The Beginning Of The End | Bianco Research

The Financial Times – Lex: Morgan Stanley and Goldman Sachs
Now Morgan Stanley and Goldman Sachs are under attack. The share price of the former has almost halved this week and it is rumoured to be talking to Wachovia about a merger. Is the disappearance of even the two highest quality investment banks on Wall Street inevitable? The reality is that the answer rests with regulators. In today’s world, Morgan Stanley and Goldman Sachs should be able to survive. Neither has the funding problems of Bear Stearns, nor it seems, the capital problem of Lehman and Merrill. Both have an impressive record of managing risk. If markets normalise, equity investors will return who accept high levels of risk for higher returns. The trouble is, tomorrow’s world may be very different indeed. Sure, funding costs will be higher, returns therefore lower and economic activity subdued. But those are secondary issues next to the quid pro quo politicians may demand for bailing out the industry.

Comment Everyone loves analogies … An asteroid hit about two weeks ago and all the dinosaurs are dying … Fannie/Freddie, Lehman, Merrill, AIG, and now Morgan Stanley and WaMu.

After the asteroid hit, the only food left are those financial institutions that are light on mortgage holdings and get their funding from a retail deposit base. Either get with a food source or die.

We believe this is the final capitulation process. It is “the beginning of the end.” Within the next three months the low price and high spread should be in place. However, between now and then it will not be pleasant. See the charts below. Both the High Yield and Investment Grade option-adjusted spreads (OAS) have widened by a similar amount, over 100 basis points in the last week!

The objective is to stay in business over the next 90 days, and as the list of those that have not survived over the last two weeks attests, it’s not as easy as it sounds. If you are still standing when this capitulation process is over, that will be the time to make money.

Then comes the ice age.