Who's on Deck?

Following the demise this year of Bear Stearns, the federal takeover of Fannie Mae and Freddie Mac, the bankruptcy filing of Lehman Brothers, and the acquisition of Merrill Lynch by Bank of America, many observers are wondering who may be the next cog in the American financial services machine to seize up. Following the Lehman-Merrill announcements Sep. 15, speculation on which would be the next giant to stumble focused on AIG and Washington Mutual. Gary Shilling, the bearish Forbes columnist and long-time Investment Advisor contributor, said “AIG seems to be on the ropes. Beyond that, all we know is that this thing is very contagious. Wall Street is really just one big glorified confidence game. I don’t mean that in a crooked sense, but it does depend on the confidence of all the players in terms of whose paper they’re willing to accept. Obviously, when confidence is lost, the particular firm that’s the object of that confidence loss is finished.”

Shilling points that when it came to Bear Stearns,” they opened the Fed’s discount window to the nonbank dealers–the idea being that that would prevent the run on the bank that sunk Bear–but that has not proven to be of much value to Lehman. They certainly had access to the Fed, but still there was not enough confidence otherwise that people wanted to deal with them.”

Losers and Winners

Lou Stanasolovich of Legend Financial Advisors in Pittsburgh suggests that “companies that own mortgages are going to have more financial trouble. Prime mortgage borrowers are starting to default; they’re currently at a 5% default rate, and late last week we heard that 70% of mortgages originated after 2005 have missed one payment or are in default–and this is with only a 6% unemployment rate. So as unemployment gets worse, so will the default ratio and foreclosure ratios.” He believes that as bad as things seem to be, “so far we’ve seen part of the iceberg surface, but we haven’t seen what’s underneath this. I think it’s going to be a lot worse than what people are anticipating.” As for who will do well, Stanasolovich believes it may very well be the smaller regional banks, “that kept it a lot closer to their vest and were very careful who they lent to–they didn’t have loose standards. Those who had issued subprime and Alt-A mortgages and questionable prime borrowers are going to suffer the most.”