Some more insights into what is going on and how deep the problems are

I recommend to read this in full length (by clicking on the link) - it confirms many of my assumptions - which is not important by itself - but more importantly, it shows how things are beyond some public misinformation (to put it diplomatically) about the situation, including the latest cover story of the Barron's.

Excerpt from:

http://ftalphaville.ft.com/blog/2008/10/20/17216/time-for-the-darwinian-flush/

Levered Loans and Corporate Defaults

There is approximately $7 TRILLION of total corporate debt in the United States. An ever increasing trend of this debt is that more and more of it is rated below investment grade. As of today, over $1 TRILLION of all corporate debt is rated BB or lower. In the mini-recession of 2002, we saw 12% cumulative corporate defaults and BB spreads to Treasuries reach a historic 1400 basis points. The bad news is that it was just a “warm-up” for where we are headed. Standard and Poor’s recently penned a report that they expect up to 23% cumulative corporate defaults by 2010. BB spreads are headed to at least 1500 basis points over their current level of roughly 1000 bps. This suggests that we will see at least $1 TRILLION of corporate debt default over just the next 2 years. In addition, all financing costs for nonfinancial corporate borrowers will be substantially elevated and pose an ongoing severe headwind to corporate earnings.

The Lehman Disaster

After living through the Lehman disaster first hand, we have a pretty good idea of what it looks like staring down the barrel of the gun. We believed that, without a doubt, the Treasury and the Fed knew how important it was to preserve the structural integrity of the global derivatives system. We could not have been more wrong (and neither could they). When they decided to let Lehman file bankruptcy, they gravely underestimated the havoc that they would wreak on the global financial system. This one decision will likely go down as the single biggest error made by the Government in this crisis. Money market funds immediately “broke the buck” leading to epic withdrawals from money markets into Treasuries. Commercial paper markets froze and back-up lines of credit were hit at the banks (who didn’t even have the money to lend). Today, there are $6 TRILLION of untapped bank lines of credit not included on U.S. bank balance sheets (with very little reserved for them). This represents more than 6x the total equity of the entire U.S. banking system. The banks simply DONT HAVE THE MONEY TO LEND. This decision signed the death warrants of the “independent” broker-dealer model. Goldman Sachs and Morgan Stanley immediately converted into bank holding companies to allow the Fed to inject capital directly into them when necessary. Concurrently with the filing of the Lehman bankruptcy, Merrill Lynch was sold (at a premium no less) to possibly one of the worst dealmakers this world has ever seen. For those of you who were participants in the late nineties, remember what Greentree ended up doing to Conseco?

The case of IndyMac is also very illuminating. At the end of their March quarter, they touted themselves as massively overcapitalized with a Tier One risk based capital ratio of 9% which far exceeds required minimums.

Here is an excerpt from their March Q1 2008 conference call that was held on May 12, 2008:

Michael Perry, Chairman and CEO - “One of the big issues that really affected our GAAP shareholder’s equity book value per share, and even our regulatory capital was the significant fair value marks that we took on our prime jumbo and Alt-A investment grade MBS portfolio which is almost 90% AAA securities. In my opinion, these fair value marks in no way represent the economic value of these securities…The bottom-line is if you add those amounts back, because I think we’ll get them back over time, our common shareholders equity on an adjusted basis would be $1.367B and our economic book value per share [sic] at the end of the quarter would be $1.556B. As a relatively large shareholder myself, this is the book value that I really look at in terms of what we are trying to preserve at IndyMac…On the capital front, on the positive side we remain well capitalized on all three capital ratios; we’ll walk through the capital ratios in just a minute pretty extensively.”

Here is the first thing the FDIC said on July 11th (two months later):

“IndyMac’s failure will cost the FDIC/US Taxpayer about $4 to $8 BILLION.”

The FDIC stated that they expect it to cost taxpayers $8 BILLION on $32 BILLION of assets! That number makes sense based upon realized losses for the FDIC in the prior S+L crisis. They realized losses of approximately 25% of assets over the 1,600 banks they took over. The real question is: How did they go from significantly positive book value to costing the FDIC $8 billion basically overnight?!?!!?! The answer is simple…WE BELIEVE THEY WERE MAKING IT UP. We have a lot to fear today. Below is a list of leverage ratios for several presumably solvent institutions. We like to look at ASSETS to TANGIBLE EQUITY (as we don’t think financial Goodwill is worth much today):