The Bloodletting, Part II

I was really hoping that I wouldn't have to post more thoughts on the financial markets recent stumble, but it's too important not to at least post a few random thoughts.

- The Fed decided to bailout troubled insurer AIG last night. While I'm against the government bailing out bad management, this one was needed. AIG wrote credit default swaps and sold them to banks who bought bad mortgages from mortgage companies. Their 'promise' was that in the event of default, AIG (the world's largest insurer, well, it was, anyway) would be good to pay back the bad loan. Lo and behold, bad loans start rolling in, and the piper demands to be paid. AIG sold these derivatives pretty much unregulated, to anyone and everyone that would buy them. Suffice to say, if the Fed didn't step in, the bloodletting would be a lot worse.

- Lots of debate as to whether or not the FOMC should lower short-term rates. Assuming the market opens dramatically lower tomorrow, I don't see this as implausible.

- Word on the street is puts for Goldman Sachs went from around $.15 to over $20 in the space of two hours. No photographic proof of this, but I don't see this as too illogical, given that it's one of two independent banks left standing.

- I overheard something a bit concerning while walking through the Financial district of San Francisco today, two well dressed men standing in front of the Mandarin Oriental whispering into their mobile phones about 'manipulation'. Then, about an hour later, a commentator on CNBC mentions the same word.

- The SEC released an emergency order today preventing naked short selling. Not sure if this isn't too late.

- Both WaMu and Morgan Stanley are seeking their own respective deals to take them out of their bad positions.

The Bloodletting

Today was obviously not a good day for anyone who is apart of this country's financial system in any way. From those employed to oversee it, to those who work for it, and finally (and probably most importantly) those who invest it. With the DJIA dropping more than 500 points, it was the worst day since just after the September 11th attacks.

I actually think that today's bloodletting was a good thing, not only for the stock market, but for the economy as a whole. Over the weekend, a couple of major things happened, first, Bank of America purchased Merrill Lynch, and the Federal Reserve decided they were not going to bailout Lehman Brothers.

Let's be clear, it's never a good thing when banks the size of Lehman and Merrill simply go away. People lose jobs and insane amounts of money. But the decision of the Fed not to bailout Lehman (and inconsequentially, they probably telegraphed the same signal to Merrill) is a sign that they think the economy may be on the mend.

Let's face it, back in March when the government bailed out Bear Stearns, nobody had any sort of accurate clue about how deep or severe the current housing crisis would be. This weekend's decision not to help Lehman, is a clear signal that the government thinks the financial community and the economy as a whole is strong enough to withstand a major investment bank going out of business. 6 months ago, this just wasn't the case.

I'm no finance expert, but I think it's safe to assume that there might be more banks that go under in the next 6 to 12 months. The important thing to remember is that the responsibility for these defaults is not the general public's, but that of the banks themselves, who got themselves in this mess to begin with.