“It is not from the benevolence of the butcher, the brewer or the baker, that we expect our dinner, but from their regard to their own self interest. We address ourselves, not to their humanity but to their self-love, and never talk to them of our own necessities but of their advantages.”
~Adam Smith, “The Wealth of Nations”
All due respect to Adam Smith, this week, it has been all about the visible hands in the market. Today the Dow Jones Industrial Average today closed at 11019.69, up 410 points, somewhat mitigating the brutal losses of Monday, in which we witnessed a 498.86 point decline in the Dow (to 10917.51 from 11416.37) and Wednesday, when it lost 446.92 points (to 10609.66 from 11056.58).
Today’s gains, should you choose to call them that, appear to be the direct result of coordinated measures by the six major central banks (the Bank of Canada, the Bank of England, the European Central Bank, the Federal Reserve, the Bank of Japan and the Swiss National Bank) intended to address the higher pressure in U.S. dollar short-term funding markets. To improve liquidity, the Federal Open Market Committee authorized $180 billion expansion of swap lines to provide dollar funding for term and overnight lending by the central banks. After an initially positive response, the market soon slumped.
For its part, the Securities and Exchange Commission (SEC) issued three new rules to help stabilize the markets and protect investors against naked short selling abuses. According to the new rules, short sellers and their broker-dealers must deliver securities by the close of business on the settlement date (three days after the sale transaction date, or T+3). The rule imposes penalties for failure to do so. The SEC also eliminated the options market-maker exception from the close-out requirement of Rule 203(b)(3) in Regulation SHO. The third new rule expressly targets fraudulent short selling transactions. Specifically, the new rule makes clear that those who lie about their intention or ability to deliver securities in time for settlement are violating the law when they fail to deliver.
Meanwhile across the Atlantic, the Board of the Financial Services Authority (FSA), which regulates the financial services industry in the United Kingdom, also introduced provisions to prohibit “the active creation or increase of net short positions in publicly quoted financial companies.” These provisions will remain in force until Jan. 16, 2009, although they will be reviewed after 30 days. A comprehensive review of the rules on short selling will be published in January. “While we still regard short-selling as a legitimate investment technique in normal market conditions, the current extreme circumstances have given rise to disorderly markets. As a result, we have taken this decisive action, after careful consideration, to protect the fundamental integrity and quality of markets and to guard against further instability in the financial sector,” said Hector Sants, chief executive of the FSA.
At the Treasury, a temporary Supplementary Financing Program was initiated on Wednesday, Sept. 17 at the Fed’s request. The program consists of a series of T-bills, in addition to the Treasury’s current program, to provide cash for Fed initiatives.
To avoid a “disorderly failure” of AIG, on Monday Sept. 16, the Federal Reserve Bank authorized the Federal Reserve Bank of New York to lend up to $85 billion to AIG. Failure by the largest insurance company in the United States could “add to already significant levels of financial market fragility and lead to substantially higher borrowing costs, reduced household wealth and materially weaker economic performance,” read the Fed’s press statement. AIG will sell certain businesses; the loan has a 24-month term and interest will accrue at the three-month LIBOR rate plus 850 basis points. AIG put up all of its assets as collateral, including stock of all of its regulated subsidiaries. The U.S. government will receive a 79.9% equity interest in AIG and has the right to veto dividend payments to all shareholders.
“These are challenging times for our financial markets. We are working closely with the Federal Reserve, the SEC and other regulators to enhance the stability and orderliness of our financial markets and minimize the disruption to our economy. I support the steps taken by the Federal Reserve tonight to assist AIG in continuing to meet its obligations, mitigate broader disruptions and at the same time protect the taxpayers,” said Secretary Henry M. Paulson Jr. on Tuesday, Sept. 16.
Later that day, the FOMC announced that it would leave the Fed funds rate at 2%. There were no dissenting votes. “Strains in financial markets have increased significantly and labor markets have weakened further,” read the press statement. “Economic growth appears to have slowed recently, partly reflecting a softening of household spending. Tight credit conditions, the ongoing housing contraction, and some slowing in export growth are likely to weigh on economic growth over the next few quarters. Over time, the substantial easing of monetary policy, combined with ongoing measures to foster market liquidity, should help to promote moderate economic growth.” It went on to acknowledge higher inflation and commodity prices and the expressed the expectation those increases would ease later this year and next.
On Tuesday, Sept. 16, Barclays Capital, the investment banking division of Barclays Bank PLC agreed to acquire Lehman Brother’s Investment Banking, and Fixed Income and Equities Sales, Trading and Research operations. Roughly 10,000 Lehman employees will join Barclays. Barclays assumed Lehman’s liabilities and will pay $250 million in cash. In addition, Barclays acquired the Lehman headquarters building in New York City and two data centers for approximately $1.45 billion. The transactions have been approved by the boards of directors and shareholder approval is not required.
“This is a once in a lifetime opportunity for Barclays,” said Robert E. Diamond Jr., president of Barclays. “We will now have the best team and most productive cultures across the world’s major financial markets, backed by the resources of an integrated universal bank.”
Lehman Brothers Holdings Inc.’s U.S. registered broker dealers will continue their normal operations. According to Barclays, Lehman is in discussions to sell its Investment Management Division to a third party.
"This is welcome news for every one of Lehman's customers,” said SEC Chairman Christopher Cox. “If approved by the court, customers will be able to look forward to an immediate transition of their accounts. Even before the transaction is completed, they will benefit because the broker-dealer and 10,000 Lehman employees will be able to continue their work with clarity about their future, and with greater funding resources for the broker-dealer's operations."
Lehman Brothers Holdings Inc. on Sept. 15 filed for Chapter 11 bankruptcy protection. However, the accounts of Lehman’s U.S. retail securities customers are with the broker-dealer and are protected by the segregation of customer securities and cash as well as insurance by the Securities Investor Protection Corporation (SIPC). According to the SEC, SEC staff have been on-site at the U.S. broker-dealer and will remain to oversee the orderly transfer of customer assets to one or more SIPC-insured brokerage firms. The SEC also is coordinating with overseas regulators to protect Lehman’s customers and to maintain orderly markets.
“For several days, we have worked closely with regulators around the world including the FSA in the United Kingdom, the BaFin in Germany, and the FSA in Japan, as well as our counterparts in other markets around the world, to coordinate our actions in the interest of orderly markets,” Cox said. “In doing so we have also worked closely with the Treasury and the Federal Reserve and market participants. We are committed to using our regulatory and supervisory authorities to reduce the potential for dislocations from Lehman’s unwinding, and to maintain the smooth functioning of the financial markets.”
