It took the SEC more time than expected to officially ask the question that the media has been asking for over a week. If Lehman used the Repo 105s so “successfully” why would other Wall St. firms not have done the same? Financial engineering that works well in one place should work well elsewhere.

The SEC has asked in specific if Repo 105s were used by the nation’s largest financial firms and if so, how often, in which countries and with which counterparties?

Valukas called the Lehman practice “deceptive and misleading”, but stopped short of saying it was illegal. That determination will be left to the SEC and Justice Department. Ernst & Young, the auditor for Lehman, has begun to argue in public that it did nothing wrong in its analysis of the investment bank’s figures and should not be blamed or shamed in public.

Ernst & Young, however, is not out of the woods yet as the SEC looks further into Repo 105s. This means the banks themselves are also still in trouble. The SEC will have to go back and recreate what the earnings of any of the financial firms that used Repo 105s would have been if the off balance sheet transactions had not been used . The issue is complicated by the fact that the federal government had “ownership” relationships with a number of large banks due to its TARP investments.

The audit firm participation may raise a series of liability questions. Auditors either were aware of Repo 105 transactions or should have been. Off-balance sheet transactions, if they are misleading, should have been flagged to CFOs, in writing, as a matter of concern, and those concerns should have been passed along the to audit committees of the boards of directors.

The Repo 105 issue is starting to look a bit like the mortgage-backed securities question. The cost of the Repo 105s will not be nearly as earth shattering as mortgage-backed troubles were, but it raises the question, once again, of where boards, auditors, and regulators were when bank executives decided, perhaps in a relatively benign way, to cook their books.

Douglas A. McIntyre

We do not really subscribe to the notion that executive compensation is the major issue in troubled institutions nor do we subscribe to the notion that executives should generally be slammed over their compensation packages.  Even if our markets are arguably no longer purely free markets, we are not yet in the world of pay caps. 

Congressman Henry Waxman questioned Fuld about his total compensation of some $400 million. He noted executives taking personalhelicopters to work, a $14 million home in Florida, million dollar paintings in his collection and much more.  Fuld has blamed naked short selling and rumor mongering overleverage and regulation over the failure of Lehman.  Fuldtoday discussed selling stock and stock options and said he did not knowthe exact number of he shares currently owned.  He did note the number ofaround 8 million shares today rather than 10 million which had been discussed.  Fuld also hintedthat he had far less influence over the compensation committee atLehman than he did the 1990′s.  But even as the questionscame, Fuld seemed rather unprepared.

What is interesting here is that this new environment of Uncle Sambailing out entities is going to set the precedent for manyhearings in front of oversight committees.  Executive compensation isgoing to be a part of the new bailout package.  It seems that more andmore CEO’s of failing financial institutions are going to get to answer one key question upfront each and every time they are in front of oversight: "Sir, howmuch have you made at this company?"

This won’t come in the form of "How much are you making right now?"…CEO’s and other executives are going to have to answer for the past aswell even for when things were running great.  Frankly, the magnitudeof such issues is very scary if you believe in free markets or if youbelieve in quasi-free markets.

How far this is allowed to go is stillunknown.  We have yet to have any real government buying of securitieswith this new $700 billion off the printing presses.  So we in turnhave no real idea of what to expect on this front.  The main issueahead to be about golden parachutes for executives wheninstitutions fail or become troubled.  But if you listened toCongressman Waxman today, you might begin to wonder if things will beallowed to get much broader in scope or if this is just a sideshow before dealing with issues which directly lead to failure.

Fuld really didn’t seem prepared for some aspects of today’squestioning.  For executives of financial firms in trouble, there aresome obvious lessons to be learned from today’s testimony.   

Jon C. Ogg
October 6, 2008

According to The Wall Street Journal, "The deal will vault J.P. Morgan into first place in nationwide deposits and greatly expand its franchise." The people who get drawn-and-quartered in the process are the WaMu bondholders and those who own the common stock. Washington Mutual shares were at over $36 a year ago. Now, they are worth nothing. About $50 billion in market cap has been destroyed.

The failure, the biggest in US history, does not mean much. Depositors are protected. The beating shareholders take is no different than any other when a large company fails.The system worked well. A healthier firm got the pieces of the failed firm on the cheap. JP Morgan will be the better for the deal and when the financial markets recover, the purchase of WaMu’s assets may look like the deal of the century.

The collapse of WaMu was similar to what happened at Lehman. Outside firms including Nomura got some tremendous financial property for next to nothing. The Japanese company had the capital to do what Lehman could not. The assets which Nomura bought may be temporarily impaired, but the stronger company can wait that out

Physicists claim that energy is never lost. It simply changes from one form to another. The current banking process may show that capital acts in roughly the same way, at least over long time periods.

The purchase of WaMu’s assets again raises the issue of whether the government bailout of the financial system is necessary. Private capital has picked up the pieces of several bank and brokerage failures and the process has happened with speed and efficiency. Capital is available if the deals are good enough.

WaMu failed and, except for a relatively small number of shareholders and employees, no one should care.

Douglas A. McIntyre

Reuters writes that the National Retail Federation says that this will be the worst holiday season in at least six years.

Reuters reports that the head of Caterpillar (CAT) says that the financial crisis has not hurt the company’s financial arm.

Reuters reports that Toronto-Dominion looked at a bid for Washington Mutual (WM).

Reuters says that September auto sales are expected to be slower that August.

Reuters say that the CEO of AIG (AIG) will have a list of assets for sale by next week.

The Wall Street Journal reports that the Fed relaxed rules for private equity firms and private investors to take stakes in big banks.

The Wall Street Journal reports that doubts about the rescue plan pushed the dollar down and oil prices up.

The Wall Street Journal reports that auto loan firms are suffering through a period where they have little liquidity to extend credit.

The Wall Street Journal reports that the head of Circuit City (CC) left the troubled retailer.

The Wall Street Journal reports that Bristol-Myers (BMY) raised it bid for Imclone.

The Wall Street Journal writes that Microsoft’s (MSFT) shares rose on news of a huge share buyback.

The Wall Street Journal reports that NetFlix (NFLX) signed content distribution deals with Disney (DIS) and CBS (CBS) for internet viewing.

The Wall Street Journal says that thousands of community banks are trying to get in on the bailout.

The Wall Street Journal reports that New York State will begin to regulate credit default swaps.

The Wall Street Journal says that GE’s (GE) financial arm may face some problems with its real estate and loan portfolios.

The Wall Street Journal reports that T-Mobile is expected to release its new handset powered by Google (GOOG) software.

The Wall Street Journal reports the a weak economy could keep inflation down even through there will be upward pressure from the bailout plan.

The Wall Street Journal reports that credit is tightening for Ford (F) and GM (GM).

The Wall Street Journal reports that the flexibility of Honda’s (HMC) plants is turning out to be a key strategic asset.

The New York Times reports that Nvidia (NVDA) launched a series of more powerful chips.

The FT reports that Lehman (LEH) bondholders could lose $110 billion.

The FT reports that money market funds are suffering huge outflows.

The FT reports that losses on bank holding in Fannie Mae (FNM) and Freddie Mac (FRE) will be larger than expected.

Bloomberg reports that Morgan Stanley (MS) and Goldman Sachs (GS) may buy regional banks to increase their deposit bases.

Bloomberg writes that investment guru Mark Mobius says that the recession may be short and investors should look for bargains.

Bloomberg reports that Paulson may push the federal deficit to the highest level since 1954.

Douglas A. McIntyre

Reuters reports that Nomura reached a deal to buy Lehman’s (LEH) Asia assets.

Reuters says that tax-exempt funds will have access to the Treasury’s new rescue facility.

Reuters reports that AIG (AIG) may face more credit agency downgrades.

The SEC will make public the short positions of some firms, according to Reuters.

Reuters reports that the U.S. government may have little choice but to use an auction process to price up to $700 billion of toxic mortgage debt it is buying from financial institutions.

The Wall Street Journal reports that legislators are working to put their own stamps on the rescue bill, probably complicating the process of it being passed this week.

The Wall Street Journal reports that Washington Mutual (WM) is in aggressive talks to decide its fate.

The Wall Street Journal reports that Lehman transferred billions of dollars from its London operation to the US, raising issues with IJK authorities.

The Wall Street Journal reports that AIG (AIG) shareholders are working on paying back the insurance company’s loan to keep the firm independent.

The Wall Street Journal says that a number of countries adopted the short sales ban over the weekend.

The Wall Street Journal reports that GM’s (GM) $3.5 billion credit line is worrying investors.

The Wall Street Journal says that stores are preparing for weak holiday sales.

The Wall Street Journal reports that Lowe’s (LOW) may cut its store growth plan.

The Wall Street Journal reports that many financial companies are lobbying to be included in the government’s $700 billion bailout.

The Wall Street Journal reports that the cost of the bailout will put pressure on the dollar.

The New York Times reports that financial companies are looking for ways to benefit from the $700 billion federal bailout.

The New York Times says that the financial rescue may include foreign banks with US  operations.

The New York Times reports that GE (GE) has been dragged down in the current market because of its status as a lender.

The FT reports that the bailout plan has put a Wachovia’s (WB) merger with Morgan Stanly on hold.

The FT reports that emerging markets face $111 billion in maturing debt.

The FT reports that the demand for autos in Russia is slowing.

Bloomberg reports that a plan to include purchases of instruments such as car loans, credit-card debt and other devalued assets to the rescue may force an increase in the size of the package as the legislation proceeds through Congress.

Douglas A. McIntyre

Reuters reports that US markets rallied on word of a potential plan for the government to take over the toxic assets of banks.

Reuters reports that a possible merger of Wachovia (WB) and Morgan Stanley (MS) raises questions because of liabilities on the big bank’s balance sheet.

Reuters reports that Freddie Mac (FRE) says that Lehman (LEH) owes it more than $1.2 billion.

Reuters reports the the new head of AIG (AIG) see a smaller, more agile firm in the future.

Reuters reports that the SEC may further tighten rules on short selling as the UK banned all short selling  of financial shares.

Reuters reports that over the last week banks borrowed an average of $48 billion a day from the Fed.

The Wall Street Journal says that Morgan Stanley chief John Mack went on the offensive lobbying the government on intervention and a curb on short sales.

The Wall Street Journal reports that Warren Buffett’s operations will buy troubled energy firm Constellation.

The Wall Street Journal says that NY attorney general Cuomo will target short sellers in a probe.

The Wall Street Journal reports that database sales lifted earnings at Oracle (ORCL).

The Wall Street Journal reports that GM (GM) dropped plans for a new crossover in favor of marketing a smaller sedan.

The Wall Street Journal reports the the SEC may put a temporary ban on short selling.

The Wall Street Journal reports that the US may no longer be considered a financial safe haven for foreign investors.

The Wall Street Journal reports that earnings at Palm (PALM) were negative but revenue rose.

The New York Times writes that Putnam closed a $15 billion fund due to withdrawals.

The New York Times writes that foreign sovereign funds are backing away from investments in financial firms.

The New York Times writes that Russia will buy stocks to stop the financial slide in that country.

The New York Times reports that the House is backing a bill to curb oil speculation.

The FT reports that Moody’s has increased its projections for losses on residential mortgage-backed securities.

Douglas A. McIntyre

Reuters says HSBC (HBC) may be a possible buyer for Morgan Stanley.

Reuters reports that Washington Mutual (WM) is being auctioned off.

Reuters reports that the Fed is not likely to change rates this year.

Reuters reports that the SEC is tightening rules on short sales.

Reuters reports that the head of Wells Fargo (WFC) is looking for acquisitions.

The Wall Street Journal reports that the Fed and European central banks will announce a coordinated effort to shore up money markets.

The Wall Street Journal reports that Washington Mutual got the green light from its largest investor to restructure or sell the bank.

The Wall Street Journal reports that Samsung faces challenges for its bid for Sandisk (SNDK) even if the US company accepts the offer.

The Wall Street Journal reports that home building fell to 1991 levels.

The Wall Street Journal reports that Nortel (NT) sharply lowered its forecasts.

The Wall Street Journal says that United (UAUA) is underwater more than $500 million on its full hedges.

The Wall Street Journal reports that Yahoo! (YHOO) is testing a new homepage.

The Wall Street Journal reports that the current crisis is the worst since the 1930s and there is no end in sight.

The Wall Street Journal reports that Russia announced a $70 billion aid package to help its free-falling markets.

The Wall Street Journal reports that Thomson Reuters putting a hire freeze on in its markets division.

The Wall Street Journal reports that the first Google (GOOG) cellphones will sell for $199.

The Wall Street Journal reports the ad spending may fall due to the current financial crisis.

The Wall Street Journal reports the CNBC ratings are up during the credit crisis.

The New York Times reports that federal aid for Detroit seems likely.

The New York Times reports that a House committee wants to interview Lehman (LEH) CEO Fuld on the collapse of his firm.

The New York Time reports that Asia companies and countries are rethinking investing in the US.

The New York Times writes that JP Morgan (JPM) is being questioned by a Senate committee on its oil trades.

The New York Times says that Google (GOOG) will not delay its Yahoo! (YHOO) deal even if regulators need more time to examine it.

The FT reports that Russian shares have lost $700 billion in value in recent months.

Bloomberg writes that the SEC will require hedge funds to disclose their short positions.

Bloomberg reports that Morgan Stanley is losing hedge fund clients

Douglas A. McIntyre

The conventional reaction to the news was that the federal government has adopted two sets of rules. The Fed will loan AIG $85 billion for two years and take a 79.9% share in the insurance company for good measure.

The Fed articulated its reasons, but did not clear up how they would be applied in future decisions:

"The Board determined that, in current circumstances, a disorderly failure of AIG could add to already significant levels of financial market fragility and lead to substantially higher borrowing costs, reduced household wealth, and materially weaker economic performance."

The government has undermined the free market system. It based the decisions to help Fannie Mae (FNM) and AIG on arbitrary swings in human judgment which ultimately are not grounded in one set of principles.

Free markets are never "free". They assume a certain amount of regulation so that some of the players will not act irresponsibly.

In AIG’s case, government officials and bankers may have hijacked the system by lobbying to keep jobs intact and prevent more abominable losses which might well have pulled under several more banks and brokerage firms.

At this point, the financial system may have to tolerate a level of regulatory uncertainty to go with the economic uncertainty which already roils the markets. In some cases the government is willing to own US financial firms. In other cases, it is willing to throw them to the wolves.

Risk is either akin to financial markets or it is not. Making a decision about how much risk is too much risk ex post facto only tells firms that they can dive off a cliff and still be saved. Moral relativism has marched into the system and any sense that actions have consequences has been muddled.

Douglas A. McIntyre

After allowing Lehman (LEH) to fail, the new arrangement with AIG raises questions of who lives and who dies on Wall St.

Douglas A. McIntyre

Reuters says that Barclays (BCS) bought the US unit of Lehman (LEH).

Reuters reports that the Fed held interest rates steady.

Reuters says that Morgan Stanley (MS) is weighing whether it should stay independent.

Reuters reports that investors see a golden era of distressed securities.

Reuters says that the Fed paid back JP Morgan (JPM) $87 billion for money it used to facilitate trades with bankrupt Lehman (LEH).

The Wall Street Journal reports that Sandisk (SNDK) made an offer from Samsung.

The Wall Street Journal reports that oil speculators who used borrowed money are being forced out of the market.

The Wall Street Journal reports that Toyota (TM) believes it will post a profit in the US.

The Wall Street Journal says that inflation fell due to dropping price of oil.

The Wall Street Journal reports that Best Buy’s (BBY) profits fell.

The Wall Street Journal reports that the Lehman failure is leading banks to sell-off commercial property assets.

The Wall Street Journal reports that lending among banks is frozen.

The Wall Street Journal reports that stocks in Russia fell 11%.

The Wall Street Journal reports that some hedge funds were left in a bind by the collapse of Lehman.

The Wall Street Journal reports that Dell (DELL) says demand for its products is soft.

The Wall Street Journal writes that GM (GM) has cut its outlook for China sales.

The Wall Street Journal reports that GM’s new electric car and cost cutting will be the basis of much of the company’s future.

The Wall Street Journal reports that Amgen’s (AMGN) bone drug cleared major testing hurdles.

The Wall Street Journal reports that Abbott’s (ABT) drug-coated stent is selling better than the company expected.

The Wall Street Journal reports that McClatchy (MNI) cut 10% of its work force and that the Newark Star-Ledger may fold.

The New York Times says that some members of Congress and experts believe that the government should create a new entity to buy Wall St.’s bad loans.

The New York Times reports that gas prices are rising slowly after Hurricane Ike hit the Texas coast.

The New York Times reports that the heads of GM (GM) and Ford (F) went to Washington to push their case for loan guarantees.

The New York Times reports that Porsche took a controlling interest in VW.

The FT reports that oil fell to $90.

The FT reports that Google (GOOG) is having trouble making inroads in Asia and Russia.

Bloomberg reports that the Fed’s rescue of AIG (AIG) and rejection of helping Lehman (LEH) puts it in the business of deciding which firms to help.

Douglas A. McIntyre