Investors anxious about banking credit crunch
NEW YORK » Wall Street and stock market investors in general aren't feeling much love for Ben Bernanke these days.
Stocks plunged on Tuesday after the Federal Reserve chairman and his fellow Fed policymakers cut interest rates by a quarter point, disappointing those hoping for a half-point reduction.
A surprise announcement a day later by the Fed and four other central banks of a plan to increase the supply of dollars in both Europe and the U.S. has drawn catcalls from some who say it won't do much to diffuse the global credit crisis.
By week's end, the Dow Jones Industrial Average had fallen 3.1 percent from where it was just before Tuesday's Fed rate decision was released. Such a downdraft underscores the growing anxiety over credit woes, and how it might spill into everything from dealmaking to corporate earnings in 2008.
"Investors are skittish," said Arthur Hogan, chief market analyst at Jefferies & Co. "If you look at the magnitude of the headwinds hitting the market and the brand of medicine we're getting from the Fed, it is hard to say we've got the right dosage."
Market participants like Hogan say one of the key "tells" for investors about how Wall Street is navigating the market dislocation is the performance of financial stocks, a sector many believe must get healthy before the market can rally.
The nation's big investment banks and brokerages are on the front lines of the credit crisis, and have taken some pretty big fiscal hits stemming from the collapse of the subprime mortgage industry. That's why Wall Street is paying close attention to their quarterly earnings reports.
Lehman Brothers Holdings Inc. beat expectations on Thursday -- but investors were rattled after the No. 4 securities firm said its fixed-income portfolio suffered $3.5 billion of losses.
Morgan Stanley warned that it expects to take a $3.7 billion writedown when it reports fourth-quarter results on Wednesday, while Bear Stearns Cos. expects a $1.2 billion charge in its report on Thursday. Goldman Sachs Group Inc., the largest investment bank, is expected to post no net credit-related losses on Tuesday due to hedging activities.
Also weighing on investors is the future for "structured investment vehicles," or SIVs, which are investment funds created by banks and sold to investors. The funds borrow short-term money and invest it at a higher rate in mortgage, bank and credit card debt.
Citigroup Inc. said it plans to assume control of the seven SIVs it advises to help them repay lenders. The viability of a SIV hinges on its ability to continue borrowing short-term money -- and that's been disrupted by the credit freeze.
What's more, massive losses from these investments could be yet another assault to the financial industry's earnings power.
Erin Callan, Lehman's chief financial officer, said "November was absolutely the worst month ever on record for the fixed-income markets." It's a powerful statement considering the summer's market turmoil knocked the Dow Jones industrial average down 10 percent before later recovering.
Though top bank executives are hesitant to say the worst is over, there are some positive signs banks can weather crisis into 2008. For instance, Lehman was able to offset fixed-income losses thanks to strength in its merger and acquisition advisory business, and there's hope others can do the same.
Big fees from advising on deals made during the first half of the year drove Lehman's M&A revenue to $388 million -- the second-highest in the company's history. Both Morgan Stanley and Goldman Sachs -- two leaders in M&A -- are also expected to fare well.
Deal flow from private-equity firms should remain strong because there's still a large amount of unspent capital ready to be put to work, E&Y said. Further, sovereign wealth funds controlled by foreign governments -- like one that invested in Citigroup this month -- could inject even more capital into the system.
"The process we're going through, though painful, is necessary," Hogan said. "The banks have to work through all the bad if we're ever going to move forward."
Hogan believes steps taken by the Fed so far haven't been enough to quell investor fear. "There's still too much uncertainty" out there, he said. That means while investors may not be feeling good about Fed Chairman Bernanke right now, they're stuck hoping he has a few more tricks up his sleeve.