Let’s see if we can make sense of the financial meltdown in the US, as it is completely counter-intuitive if you watch any of the news coverage.
Lehman Brothers, an investment bank, went into the toilet on Sunday/Monday, essentially owing more than they had. At the same time, Bank of America bought Merrill Lynch, as Merrill Lynch owed more than they had, getting Merrill at a fire-sale price. Meanwhile American International Group is looking for international money to prop up their share price. Goldman-Sachs, yet another investment bank reported "disappointing" quarterly results today. Morgan Stanley is expected to follow suit with a crappy quarter tomorrow.
FYI: None of these organizations are ‘banks’ in the sense that they take depositors’ money and loan it out to other folks. These are investment ‘banks’ that buy shares in other companies, or buy derivatives of shares, or hedges, or simple gambles with Other People’s Money.
Each of these financial meltdowns are traceable back to the mortgage lending fiascos of the past few years. A side of bacon and a box of rocks could get a $250,000 mortgage with nothing down, no job, no prospects of a job and not even so much as a pulse.
The companies that sold these things made all their money up front, with their service fees, documentation charges, lending fees, paperclip fees and charges for the air that they breathed in. Some would even roll the fees into the financed amount so the side of bacon and box of rocks could move in next week. Naturally the mortgage company, essentially paper shifters, didn’t want to own the mortgage, they wanted to package a couple of hundred of these loans up and sell them.
Investment banks looked at the title "Mortgage-Backed Security" and figured, What the hell, why not? Mortgages are sensible investments and if worst comes to worst and ten percent of the loans are dogs, we wind up owning a few houses. However, to ensure that the dogs wouldn’t drag down the price, they packaged several smaller packages into larger packages and then sold the lot to other investors, collecting their fees, commissions and nickel and dime charges up front.
The buyers, usually larger investment houses and funds would figure "Hey, Merrill Lynch doesn’t sell crap, so we’ll charge our customers a premium for getting a piece of this pie." So they did, again making their money up front.
Every quarter during the last few years you would hear about ‘whispered’ numbers and ‘street numbers’ regarding the quarterly profits of all the investment banks. What these are, essentially, are rumours and semi-educated wild-ass-guesses by other gamblers regarding who is going to report what level of profit per share, the dividend. At the same time the stock market is betting, via the share price, that everything is peachy. Meanwhile others are betting that the share price is going to drop and splash up like a high-fibre turd.
This translates into brokers, depending on their orientation, calling their customers, be it individuals, or groups of investors and screaming "buy" or "sell". Oddly enough these brokers and their companies, depending on their insider knowledge, gut feel, or corporate line, make commission on the sales.
Then there are the nay-sayers who have a bunch of buyers lined up to buy shares after the bad news hits, the so-called dead-cat bounce, who own the shares for a hour or two, then sell it at the peak of the dead-cat bounce to others. More commission changes hands as one group bets that the dead cat will bounce a little bit higher, or lower.
We’ve seen the counter-intuitive. Merrill Lynch’s share price went up when it was disclosed that it was being bought, while Bank of America’s shares went down as the buyer. This is nothing more than insiders betting with Other People’s Money, hoping to make a few thousand dollars selling a cadaver before the autopsy.
Lehman Brothers, Merrill and hundreds of other investment ‘banks’ are running what is little more than blatant insider trading in rumour, innuendo, suggestion and a complete lack of due diligence. Essentially they are no better than the idiots who bet on slot machines or dice, or even the lottery. Except they get to charge a commission on every bet with Other People’s Money.
More correctly, your money. This would be your RRSP, or 401-(k) or your mutual funds, or even your mortgage. When the investment ‘banks’ lose money, they have to charge more and this affects your finances.
The real banks say that expenses are up, so they have to charge more, or turn down people, or stick a whack of fees up you to nickel and dime their way back to the ‘whispered’ number of a quarterly dividend being bet on by brokers playing with Other People’s Money.
RoadDave 