Lehman Brothers going Bankrupt?

The firm told investors that it had not borrowed money from the US Federal Reserve on Tuesday and had liquidity of “well above” $40bn

With the rumors surrounding Lehman Brothers about how they need another 4 billion of capital, you would think coming out to state they have more than 4 times that amount of liquidity would stave a sell-off.

I’m guessing the Bear Stearns debacle is too fresh in everybody’s minds. The last time a CEO came to deny liquidity problems, it promptly went bankrupt in three days.

If you’re an employee you might be thinking of buying puts to hedge the risk of losing your job and your life savings. Perhaps thats why trading of put-options rised to 280,000 contracts, quardruple the 20-day moving average!

Is Your 401(k) Plan Diversified Enough?

Its no far stretch to say the biggest loser in the Bear Stearns bankruptcy were its employees. 1/3 of the company stock was/is held by Bear Stearns employees who’ve had a substantial amount of their life savings wiped out as well as finding themselves out of job. Clearly, holding company stock results in a rather substantial exposure to idiosyncratic risk, the risk of their stock holdings being reduced to nothing, and the risk that they’ll be out of a job by tomorrow. Since you can’t exactly diversify your job, it’ll make sense to reduce the risk in one’s portfolio.

Unfortunately, that usually doesn’t happen. Participants in 401(k) plans offering employer stock invest on average about 33 percent in company stock. An introductory course in finance will tell you that increasing unsystemic risk, so why do most people expose themselves such risk? Moreso the extremely smart bankers in Bear Stearns? (Although top management has obvious problems with risk management.)

Warren Buffet doesn’t believe in diversification. He’s quoted as saying “Wide diversification is only required when investors do not understand what they are doing.” Working day to day in a company probably provides not only the reassurance that the company won’t go bankrupt tomorrow, but that the company actually has decent prospects and holding the stock might be a rather good idea. To hell with diversification, I know the company, I know what I’m doing and I’ll make a lot more money holding on to the stock.

Unfortunately, bad decisions are made by top management. And no matter how well employees might know and be able to influence the company, their effect is severely limited. They might be working for the company but if half of your life savings are dependent on your top executives not screwing up, you’re still going to be exposed to an inordinate amount of unsystemic risk.

So like Enron before, Bear Stearns is a sad reminder that unless you’re smart enough to be the richest man in the world, it might be a very good idea to just diversify…

Contrarian Indicator: CEOs?

In the current recessionary environment, if a CEO comes out to say that all is well, is that an indicator to short the stock?

On the 31st of January, after a worse than expected quarterly loss, MBIA CEO Gary Dunton came out to say that “We believe that these steps, along with reduced capital requirements resulting from slower business growth, will result in our capital position surpassing rating agency Triple-A requirements … and will allow us to continue serving the needs of our clients and investors”

February 28th, John Stomber, CEO of Carlyle Capital, reported that during the fourth quarter the company’s portfolio stabilized and generated returns consistent with our near term targets, continuing to run the business to preserve the value of our shareholders’ equity and to position the Company to meet our long run objectives of earning an attractive risk adjusted return and paying a consistent dividend in the future.

On March 12th Bear Stearn’s CEO Alan Schwartz came out to say that Bear Stearns would have a profitable 1st Quarter and that the company had a $17 billion cushion against losses.

By March 12th, Carlyle Capital is bankrupt. March 17th, Bear Stearns has been sold to JPMorgan for $240 million. MBIA while still grasping to its AAA foresees further write downs and withdraws from Fitch ratings.

MBIA

Carlyle Capital Corporation

Bear Stearns

Such a situation not only brings up a whole lot of questions surrounding the legality of issuing such statements but the very credibility of company guidance. Is this fraud? Or for conspiracy theorists, is the misinformation deliberate, to allow insiders to get out of positions beforehand?

Either way, in current conditions, it might just be a good idea to start shorting a stock whenever a CEO comes out with “good news”.