Toomre Capital Markets LLC

Late last week and during the weekend of April 12^th 2008, the G-7 Finance ministers met in Washington. Rarely are commercial interests part of these meetings. However, on Friday evening the finance ministers and central bankers invited representatives of some investment and global banks to join them for dinner. Deutsche Bank, Mizuho Corporate Bank, Citigroup, Lehman Brothers, JP Morgan and Bank of America were rumored to be among the ten or so global institutions invited. According to The London Telegraph, the focus of the dinner was to warn them that more regulations are inevitable in wake of the financial credit crisis.

The just concluded week of April 11^th 2008 ended on a down note. The earnings announcement (and considerable disappointment therein) by General Electric caught many by surprise and resulted in the largest one day decline in the GE common share price since the 1987 market crash. Perhaps one of the most widely held common stocks, General Electric was thought to be relatively immune to the on-going credit crunch due to its strong balance sheet (and "true" AAA/Aaa ratings), its diversified portfolio of short and long-cycle businesses and its truly global market exposure where more than half of its earnings resulted from activities outside of the United States. Yet even GE disappointed. The chief culprit was attributed to the global credit crisis and weaker American economy. According to The Wall Street Journal, CEO Jeffrey Immelt said, "We assume the economy is going to be very tough and remain very tough." Accordingly, he lowered GE's earnings growth rate to at most 5% for the year. That was a far cry from his pronouncement on December 12^th 2007 that "10% earnings growth next year is 'in the bag'", which also partly explains the sharp share price sell off.

As readers of this Insights section many recall, Toomre Capital Markets LLC ("TCM") has been warning that this credit crunch triggered by the American subprime mortgage default crisis will take far longer to work out than many in this near-instantaneous world of communication might fully appreciate. Many in the financial markets are buffeted by the 24x7 news cycle and feel compelled to react to the latest change(s) in this or that stock, credit, commodity or foreign-exchange price. Is it any wonder then that volatility as a whole as sharply increased from early 2007 levels, many are now decrying "complexity" and most are extremely fatigued? This credit crunch will take yet further time to work out. The key question is, though, Are we at the beginning of the end or just at the end of the beginning of the credit crisis?

Tomorrow, on Wednesday April 2^nd 2008, Federal Reserve Chairman Ben Bernanke is scheduled to testify before the U.S. Senate Banking Committee. His testimony last July 19^th resulted in headlines like Subprime losses could hit $100 billion: Bernanke. After today's whopper of a $19 billion write-down from UBS, Bloomberg is now tallying total sub-prime losses at approximately $232 billion. What will tomorrow's headline be? Perhaps Chairman Bernanke might suggest that the subprime losses might hit $500 billion or even more?

Back on July 21, 2007, Toomre Capital Markets LLC ("TCM") created the post Does $50 Billion in Sub-Prime Losses Mean Anything? At the end of that post, Lars Toomre concluded with:

TCM worries that many investors do not fully appreciate how much the investment game of the past several years is changing. Liquidity is going to be a much more valuable commodity than many realize or appreciate. Perhaps the Great Unwind is truly approaching?

The Great Unwind reference was to the provocative research piece that Stefan-Michael Staimann and Susanne Knips at Dresdner Kleinwort put out in early 2007 detailing how closely hedge funds were linked to the investment banking industry and how that business model was likely unsustainable. They strongly declared:

We believe that the great unwind is inevitable, but impossible to time. It looks like the process of building up leveraged spread bets has already run quite far. Risk premia in many markets are very low, making it increasingly difficult to find spread bets for new money. Market volatility has been driven to record lows (remember: selling a put is like shorting volatility). The process may not have much more room to run and may start to be more sensitive to factors that could threaten its delicate balance (such as a deterioration of corporate credit risk).

While Lars Toomre at Toomre Capital Markets LLC was preparing the following post about Lehman Brothers being concerned about its liquidity amidst the Bear Stearns liquidity fallout, the United States Federal Reserve has stepped forward to attempt to settle the Capital Markets ahead of Monday's possible St. Patrick's Day Massacre. Specifically, the Federal Reserve has done the following:

1. Immediately cut the primary lending rate from 3.50% to 3.25%, and
2. Authorized the New York Federal Reserve Bank to create a new lending program for primary dealers to provide funding for those involved in the securitization markets.

This second step clearly is intended to keep the likes of Morgan Stanley, Merrill Lynch, Goldman Sachs and Lehman Brothers liquid in the event that the critical repurchase market seizes up further (like it was starting to do on last Thursday and Friday). This second move likely will somewhat ease the pressure that the major investment banks were going to be feeling on Monday morning. The critical question is Will this be enough in a world where the markets truly go to an all sellers state???

Lehman Brothers is a former employer of both Aldon Hynes and Lars Toomre. At one point, Lars reported directly to Joe Gregory who has gone on to become President of the much larger firm that Lehman Brothers Kuhn Loeb has evolved into today. Aldon in fact was being wooed by Joe Gregory and Christopher Pettit when the new story ran across the scrolling Dow Jones News boards that Lars had left the company. Many people commented at the time that they never remembered a time in the previous decade when the fixed-income trading floor simply went deathly silent. During that same period in the late 1980s, Dick Fuld still was very intimately involved in the growth of the mortgage business and how its contribution to the larger Lehman Commercial Paper Inc. helped propel the Lehman management team to eventually take over all of the Capital Markets operations hence completing the 1984 Shearson American Express / Lehman Brothers Kuhn Loeb merger.

Over the past several days, there has been considerable speculation about what other firms might be impacted by the liquidity concerns that befell Bear Stearns in the past week. Much of that speculation has centered on Lehman Brothers since that global investment bank was the largest underwriter of residential mortgage-backed securities ("RMBS") during the 2005-2007 boom years and it also has a substantial commercial mortgage-backed securities business ("CMBS"). The CMBS underwriting business has also dramatically slowed and with the announcement of its fourth quarter results, Lehman Brothers has admitted that it has been caught with a decidedly large commercial mortgage inventory.

In its coverage about the Bear Stearns purchase by JPMorgan for the surprising low price of $2 per share, The Wall Street Journal in the article J.P. Morgan Rescues Bear Stearns reveals the following about Lehman Brothers: