The SMLEC and Black Monday's 20th

Citigroup, JP Morgan and Bank of America recently unveiled their $100bn SMLEC (Single Master Liquidity Enhancement Conduit), which is designed to prevent a fire sale of illiquid Asset Backed Securities, which have been plagued by the recent subprime mortgage crisis. While the announcement briefly relieved fears of financial crisis, and while other banks have bought into the plan, the SMLEC has also raised a lot of questions. Many bankers are worried that the willingness of the SMLEC to buy assets at higher-than-market prices is a moral-hazard; they think that the financial institutions should take the hits for their risky bets. Moreover, many critics see the SMLEC as short term relief from symptoms of a much greater problem, and argue that the SMLEC will only push the problem deeper into the future. It remains unclear what role the Federal Reserve is playing in this mess. You can read more about it on FT.com:

On Wall Street: Out of frying pan but fire sale is on hold

Last Friday was the 20th Anniversary of Black Monday (October 19, 1987). Black Monday was one of the greatest financial crises of the 20th century, and basically occurred when a relatively small sell-off (due to fears of overvaluation) was massively amplified by systemic risks within the markets. As equities were sold off, many portfolio managers attempted to protect their portfolios through the same hedging strategy. But ironically, the more they hedged against their losses, the more losses they incurred. This led to more hedging and more losses, and the market quickly spiraled into free-fall. The market dropped 23% in one day, the largest single day drop on record.

Last week, many investors were spooked by the 20th anniversary of this crisis, especially since the subprime mortgage crisis has created so much uncertainty within the markets. While some investors were worried after the sell-off late Friday that a repeat scenario would occur at the beginning of this week (Mark and Tyler included), markets seem to have rebounded on strong earnings reports from companies like 3M, Apple, DuPont and AT&T, and also on news that other banks will be supporting the SMLEC.