“At no time in history has the biggest money in the world been as MISALOCATED and invested as it is now.” –Ty Andros

…well put Mr. Andros. Today marked the worst day since markets opened after 9/11. Bonds soared while commodities, save gold, took it on the chin. By the way, if you have been a reader of mine, our long gold short oil position that I discussed several weeks back in an issue of Bourbon & Bayonet has done tremendously well in violent commodities market to say the least. You can visit the issue here. Moving on…

There is an enormous amount to take in since what is being called “Black Sunday’s” occurrences. Prior to Lehman Brother’s declaration of bankruptcy, Bank of America pulled its bid on the failing investment bank, only to walk away with Merrill Lynch for a mere $50 billion (all in stock). More on both BofA’s buyout and Lehman’s bankruptcy shortly…

Also, in today’s news, AIG, the nation’s largest insurer, is on the brink of collapse as well. I’ll be discussing what is in store for the struggling insurer and what the Fed’s involvement will mostly entail in a B&B to come later this week. Speaking of the Fed, our favorite currency debasers were making headlines today as they continue to change the rules as the game goes on.

All in all, we have a lot to cover, so without further ado…

Bank of America Strikes With Ignorance

Bank of America is at it again. This move caught many analysts off guard, mostly for the reason that many assumed Merrill’s books weren’t in that bad of shape compared to its peers. The oddity here, as should be asked by BoA share holders, is the price of the deal. At a $29 /share equivalent, or 42% premium from Friday’s close, the question that should be asked is why so much?

It’s a good question, and one that I struggle to find an answer myself. These companies can’t find suitors for a capital injection at current prices, so why would someone come in and actually pay a premium? Can we simply call it stupidity? In fact, that’s exactly what I would call it…or call him.

Ken Lewis, CEO of Bank of America, is a complete moron. Have we forgotten Countrywide Financial already? I don’t blame you, because the aftermath of that deal has experienced zero coverage.

Mr. Lewis went ahead, under some government pressure, and bought Countrywide without looking into CF’s balance books or doing any real due diligence for that matter. It seemed they got in for cheap at the time of the deal, but it was a different story once they actually began to dig through CF’s balance sheets, and dig they did.

Analysts went through every mortgage that CF owned one by one. What they found out is they were had a massive amount of mortgages that were backed by empty homes that had had the copper piping ripped out and were pretty much ransacked. Many of the homes were simply bulldozed and the property was either sold or held on balance. To make a long story short, the end result was a $200 million loss for BofA…nice work Ken.

That is exactly the sort of transaction that took place over the weekend. I watched this poor sap’s (Ken Lewis’) interview on CNBC this Monday afternoon, and he said just that. He mentioned something along the line that BofA had analysts working on Merrill for some time, like every bank has analysts do, but they hadn’t looked into the books yet.

This is another deal that Ken Lewis has rushed into blind, but the stakes are higher this time. Let’s not forget that Merrill Lynch has the largest retail brokerage operation on Wall Street. How this fits onto BofA’s balance sheets and how the massive size of Merrill’s retail brokerage operation holds up going forward in this credit crunch will definitely be interesting to see.

Bank of America has definitely founds its way into my cross hairs. I’m not ready to call a naked short here, but I will definitely keep an eye on these guys going forward. You, dear reader, will be the first to hear if I uncover something worth noting.

But what about the investment bank that Bank of America DIDN’T buy?

Lehman Brothers No More

Woe is Lehman…more like, woe is Lehman’s shareholders. What I would like to do is discuss some of the details and implications of Lehman Brothers’ declaration of Chapter 11 bankruptcy.

So here’s how Chapter 11 work: The lights won’t simply turn off in Lehman’s offices tomorrow. First and foremost, the bankruptcy will go to the receivership court, where a ‘receiver’ of Lehman’s assets will be identified. This receiver will be put in charge of the division and sale of Lehman’s assets. This simply means, Lehman’s employees will start digging through the books to identify assets and their potential value. Those assets will then be sold at whatever prices can be gotten. They will then take the capital received from the sales to pay (most likely pennies on the dollar) the preferred bond holders as much as they can, which I can’t imagine will be much.

The one item worth noting here is that Chapter 11, which is different from Chapter 7, can take 10, 12, or even 15 years to completely undergo valuation and liquidation. I truly believe this to be a postponement of the asset fire sale until after this coming election. Although a major wheel has fallen off the train that seems to barreling ahead, I believe the Republicans will attempt to keep this financial crisis somewhat contained for the time being.

Essentially it is a very slow moving process, especially considering the size of the bankruptcy. The parties and counter parties will all have to be notified as to where the liabilities stand, and I’m sure there will be countless lawsuits along the way.

More to Come

That does it for the first part of this piece. There are many implications/consequences that I can’t wait to share with you in the second part of this series later this week. We will dig into the potential effects a failure in AIG, which is bigger than both Bank of America and Merrill Lynch, would look like. I will also take a look at what the most recent change in Fed policy means for you and me, financial markets, and the economy, but before I go, I would like to say one thing.

I’ve heard bottoms called in the credit crunch following basically every major fall out since the first collapse of the Bear Stearns hedge funds last summer. I’m sure we will hear more than one analyst calling a bottom tomorrow on CNBC or whatever main stream media you wish to watch, listen to, or read. Readers of mine know that, although I foresaw most of these occurrences, I’m not ready to call a bottom, but I am ready to call it something.

Simply put, I believe that today (Monday) marks the end of the beginning.

Nicholas Jones
Analyst, Oxbury Research