of credit default swaps written against it, which turned out to be worse than expected.
The Lehman debt had been trading at 13 cents in the dollar, indicating that the payout on the CDS would be 87 cents. In the event, and with pandemonium on Wall Street, the auction produced a price of 90.25 cents in dollar, which is what the 350 or so banks and investors who sold default swaps over Lehman will have to cough up.
According to Bloomberg, this will be the biggest ever payout in the $US55 trillion CDS market.
Meanwhile the rapid shrinkage of the hedge fund industry due to a redemptions run, and the resulting stockmarket panic, is wiping out global retirement savings which will be an important and lasting effect of this crisis. But it is one that the authorities are not focusing on at this stage.
That’s understandable. Their first responsibility has been, and still is, to save the world’s banks, without which there will be no economic activity to speak of and no jobs from which to retire.
The trouble is both the central banks and the politicians have made a complete hash of it so far.
The provision of liquidity by central banks has kept cash flowing to banks, but in some ways this has been ineffective because it’s given banks an alternative to dealing with each other. Why would you deal with a bank when you can go to the Federal Reserve for all your needs?
And this week’s coordinated rate cut of 0.5 per cent was not enough as it turned out. In the context of a complete shutdown of interbank lending and a mass hedge fund liquidation it produced no more than a blip on the screens.
The US Government’s much-vaunted $US700 billion bailout, which President Bush continued to promote last night, has entirely failed to settle markets.
That’s because the transmission of the capital into the banks is too complex, optional for the banks and indirect in its approach. What Treasury Secretary Henry Paulson should have proposed, and will almost certainly be forced to come up with soon, is direct capital injections into banks in return for equity – in other words, nationalisations.
And as for the Europeans … well, up to a week ago they had a completely delusional central bank that was refusing to cut interest rates because of the threat of inflation, like the mad generals fighting the last war.
And there is no European Government and deep suspicion between the haves and have-nots, so coordinated action to recapitalise the locally-based, pan-European banks has been impossible.
The British Government plan to inject £50 billion of new equity directly into banks, plus guarantees for interbank lending as well as extra liquidity, was the best plan yet.
The G20 meeting and the IMF and World Banks meetings, both in Washington over the weekend, must produce something similar on a global basis.
With the benefit of hindsight, it turns out the US Government should have bailed out Lehman Brothers after all - while it was nationalising AIG, putting Fannie Mae and Freddie Mac into conservatorship and organising the emergency takeover Washington Mutual.
This latest, steepening of the downward spiral can be traced directly to the Lehman collapse on September 15. The Bush Administration, along with Fed chairman Ben Bernanke and New York Fed chairman Tim Geithner, made a decision not to save Lehman because the markets had to be taught a moral hazard lesson. The lesson was learnt, but the pupil died.
Now Morgan Stanley is fighting for survival, along with General Motors and Ford, not to mention Iceland.
