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"We think the worst is definitely behind us," Sam Molinaro, the chief financial officer at Bear Stearns (BSC, news, msgs), told Wall Street analysts and investors during a company earnings conference call Sept. 20.
Wall Street would be happy if you believed that. The belief "the worst is over" in the crisis that panicked the financial markets in August and still hasn't let go of its death grip on the debt markets is the best hope that Wall Street's investment banks have of getting out of this mess with their skins intact.
But don't you believe it. There's not a chance the worst is over, and Wall Street knows it.
Wall Street knows the big investment banks that reported in mid-September aren't out of the woods. They all took relatively tiny write-offs -- $700 million on the fixed-income portfolio at Bear Stearns, for example -- on the damaged goods in their portfolios, and if they can't trade their way out of this mess, they've got more big losses to write off in the quarters ahead.
Will news be worse than bad?
Wall Street is afraid that the big banks still to report in mid-October could drop a bomb on the markets. Bank of America (BAC, news, msgs), JPMorgan Chase (JPM, news, msgs), Wachovia (WB, news, msgs), Washington Mutual (WM, news, msgs) and Wells Fargo (WFC, news, msgs) all report Oct. 17, 18 or 19.The fear is that because these banks held on to more of the mortgages, credit card debt and buyout loans they packaged than the big investment houses did, they'll have more to write off. Citigroup (C, news, msgs), which reports officially Oct. 15, delivered a bomb Monday, when it warned that earnings would fall by 60% for the third quarter as a result of a $1.3 billion write-down of its debt portfolio and $600 million in fixed-income trading losses.
Wall Street doesn't believe any of the banks have trading desks capable of generating profits from this meltdown as Goldman Sachs did, and the warning from Citigroup certainly won't make that fear go away.
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The fear isn't that the quarterly reports from these banks will be bad -- everyone knows that they will be -- but that they'll be much worse than expected. So bad, perhaps, that someone will blurt out the message Wall Street doesn't want you to hear: "The worst isn't over."
And that, Wall Street fears, would be enough to spook the debt markets again and remove any hope that the big investment banks that created this mess will be able to dance their way out of it.
Stock prices reflect doubts
Am I being too cynical? Surely, Wall Street executives wouldn't say one thing while they believe another, would they? Let's look at the price action in the shares of the big investment houses and the big banks in the days after Bear Stearns reported that the worst is over.The financial markets breathed a sigh of relief that the third-quarter results reported in mid-September by Bear Stearns and Lehman Bros. (LEH, news, msgs) weren't any worse. And Wall Street was shocked speechless when Goldman Sachs (GS, news, msgs), a third big investment power in the asset-backed debt market, reported third-quarter earnings $1.76 a share above Wall Street estimates and up 88% from the third quarter of 2006.
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Jubak’s Journal: Will Merrill take a hit?Now that Citigroup has announced a $2 billion drop in third-quarter profits, Wall Street’s worries shift to Merrill Lynch. The fear is that Merrill will show losses in its loan portfolios without making up the difference with trading gains.
But notice what's happened since then. No one has panicked and sold, but no one is snapping up these shares, either. Lehman Bros. climbed 10% on Sept. 19, the day after it announced earnings, but has given all of that back and then some.
Bear Stearns jumped all of 1% on its positive earnings news, gave all that back and more by Sept. 24, then shot up 7.5% on Sept. 27 on rumors, since debunked, that Warren Buffett was interested in buying a stake in the company. Goldman Sachs actually fell the day it announced its phenomenal earnings news, but it climbed 5.5% between Sept. 19 and 27.
And the big banks still to report? For the Sept. 19-27 period, they were down 1.6% to 6.4%:
| Bank | Sept. 19 price | Sept. 27 price | % change |
|---|---|---|---|
$64.11 | $62.42 | -2.6% | |
$115.64 | $122.60 | 6.0% | |
$205.50 | $216.84 | 5.5% | |
$51.07 | $50.27 | -1.6% | |
$48.27 | $46.88 | -2.9% | |
$47.57 | $46.21 | -2.9% | |
$51.91 | $50.66 | -2.4% | |
$38.32 | $35.87 | -6.4% | |
$37.30 | $36.02 | -3.4% |
That's hardly the kind of relief rally you'd expect if the worst were over. And that performance is especially anemic considering the Federal Reserve cut short-term interest rates by a half-point Sept. 18, unleashing a rally in much of the rest of the market.
Banks make more money when interest rates fall, and their net interest margins go up. So these stocks had reason to rally. That they didn't is testimony to the fear that something will blow up in mid-October.
Continued: What's happening at Lehman Bros.