Wall Street shake-up not end of world, local experts say

Jeff Richgels  —  9/16/2008 7:05 am

The sky isn't falling.

Stocks initially plunged Monday morning as investors reacted to a stunning reshaping of the landscape of Wall Street that took out two storied names: Lehman Brothers Holdings Inc. and Merrill Lynch & Co.

Lehman, burdened by $60 billion in soured real estate holdings, filed a Chapter 11 bankruptcy petition after attempts to rescue the 158-year-old firm failed. Bank of America Corp. said it is snapping up Merrill Lynch in a $50 billion all-stock transaction.

But the markets steadied and recovered some lost ground as investors realized the world wasn't ending. The Dow Jones industrial average fell more than 330 points but recovered nearly half that plunge before falling back to roughly midway between the day's low and high.

"It wouldn't surprise me to end up ahead" for the day, David J. Ward, president of Madison-based NorthStar Economics, said in a phone interview Monday morning.

Ward said the turmoil for financials might be obscuring the significance of continually falling oil prices -- which tumbled sharply below $100 per barrel Monday -- falling interest rates in mortgage markets and the strengthening of the dollar relative to other currencies.

"The world isn't coming to an end," Ward said. "Big parts of the economy are just fine."

Gregory Jones, president of Madison-based Forward Investment Advisers, agreed things are not as bad as the financials' turmoil might indicate, noting that the Dow is still only down slightly for the quarter.

"There's a lot of volatility, but I think it helps us get to the light at the end of the tunnel," Jones said.

Lehman's bankruptcy plans and Merrill Lynch's forced sale -- along with American International Group Inc., the world's largest insurance company, asking the Federal Reserve for emergency funding as it plans to announce a major restructuring -- are the biggest developments yet in the 14-month-old credit crisis that stems from now-toxic subprime mortgage debt.

Investors are worried that trouble at AIG and the bankruptcy filing by Lehman, felled by $60 billion in bad debt and a dearth of investor confidence, will touch off another series of troubles for banks and financial institutions that may be forced to further write down the value of their own debt assets.

Wall Street had been hopeful six months ago that the collapse of Bear Stearns would mark the darkest day of the credit crisis.

But AIG's troubles a week after its stock dropped 45 percent are worrisome for some investors because of the company's enormous balance sheet and the risks that troubles with that companies finances could spill over to the companies with which it does business. AIG, one of the 30 stocks that make up the Dow industrials, fell $5.63, or 46 percent, to $6.51 Monday as investors worried that it would be the subject of downgrades from credit ratings agencies.

Investors did have some more solid footing than they might have predicted at the end of last week, when Lehman's troubles and those of AIG weighed on the markets. A global consortium of banks, working alongside government officials in New York, announced a $70 billion pool of funds to lend to troubled financial companies.

And the deal for Merrill Lynch pays a 70 percent premium to the brokerage's closing price Friday. The stock has been squeezed in recent weeks, leading many Wall Street veterans to point to the company as the next behind Lehman as likely to run into trouble with bearish investors and get hit by intensified selling. The deal to pair the company with Bank of America, a huge bank with a big asset base, removes some of the worries that Merrill would be the next to fall after Lehman.

"It was quite a historic weekend," Ward said. "This to me is the comeuppance of the financial engineering that started as far back as Enron. I hope this is the climax of it. It takes a couple of things off the table -- the fear that Lehman would fail is realized, and (the sale of) Merrill tells us that the crisis was a lot deeper than realized."

Merrill, he said, had history and size and a pretty good position relative to the subprime mortgage crisis, but it was unable to get the liquidity it needed.

Lehman's bankruptcy marks the first time in the crisis that the Federal Reserve didn't step in.

"Even the government at some point has to let the market take its course," Ward said. "And I'm not sure that's the worst thing. The protection of bankruptcy will let them proceed in a timely manner (with asset sales). Lehman stockholders probably won't get much, but debt holders and others may come out OK. It will just take a year or so to unwind."

Ward predicted "bottom fishers and vultures will be moving in en masse" in search of good deals, "and to me that would be a sign that the crisis has peaked or bottomed or whatever geometry you want to put on it."

Jones agreed that while it's going to take a while for the crisis to work itself out, it's good that the Fed stepped back and let Lehman go.

"This kind of sets the precedent that the Fed isn't a piggybank anymore," Jones said. "There will be repercussions, but I think that was the appropriate course of action. What we're seeing now is letting the free market work things out."

"This is something that needs to happen," he added. "We've seen it before with tech companies."

The average investor shouldn't make any panicky moves, such as converting their retirement holdings to cash, Jones said.

"To make a drastic change of getting out of stocks now would kind of be taking a tram down to the bottom of the Grand Canyon," he said. "I'm not saying this is the absolute bottom, but getting out now would be absolutely the worst thing to do. If you sell now and go into a CD, you might feel good short-term, but in two years you will really be behind."

Bond prices surged as investors fled to the security of government debt. The yield on the benchmark 10-year Treasury note, which moves opposite its price, plunged to 3.54 percent from 3.72 percent late Friday.

Investors need to have a long-term horizon, both Jones and Ward advised, adding that smart investors like Warren Buffett look to buy stocks at times like this.

"I'm a contrarian, so my advice would be to look for bargains," Ward said. "Just be prepared to put your seat belt on because things could rock around a while before it all settles out."

The Associated Press contributed to this report.

Jeff Richgels  —  9/16/2008 7:05 am