What a carve up

Well, the clock sits at two minutes to midnight on Lehman and Flash is frankly bewildered about how to trade this one.

Perhaps it would be better not to trade it at all. Trouble is, Flash has some decent long Dow and S and P positions sitting comfortably in three figure profits. But if the wider market decides to take this as a signal to go into full blown panic, then Flash will have to just cut them.

On balance he thinks he will cut the Dow long position in half when the futures indices open at 10.30pm tonight (if it's not cut in half for him) and put some hedging short equity positions on pronto.

Flash still stands by his view though that perhaps this isn't quite armageddon because so much is known - what may well not be known is the extent of all the other banks' exposure to Lehman (or ToxInc as FT Alphaville coined their 'bad bank' on Friday) - and that could have serious repercussions. So if there's even so much of a flicker on the price, as inevitably there will, the HBOS and Barclays long positions will go first thing tomorrow - and the same will probably be true for plenty of other much bigger fish. It's hard to see how most of the financials couldn't be heavily exposed to Lehman, unless they'd already got some damn good hedging in place ahead of this. (The hedging in all probability consists of heavy-duty short positions in their competitor institutions). Hence a mega selloff of bank shares?

Nouriel Roubini has this scary paragraph:

It is now clear that we are again – as we were in mid- March at the time of the Bear Stearns collapse – an epsilon away from a generalized run on most of the shadow banking system, especially the other major independent broker dealers (Lehman, Merrill Lynch, Morgan Stanley, Goldman Sachs). If Lehman does not find a buyer over the weekend and the counterparties of Lehman withdraw their credit lines on Monday (as they all will in the absence of a deal) you will have not only a collapse of Lehman but also the beginning of a run on the other independent broker dealers (Merrill Lynch first but also in sequence Goldman Sachs and Morgan Stanley and possibly even those broker dealers that are part of a larger commercial bank, I.e. JP Morgan and Citigroup). Then this run would lead to a massive systemic meltdown of the financial system. That is the reason why the Fed has convened in emergency meetings the heads of all major Wall Street firms on Friday and again today to convince them not to pull the plug on Lehman and maintain their exposure to this distressed broker dealer.

So tomorrow will not be a good day for the banks, unless some unctuous calming anti-panic lotion is administered by Uncle Ben or his acolytes before midnight. Not good at all. The end of tomorrow might be good day to do some financial bottom fishing if you've got a long line (of credit??). Nasty, nasty.

It also depends if Lehman's liquidation is orderly or disorderly. Perhaps at the very least an orderly liquidation might enable some sense of rationality to prevail. It would be in all the banks' interest for this to happen, and Flash expects an unctuous statement to this effect before the night is out.

If a deal - or at least a clear 'road map' to dissolution - isn't forthcoming then it won't be much fun out there at all. Or perhaps this is just the final shakeout, the Big Capitulation. Or perhaps (for the reasons outlined in the last blog, not). Flash is watching and waiting, and pleased that he's reduced his risk and has a fair chunk of the fund sitting in cash right now.