Banks

The last month has seen a rash of activity in the US brokers and large banks, in particular, we have the departing of Stan O'Neal and Chuck Prince from Merrill and Citi respectively. This got me thinking, are there going to be more financial repercussions from the credit crunch, or have we seen the worst already?
There are two main issues with US credit markets at the moment and the two issues are inter-related. First, many mortgage lending standards were lowered in a rush to generate business. People who should not have qualified for loans were ushered into subprime mortgages, because the investment banks needed the mortgages to feed into their securitization machines. The second issue is that investors became complacent with risk and invested too heavily in the structured securities (CDOs mainly), that were built upon the shaky mortgages mentioned earlier. The great demand for yield produced products that generated yield, CDOs. What investors should have realized was that yield cannot be generated out of thin air; in fact, a AAA rated CDO tranche is definitely not the same as a AAA rated corporate bond. Unfortunately, complaceny is a human nature.
In my opinion, we have yet to see the end of the credit crunch, because the big investors have yet to mark down their holdings of CDOs. Although the big banks may have taken big baths lately (Merrill - $8.4B, Citi - $11B, MS - $3.7B), we still have a ton of CDO paper sitting on the books of investors such as pension funds and hedge funds. For one thing, these investors are not as heavily regulated as the banks, and are not required to report as frequently/succintly. For another, these investors may not be as sophisticated. Imagine, if the guys selling this stuff can lose tens of billions, what is going to happen to the guys buying this stuff?
Another indication that the credit crunch is not yet over is the reluctance of the street to actually write down these investments. We have Citigroup trying to organize the M-LEC to rescue the $80B they hold in off balance sheet SIV (Special Investment Vehicles - leveraged funds that invested heavily in CDOs). The organizers of M-LEC (Citi, BOA, Wachovia, etc) want the fund to buy assets from the locked up SIVs at 'market' prices, because they do not want to prevent a firesale. The irony is that M-LEC will only buy the highest rated securities, leaving the SIVs holding the most illiquid paper. What a great way to prevent a firesale.
This is like a game of 'don't show, don't tell'. If they don't have to sell the assets to the street, then they won't have to mark them down to their market values. This is great as long as everyone plays along. What happens at the end, when the SIVs all sell their best assets to M-LEC? Who wants to be the one holding the bag?
Apparently, State Street doesn't. This past week, in the game of 'chicken', State Street blinked first and started unwinding one of their CDOs. What is most telling is that the formerly AAA tranches were immediately downgraded by S&P to BB and CCC-. To put that in perspective, AAA is the best rating one could give. CCC- is a company currently vulnerable and dependent on favorable economic conditions to meet its commitments. How can something go from AAA to CCC overnight? Your guess is as good as mine.
In conclusion, I do not believe the credit crunch is over yet, in fact, I would be very hesitant jump into any of the financials at the moment. Much better to preserve capital and look for entry points when everything has cleared away.
-Jason