Cut to the Chase: A Tale of Financial Brinkmanship
Here’s a story that is as scary as any on Wall Street today--no matter which side you believe.
Banking giant Chase Manhattan Corp. last week needed to reset the 9.66% yield it was paying on $200 million worth of its debt. The routine reset is required every two years, under the original terms of these particular notes.
The reset had to be done via an open auction. Chase held the auction a week ago Tuesday, as scheduled. The end result was that Chase was forced to reset the yield at a stratospheric 13.017%, as investors showed exactly how worried they are about the weak financial standing of the company, just one of many troubled banking titans.
As shocking as that number was, however, it’s not the worst of the story--not, at least, according to Michael Murphy, a San Francisco money manager and professional short seller. Murphy now contends that Chase initially could find no one to bid for its notes within the ceiling of five percentage points over current two-year Treasury note yields.
That ceiling was originally set by Chase. If the notes couldn’t be refinanced within the limit, Chase would be required to redeem the notes--or go into default. Murphy claims that Chase was panicked as the auction approached, and called the Federal Reserve to warn that if the notes couldn’t be sold, Chase’s situation could shake the entire U.S. financial system.
The Fed, Murphy contends, then called investment banker Salomon Bros., “and ordered them to quickly put together a small syndicate to buy the bonds, probably guaranteeing them against loss.”
Salomon did indeed lead the purchasing syndicate. And the 13.017% yield was 4.92 percentage points above the two-year Treasury note yield--a slim 0.08 points from potential disaster for Chase.
Chase’s comment on Murphy’s story? “No truth whatsoever,” said a spokesman in New York. Nor, he said, were the latest rumors true--that Chase couldn’t sell its short-term commercial paper in the market Tuesday, and had to borrow from the Fed’s discount window. That talk helped push Chase stock down 87.5 cents Tuesday to $15, its lowest close in 11 years.
The Fed, as a matter of policy, declined to comment on Murphy’s version of the auction.
But a Salomon trader, who requested anonymity, noted that any auction “is a real good poker game. There’s no incentive for any prospective player to show his hand” until the last minute. So it isn’t unusual that the sale was taken down to the wire, the trader said.
The trader also said Salomon resold the notes a day after the auction to other investors, at a profit. So there clearly still are people who will buy Chase’s debt, at least at a 13% yield. As for Murphy’s allegation that the Fed requested that Salomon jump into the deal, the trader said, “To the best of my knowledge, the Fed did not ask us to buy the issue.”
Murphy acknowledges that, as a short seller--someone who routinely bets on lower stock prices ahead--people may question his story. But he says, “I got this directly from an investment banker type,” not from traders. “He (the banker) said to me, ‘You’re not going to believe this,’ ” Murphy said.
Many Wall Street analysts say they don’t know what to believe. It’s clear, they all agree, that investors are terrified that one or more major banks will sink under the weight of bad loans, as the economy continues to deteriorate. Warnings to that effect were all over Capitol Hill last week. Stocks of many of the biggest banks already sell for the lowest prices since the early 1980s. The market is saying that the risk curve is practically off the charts.
Now, that was the same message in 1982, as well--the last time there was talk of a worldwide depression and a banking crash. It didn’t happen, and the stocks recovered sharply in the mid-80s.
The difference now is that the banking problems are already severe, and the recession apparently is only beginning. In mid-1982, when the depression talk grew loudest, the recession of the time already was drawing to a close.
So even if Chase’s note sale went far more smoothly than Murphy asserts, the level of concern about Chase and other major banks is a red flag for the stock market. If the banking system continues to weaken as recession grips the economy, so too will investor confidence weaken. That suggests we’re nowhere near a bottom yet in the market. Bargain hunters ought to beware.
The bottom line, says Frank DeSantis, a bank analyst for brokerage Paine Webber in New York, is that “the U.S. economy can’t afford to have even one of these big banks have a liquidity problem.”
Big Shifts at Fidelity: Fidelity Investments, the Boston-based mutual fund kingpin, announced a major reshuffling of portfolio managers Tuesday. C. Bruce Johnstone, 49, was named head of the company’s London-based international investing operations, which manage about $11 billion in overseas investments.
Fidelity Chairman Edward C. Johnson III said the move reflected the firm’s belief that investment success in the 1990s will require an increasingly global view.
Johnstone had run Fidelity’s $4.1-billion Equity Income fund. He will be replaced by Beth Terrana, 33, who has run the firm’s $1.7-billion Growth & Income fund. Succeeding Terrana, meanwhile, is Jeff Vinik, 31, who has run the $310-million Fidelity Contrafund growth stock fund. And Vinik will be succeeded by Will Danoff, 30, who has been an assistant manager at Fidelity’s flagship, the Magellan stock fund.
Their young ages show that Fidelity places a lot of faith in portfolio managers whom other investment firms might consider too unseasoned. But both the Growth & Income fund and the Contrafund performed far better than the average stock fund in the late-1980s. In 1989 alone, Growth & Income returned 29.6%, versus an average 23.2% return for its peer funds. Contrafund gained 43.2%, versus a 25.4% growth-fund average.
In fact, it’s Johnstone’s performance that has been most disappointing lately, leading to speculation that he needed a new challenge. His 20-year results are strong, but in 1989 the Equity Income fund gained 18.7%, versus an average 21.4% for its peers. And through last week, Equity Income was off about 13% year-to-date, versus an 8.5% average loss for its peers. In contrast, Growth & Income was down about 8% for the year, and Contrafund was off just 1%.
TROUNCING THE BIG BANKS
How some major banks stocks have been hit this year, and the last time the stocks were trading near their current levels:
52-week Tues. Lowest Stock high-low close since Bank of Boston $28-$7 1/2 $8 1/4 1982 Chase Manhattan 44 7/8-15 15 1979 Chemical Banking 41 1/8-19 1/2 19 1/2 1982 Citicorp 35 1/2-17 17 3/4 1987 First Interstate 68 1/2-26 26 1/4 1982 Fleet/Norstar 29 1/4-13 1/2 13 7/8 1984 Manuf. Hanover 44 3/4-22 1/2 25 3/4 1988 Mellon Bank 35 5/8-18 19 3/4 1980
Source: Value Line Investment Survey
