“At the peak, all manner of economic sins remain hidden …

… but retribution is now upon us”

To lose on investment bank upon a weekend is unfortunate, but to lose two does smack of carelessness. Banking is a confidence trick and the markets have lost faith in the old broker / dealer investment banking model. And there are a few banks who, like the Monty Python’s Norwegian Blue Parrot, are merely nailed to their perch at this stage. Investment banking as we knew it may be extinct.

The Overnight Wrap

• So you all know by now Lehman’s are seeking Chapter 11 protection (see note below) and that Bank of America is taking over Merrill Lynch in a $44bn share swap.
• AIG who have been playing like the Man Utd back four is in serious trouble and seeking new quick capital. Reuters reports that AIG have approached the Federal Reserve for $40bn.
• Perhaps the most extraordinary news is that the Fed (aka fireman Ben Bernanke) has announced that they have widened the collateral they are willing to accept to include EQUITIES! This shows the degree of the panic and possible contagion out there that the Fed is so desperate as to take SHARES from the dealers to keep them afloat!
• 10 banks have announced a liquidity fund of $70bn to ensure each others safety in a crisis. Any one member can tap the fund for up to a third of the value. Not many banks have $7bn in spare capital! But now they can put up equity to get the cash if needs be…and they will.

Lehman’s Can’t Just Restructure & Re-Emerge!

Note that US Financials do NOT have an option under Chapter 11 bankruptcy protection to restructure as do other businesses. In simple terms the core business of Lehman’s are on a one way street to liquidation under Chapter 7.

As the next potential immediate financial tsunami may come from the unwinding of countless complex derivative trades (credit default swaps) written against Lehman’s. It’s a case of making a claim on your house insurance, but if your insurance company is gone bust, you suffer a double loss as you also had to pay a premium. In short prepare yourself for a fresh round of bank write downs as trades with Lehman’s are worth diddly squat.

Who’s Next For The Chop?

Sure, there will be the usual clarion call from Mr Buy Side saying that this is finally rock bottom. Note some muppet analyst at Citibank had a BUY rating on Lehman’s up until last Thursday with a $35 target for the shares. These people are shameless charlatans who should get out more often. We heard similar guff from Cramer & Co after the bailout of Bear Sterns and the nationalization of Fannie Engels and Freddie Marx.

Arguing the other side, Dr Doom Nouriel Roubini says “all independent B/Ds (broker/dealers i.e. investment banks) are toast, they are highly leveraged, and their business model is fundamentally flawed.” Financials are facing a “disaster”; broker-dealers “are going to disappear.” It’s a fundamental, radical change on Wall Street. He expects WaMu to go under and that AIG is in trouble.

What he is saying it that it’s not much good owning an Off License during prohibition.

The whole financial sector still has enormous capital needs.

Watch WaMu (Washington Mutual), UBS, the US auto makers, AIG (who increasingly appear to be the hippo in the sitting room) and Deutsche Bank (whose balance sheet dwarfs their equity base!) Other’s who look ropey are HBoS, Dexia, ING, Bradford & Bingley and Fortis.

What Do The Central Banks Do Next?
Sleep with one eye open and watch out for the Fed’s FoMC meeting tomorrow. The market is now baying for a 25bp (1/4%) cut but the Fed are running out of ammo.

We are in uncharted territory here but what price a co-ordinated global rate cut (note the “we stand ready” stuff from the BoE this morning)… the ECB won’t like it but…

Data Today
ECB President Trichet is speaking today at 10.00. I wonder what he will have to say about Sunday’s US bank failures and the implications for European banks?

In the US, there is the Empire State Manufacturing Index at 13.30 and August’s Industrial Production at 14.15.

At 14.30, the real action should begin as US equity markets open and react to everything that has happened.