Please give to The Capital Times Kids Fund.

Confessions of a Money Manager: Watching the decimation on Wall Street

Ray Unger  —  9/19/2008 12:47 pm

After church last Sunday one of my long-time friends buttonholed me, and with visible anxiety, asked: "What's going on with all these bailouts?" He went on to say: "I saw what happened to those huge mortgage companies (Fannie Mae and Freddie Mac) and heard about the others, can the government keep bailing everybody out?" He continued to pepper me with questions until I finally said, "Hold on!"

I tried to explain the Fannie Mae, Freddie Mac situation as best I could, but time and access to information were limited. If he's reading this column, here's a more detailed explanation.

First, the so-called "bailouts" of Fannie and Freddie were not your garden-variety bailouts. They're more akin to bankruptcy seizures because federal officials kicked out management, took responsibility for the assets (predominately FHA and VA mortgages the government already guaranteed) and assumed day-to-day operations. In the process, the U.S. Treasury was authorized to advance up to $100 billion to each company to assure the continuous operation of providing liquidity (money) to banks and other lending institutions that originate residential mortgages.

So who took the loss? Well, the U.S. Treasury is now on the hook for $200 billion, but these funds are not lost assets. If those loans are repaid -- admittedly a big if -- the U.S. Treasury may not lose anything.

That's not the case for the common stockholders. Sorry, but they lost to the tune of billions. Fannie Mae's market capitalization (number of common shares outstanding times the stock price) was $35.3 billion at year-end 2007. At today's current price of 43 cents a share, the stockholders of Fannie Mae lost some $34.8 billion in market value.

Likewise, Freddie Mac's market capitalization on December 31 was $18.4 billion: it's now only $175 million. Between these two companies, shareholders lost just over $53 billion. If you didn't own shares in these two companies, consider yourself fortunate. You dodged a huge bullet.

But wasn't the bailout of Bear Stearns last March a more traditional bailout? Yes, and no. It was more of a shotgun marriage between it and JP Morgan Chase. At the behest of the Federal Reserve, JP Morgan acquired the common stock of Bear Stearns for $2 a share (it was later raised to $10 per share). To calm the anxieties of JP Morgan, however, the Federal Reserve agreed to pony up $30 billion to cover Bear Stearns' less liquid assets. Depending on the ultimate disposition of those assets, the Fed may or may not lose money.

Like Fannie and Freddie, however, the common shareholders of Bear Stearns' stock took a huge beating. In December, Bear Stearns' market capitalization was $11.4 billion: the JP Morgan buyout netted them only $1.36 billion, or a loss of some 88 percent of their market value since year-end.

Now the collapse of Lehman Brothers Holdings (LEH $0.13) was entirely different. They were hoping for a bailout, but that never came so it was forced into bankruptcy and its market capitalization of $39.6 billion (as of Dec. 31) was slashed to a mere $90 million -- close to a total wipeout.

Monday's stock market panic was also about the teetering finances of global insurance giant American International Group (AIG $2.05). On Tuesday, the federal government announced a "bailout" but it was just like the seizure of Fannie and Freddie. For a loan of $85 billion, the federal government acquired 79.9 percent of the shares of AIG. In effect, it was nationalized. Now some may argue that the government did the same with Fannie and Freddie, but they were government sponsored entities. AIG was a totally private concern up until Tuesday.

Again, who were the big losers? The shareholders. AIG's market cap was $153 billion last December. Today, it's only a fraction of that amount -- $5.51 billion -- representing a loss of over 96 percent.

The five companies mentioned above (Fannie Mae, Freddie Mac, Bear Stearns, Lehman, and American International Group) suffered a combined market capitalization loss of approximately $251 billion. That's over a quarter of a trillion dollars! And these losses don't consider the losses of scores of other financial institutions. But it you didn't own the financials, you were spared.

Yes, the stock market has been clobbered. Yes, your mutual fund shares may be down some 20 percent like the Dow Jones or the Standard & Poor's 500. But you can recover. Those who owned these financials were decimated.

Now being decimated isn't as bad as you think. The Roman legions used decimation to punish mutinous soldiers; they divided the men into groups of ten and each man drew a lot. The one who drew the unlucky one was put to death.

What we've witnessed since the first of the year is close to a decimation in the financial sector. Only the "lots" were self-inflicted. If you're one of those who owned shares in the above, my heart goes out to you. But for the rest of us, there's hope. Once this decimation on Wall Street is over, we can get back to the business of genuine recovery.

Ray Unger  —  9/19/2008 12:47 pm