Monday, July 07, 2008

Bizarre facilitators of downward spiral in financials

The downward spiral in financials is being aided by what would seem to be an unlikely source, that's the financial companies themselves. In this extremely fragile market for the sector, any bad news more or less affects everyone in the group even if it affects the culprit or culprits of the day somewhat more than others. So it seems odd that just about every other day the analysts at Goldman, or JPMorgan, or Citi, or another major firm emphatically downgrade a few of their industry peers or associates, projecting ever deepening losses. Down, down, down they all go, call it the analysts' revenge. Today's shock research news from Lehman sent Fannie and Freddie tumbling, the market reversed, and now Japanese banks are sliding. Strange really that Lehman, who along with the departed Bear Stearns was the market leader in the mortgage backed markets, would lead this charge. The Lehman analysts got the headlines and scared the bejesus out of already terrified investors, by highlighting that the FASB, the accounting rules making group, was considering new accounting rules that may include rules that would require Freddie and Fannie to raise massive amounts of new capital but that it is likely that Fannie and Freddie would be exempted from those new rules if they were instituted. Hmm, sound like a done deal?, sell, sell, sell, there's no more appetite for risk, none, can't take any more chances, losses are already too great.

Veteran Lehman analyst Bruce Harting and his team are now in financial headlines around the world. The nuance of their comments is ignored and they of course knew that it would be. Why is this self immolation occurring.

One could say that some firms that have been busy handing out downgrades, notably Goldman and JPM, could possibly have some Machiavellian rationale, being in the top tier of a deteriorating industry that will thrive near term only on market share gains as the revenue pie is getting smaller. You certainly couldn't make that case, however, for the analysts at Citi and Lehman. Thinking that these self fulfilling downgrades are just the result of thorough analysis and letting the numbers speak for themselves would be the stiff upper lip approach, all's right with the world, but it might be naive.

Could this be the analyst's revenge, their time to grab the limelight after being shut out of the big salaries and big media audience by Spitzer's castration of their profession. That has been a disaster on all fronts with the exception of Spitzer getting to be governor for a few months but that's another story. But to touch on this tangentially, the brokerage firm securities analysts were once viewed as being controlled by the corporate finance departments and the main line institutional investors. With the link to corporate finance departments not possible in their paycheck, the best analysts departed and the major institutional investment firms began relying on their internal sources more than before. Other than their corporate office there's now only one major constituency that these brokerage analysts work for...

That's the high volume trading hedge funds, that have enough flow to actually have commissions add up to meaningful numbers for these analysts' firms and who can hire analysts who have done good work for them when they leave the Street, and pay them more in one year than they made in ten years working for the brokerage firm(it's an exact parallel to members of Congress departing to work as lobbyists and consultants for massive salaries, or even the head of the executive branch doing same).

It's so obvious that no proof is needed some might say. Combine this flawed brokerage research analyst function with bad mark to market accounting rules(discussed in eyesnotsold previously and agreement here with Steve Schwartzman actually) and the ever vicious competitive nature of Wall Street(never to be underestimated), and then mix in the predatory nature, huge wealth, and unconstrained practices(no uptick rule) of the trading hedge funds and what you get is a financial system under intense pressure that will not likely ease soon.

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