Posted on 10/18/2001 11:26:30 AM PDT by Antiwar Republican
October 18, 2001
Wall Street Journal
Banks and Regulators Drew Together To Calm Rattled Markets After Attack
By ANITA RAGHAVAN, SUSAN PULLIAM and JEFF OPDYKE
Staff Reporters of THE WALL STREET JOURNAL
The stock markets bent, but they didn’t break.
After huge losses in the week after the terrorist attacks, several stock indexes stand just a shade below their Sept. 11 levels. Despite some initial fears of a crash, there was no wholesale dumping of stocks.
There are many reasons the market stabilized, ranging from companies’ stock buybacks to ordinary perception of value by investors. Part of it was quick action by government officials and regulators, such as easing rules on buybacks. But a key element was a series of behind-the-scenes and little-known maneuvers by Wall Street players. Together, these steps and the regulatory moves helped prop confidence and smooth out the market’s mechanics.
The Federal Reserve saved the government-bond market from seizing up. The Fed pumped more than $45 billion into the banking system when it became clear that Bank of New York, which had offices near the World Trade Center, had huge problems in processing trades. And after Bank of New York, a middleman in many fund transfers, delayed making up to $100 billion in payments to other banks, the Fed flooded the financial system with more dollars. It bought government securities to let the investment banks selling them meet immediate funding needs after others failed to pay them quickly for pending trades.
Some securities firms strongly discouraged their analysts from making negative stock calls. Legg Mason Wood Walker, for instance, did this in informal chats with research executives in the days before the markets reopened. "We wanted to help the retail investor fight the urge to panic," says research chief Ira Malis. And just before the markets reopened Sept. 17, Merrill Lynch & Co. officials told some analysts who were set to speak on the morning research call that there wouldn’t be any downgrades, as they would be meaningless with the markets in such turmoil.
Several Wall Street firms, including UBS Warburg Inc. and Bear Stearns Cos., tried to keep a lid on short sales, or bearish market bets. And some influential investors, including Art Samberg, co-manager of Pequot Capital Management, the nation’s largest hedge fund, told troops not to make bearish bets on the market’s opening.
"If there was a national team effort, this was it," says Tom Russo, a Lehman Brothers Inc. vice chairman.
‘Confidence Game’
Some of the most important steps addressed mundane areas such as trade processing, sometimes thought of as the financial plumbing of Wall Street. "This whole thing is a confidence game, and you better damn well think carefully of anything that can shake confidence," says E. Gerald Corrigan, a Goldman Sachs managing director who headed the Federal Reserve Bank of New York during the 1987 crash. "A fundamental breakdown in the plumbing system can do that to public confidence in the financial markets, and in particular, the stock market."
The biggest test came right after the attacks. The markets were shut because of massive damage to communications systems. "The concern and worry ... was overwhelming," says Merrill Lynch Chairman David Komansky.
Within hours, a flood of calls to the New York Fed and the Securities and Exchange Commission offered a chilling field report. Citigroup and J.P. Morgan Chase executives witnessed something they had never seen before: cash hoarding. A number of corporations were trying to draw down their credit lines at banks, while individuals were lining up at ATMs for cash.
Facing Defaults
By 11:30 a.m., Citigroup and J.P. Morgan Chase knew they had a problem. The attacks had cut electronic ties between some banks that act as middlemen in the market for commercial paper – short-term loans used by corporations to meet funding needs. Now a number of companies, facing potential defaults on their commercial paper because they couldn’t "roll it over," or reissue it, were anxiously ringing their bankers to draw down loans.
Initially, J.P. Morgan Chase, the lead bank on a number of syndicated corporate loans, and other banks were having trouble providing their portion of these loans. Chase, for instance, didn’t immediately fund its $100 million portion of an $860 million revolving credit facility that American Airlines drew down on the morning of Sept. 12.
Some Wall Street executives say J.P. Morgan Chase was unwilling to advance cash immediately to clients such as AMR Corp., parent of American Airlines, or to put up money for other banks on loans where it served as the lead agent. A J.P. Morgan Chase spokeswoman says the bank was willing but unable to do so because of disruptions to its lower Manhattan operations, which weren’t damaged but had to be evacuated. She says the evacuation kept the bank from allowing corporate clients to draw funds from existing credit lines until the day after the terror attack.
An AMR spokesman says that "a number of banks, including J.P. Morgan Chase, were physically unable to fund on Sept. 12 because their administrative areas were affected by the World Trade Center attack. However, J.P. Morgan and others funded early on September 13, and all banks were, and continue to be, very supportive of us."
Several banks that were close to the World Trade Center did manage to fund their portions of corporate loans immediately. These included Citigroup, which also is in lower Manhattan and had to relocate its lending operations after the attack. Citigroup, the lead bank on the American Air loan, funded the airline’s entire loan on Sept. 12 on behalf of the bank group, an AMR spokesman says, and was reimbursed by each bank shortly afterward.
On Sept. 12, the day after the terror attack, J.P. Morgan Chase began funding loans again, and just in time. If Citigroup and Chase hadn’t been willing to advance the money to their corporate clients, this could have triggered commercial-paper defaults. These, in turn, could have have sent stock and bond markets into a tailspin and caused a crisis of confidence.
Back-Office Logjam
On that Wednesday, Wall Street chiefs huddled at the midtown Manhattan offices of Bear Stearns Cos. A top concern was Bank of New York, a middleman that handles about 12% of funds transfers in the U.S. -- $900 billion on a typical day – and processes up to $1 trillion a day in government-securities trades. With its offices damaged and those of the leading bond broker Cantor Fitzgerald LP destroyed, executives were nervous that a mundane back-office logjam could spiral out of control. "The clearing issue was of great concern to everybody," says Mr. Komansky.
Government officials and regulators quieted the executives’ concerns. Treasury Undersecretary Peter Fisher told them the Fed "will be providing the banks with all the funding they need and the brokerage firms will have access to that."
One banker broached a sensitive issue. Could the banks have some leeway regarding Rule 23-A, a Depression-era law that prevents banks from using customer deposits to fund their risky broker-dealer business? "We’re not sure you will be accommodating about 23-A," the banker fretted.
His concerns were assuaged. "We will be as accommodating as we can be," replied Joyce Hansen, a New York Fed official, according to people who were in the room.
To the bankers, the message was resoundingly clear. The Fed was willing to suspend certain time-honored regulations to make sure financial institutions felt sufficiently protected. This was critically important: Big banks and securities firms borrow heavily to fund day-to-day activities, so a funding crisis could have been devastating.
As Wall Street chiefs were sorting out these issues, Mr. Malis, the Legg Mason research chief, was phoning each of the firm’s 33 analysts and laying out a new, though informal, policy. With so much uncertainty, the firm didn’t want negative changes to stock recommendations until after the market reopened. Though not a ban, "the hurdle to downgrading a stock was very, very high," says the Baltimore firm’s chief market strategist, Richard Cripps.
Analysts were told late on Sept. 12 that for the time being, any proposal to downgrade a stock had to go before the firm’s investment committee. Explains Mr. Cripps: "Institutional investors were telling us they did not want to see downgrades."
Meanwhile, Salomon Smith Barney bond chiefs, operating out of makeshift offices in East Rutherford, N.J., were pondering a key decision: Should they close on a $1.25 billion underwriting for Delta Airlines of equipment trust certificates backed by aircraft? The bank’s lawyers looked at the possibility of breaking the deal by exercising a "material adverse change" clause.
But Salomon bond chiefs felt that would be seen by investors as a big no-confidence vote and could send the corporate-bond market into a tailspin. Salespeople at Salomon and co-manager J.P. Morgan began phoning investors, telling them the deal would go through, though the interest rate might change if the airline sector was downgraded. The deal closed five days later at an interest rate between 0.75 percentage point and one point higher than first envisioned.
On Thursday, Sept. 13, the bond markets reopened. Jack Ablin, chief investment officer of Chicago-based Harris Trust, which manages $20 billion in stocks and bonds, got a firsthand view of the damage. He discovered that $200,000 in Treasury bills Harris Trust had had bought on Sept. 10 weren’t sitting in its account. Harris Trust had bought them from ABN Amro through TradeWeb LLC, an online trading firm with offices on the 51st floor of the World Trade Center. Moreover, ABN Amro was among the many firms that used Bank of New York to process trades.
To ease cash concerns among primary dealers in bonds – which include investment banks that aren’t able to borrow directly from the Fed – the Fed on Thursday snapped up all the government securities offered by dealers, $70.2 billion worth. The next day it poured even more into the system, buying a record $81.25 billion of government securities.
On Monday, Sept. 17, stocks were poised to resume trading after the longest halt since a "bank holiday" declared during the Depression. Legg Mason, knowing some analysts would want to downgrade certain stocks, offered a middle course: It said they could suspend their ratings on stocks. Internet-stock analyst Thomas Underwood suspended his ratings on Priceline.com Inc., Sabre Holdings Corp. and eBay Inc.
After the four-day trading halt, "it would have been irrelevant to rate stocks or [or talk to investors] about recommendations that were based on prices" that were nearly a week old, Mr. Underwood says. (A day later, with his stocks down steeply, he reinstated coverage with a "buy" on Sabre and eBay and a neutral rating on Priceline.)
Forty-five minutes before the market opened, Jay Goodgold, a Chicago sales manager for Goldman, phoned Henry Herrmann, chief investment officer at mutual-fund group Waddell &Reed. His message: "Goldman has ample capital and we are in a very liquid position, and if it is important, we would be very happy to make our capital available to you." Translation: Goldman was willing to take the other side of trades that the mutual-fund company wanted to make – that is, buy any stock the fund firm wanted to sell.
Mr. Herrmann didn’t do much trading that week. But some corporations did jump in – as buyers. In some cases they were taking advantage of regulators’ newly relaxed stock-buyback rules.
At Kinder Morgan Inc., a Houston energy company, Chief Financial Officer C. Park Shaper told Lehman before the market opened Sept. 17 that if Kinder Morgan’s stock fell, "we would be more aggressive in buying back shares." They were, buying $150 million of its own stock over the following month.
Discouraging Short Orders
Some securities firms used their clout to discourage short sales – selling borrowed stock in hopes of replacing it more cheaply after a market decline. UBS Warburg traders told clients they should be "measured in undertaking short-sale activities," says a person familiar with the initiative. Bear Stearns’s stock-trading chief, William McLaughlin, told his traders "to take short orders reluctantly."
At Pequot Capital, Mr. Samberg huddled with the big hedge fund’s staff before the markets opened Monday, telling traders: "Let’s not be predatory here. Let’s get to a market-neutral position and not strain the system."
At the close on the first day of resumed trading, the busiest day in Big Board history, the Dow Jones Industrial Average was off 684.81 points, or 7.13%. Still, some market pros were relieved. "I was surprised – I thought it clearly could have been nasty," says Merrill’s Mr. Komansky. "I think there was a widespread feeling by people not to take advantage of the market. It was not organized. There was just a feeling on Wall Street that we had been invaded."
Still, the worst wasn’t over. Two days later the market stumbled again, the Dow Industrials tumbling 400 points by early afternoon. At 1:39 p.m., John E. Roberts, a Merrill chemicals analyst, sent an e-mail to clients. "Merrill Lynch management discouraged any ratings changes today," he wrote. But he offered his views on three stocks he considered good "defensive" plays.
In an interview, Mr. Roberts says Merrill didn’t convey anything formally to the analysts – he just got "a general sense" that prices were fluctuating so wildly that midday rating changes wouldn’t be meaningful. A Merrill official says that with the market clearly poised to open lower, there wasn’t much point in analysts predicting that. Merrill’s policy wasn’t designed to reduce the severity of a market decline, a spokeswoman adds.
As stocks hit their lows that day, Wednesday, Sept. 19, traders noticed a hopeful sign. Goldman, Merrill and Lehman were large buyers for their clients of S&P-500 stock-index futures and NDX futures, tracking the Nasdaq 100 index. That suggested some big investors believed that the market was due for an upturn.
"People were looking for a ray of light," says Terence Duggan, a trader at Pimco Equity Advisors. "When [futures contracts] started to move, everyone dove in."
A bout of buying lifted the Dow Jones Industrials by more than 250 points in the last hour of trading that Wednesday, trimming the loss for the day to about 144 points. By the following Monday, 13 days after the attack, stocks were clearly on the rebound. The industrial average, which fell Wednesday by 151.26 points to close at 9232.97, is now down just 3.9% from before the terror attack.
So the system had steadied, with a little help from its friends. Says Laszlo Birinyi, global trading strategist for Deutsche Bank: "The financial markets were held together perhaps more than anyone expected."
Perfectly parallel to what happened at the lows after Black Monday.
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