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Babcock and Brown « Previous | |Next »
June 15, 2008

The credit crunch was supposed to all over and things were getting back to normal. So how come Babcock and Brown, Australia's second-biggest investment bank and one time darling of the market boom, has fallen from grace so fast? A few weeks ago the bank was worth about $15 a share - this weekend it's worth a third of that at $5.25 after falling more than 50% in recent days. The stock was worth $34.60 a year ago.

Hedge fund attack say the economic commentators in the Australian Financial Review. The debt -driven business model, deals based on big debt and rising asset prices, is out of favour, the hedge funds are targeting leveraged corporations, and Babcock and Brown are now under pressure to sell their assets.

As Robert Gottliebsen says in his 'Babcock's Deal Addiction' in Business Spectator, the hedge funds knew the market capitalisation (or share price) trigger point ($7.50) and they start short selling the stock.

The process creates panic and down the stock goes and it does not stop until the lending clause has been triggered. Undoubtedly, a gradual liquidation of assets will probably now take place by Babcock and Brown to repay banks as their loans fall due. It will be very difficult to keep this process orderly while at the same time dealing with the hedge funds

Can we trace this situation back to the easy money and low interest rates in the 1980s and 1990s in the US, when laissez-faire mentality amongst the monetary authorities ruled? How did the monetary auhorrities ---central banks, financial regulators and governments-- allow speculative fever in housing and financial markets to become so intense--the credit bubble-- that it turned into a bust. If we remember, debt had been growing faster than incomes in most corners of the English-speaking world.

Our economic high priests (economists) claimed there was nothing to fear. Sure, there was more debt around, but the architecture of the financial system was more robust and could bear more strain. Then last summer, the great edifice of credit started to collapse. In this review of Charles Morris's The Trillion Dollar Meltdown in the Sunday Times Edward Chancellor says that the fact that the subprime mortgages had little prospect of being repaid bothered no one:

Everyone in the credit system (the home appraisers, mortgage brokers, lending banks, Wall Street firms that acquired bundles of mortgages and sold them on, ratings agencies that stamped these securities with their investment-grade imprimatur, as well as the hedge funds that snapped up the riskiest slices of debt) was primarily concerned with fees. This encouraged reckless and predatory lending. Morris points out that the new credit system actually favoured riskier loans because they meant higher rates and produced more “spread” for market participants to play with.

The $1 trillion refers to the amount of defaults and writedowns Americans will likely witness before they emerge at the far side of the bursting credit bubble, Bubbles lead to busts. Busts lead to panics. And panics can lead to long, deep economic downturns,

The current crisis--and its impact on Bacock and Brown-- discloses the limits of the free-market ideology that has held sway since the early 1980s.The growth model - as applied by Macquarie and B&B---worked in a bull market. Now asset prices are falling. The banks have stopped lending. So there are precious few buyers for any major assets at all. This is a bear market. B&B is a group that has relied on doing huge one-off deals for income.

| Posted by Gary Sauer-Thompson at 4:18 PM | | Comments (6)
Comments

Comments

I believe that this is a massive effort to short the stock that should be investigaged by the SEC, all transactions leading up to this event should be reviewed, you have major merchant banks like UBS giving out buy orders for BNB just weeks before this event happened. All the merchant banks shorting this stock were probably aware many of their clients bought this stock on margin and that a push to bring it down would trigger automatic sell orders for them to buy it up. This is immoral if not illegal.This is my view anyway.

be aware
Wall Street's financial innovations didn't manage risk; they enhanced risk. They were so non-transparent and complex that neither Wall Street nor the ratings agencies could properly assess them.

Alan Blinder, a former vice-chairman of the Federal Reserve wrote a thoughtful column in The New York Times yesterday about bubble bursting.

He distinguished bubbles fueled by irresponsible bank lending, such as the currently deflating housing price bubble, from those that the banks had nothing much to do with, such as the 1990s tech-stock bubble. His view is that the Fed can and should act to rein in the former, whereas it should let the latter burst of their own accord, then help to pick up the pieces.

http://www.nytimes.com/2008/06/15/business/15view.html

The factor that caught many players by surprise this time was the way last August that the lending market seized up. Theoretically, money is always available if you are prepared to pay enough for it. But when there's been maybe a trillion dollars of losses, but nobody knows whose they are, nobody would lend to anybody in case the borrower turns out to be one of the losers.

Sustained shorting of a stock can be a pretty savage attack, but only if a company is vulnerable. B&B may be vulnerable, but Macquarie for example isn't, despite the fact that it's got a whole bunch of assets on its books that in the normal course of events it would have gotten rid of.

Gary,
was the fall of Babcock and Brown due to short selling by the hedge funds--as MikeM and others argue? Or was it loss of confidence in management and a balance sheet that is recklessly leveraged and overwhelmed by related-party revenues? See this

MikeM,
Shoort selling is certainly happening. Transpacific Industries chairman Terry Peabody has accused hedge funds of attacking his stock in a short-selling onslaught that was exacerbated by a significant shareholder deliberately lending the stock to be sold short.

Peabody has described the stock-lending practices of the shareholder as "despicable", saying his company's share price had halved due to the short-selling frenzy that began in December.

Has short selling and stock lending come under scrutiny by regulators because vulnerable companies, such as those with large borrowings in the current environment of tight liquidity, were targeted by global traders?


Peter,

B&B is still alive.

Loans against stock of the kind that Opes was making were extremely risky, which is why the established margin lenders such as Macquarie wouldn't have a bar of them. And borrowers were a sitting target for attack by shorting, ironically with shorters sometimes borrowing the same stock that the victims had lent as security.

As soon as the market found out that a company director had a hefty chunk of stock for which he'd paid 10% and borrowed the other 90%, that guy was toast.

I don't think short selling was the main factor with B&B though. They had a lot of short term debt (too much to be safe in the current climate) which the market anticipated they would might not succeed in refinancing.

However Bloomberg has just reported that B&B Power stock has reached its highest level since June 12 after B&B announced that they have refinanced $A2.7 billion in debt and is seeking to sell some assets.

I figured at least 2 years ago that the mushrooming of sub-prime housing lending would cause heaps of trouble sooner or later and plenty of other people did too. But I think what nobody foresaw was the way that global debt markets just seized up. It was what Nassim Nicholas Taleb would call a "black swan event". His book about black swan events is highly entertaining, http://www.fooledbyrandomness.com/. If you want a shorter explanation, Malcolm Gladwell profiled Taleb in The New Yorker in 2002. The piece is available online at http://www.gladwell.com/2002/2002_04_29_a_blowingup.htm