Wall Street to Main Street: Brace Yourselves

Monday's market meltdown had our pundits typing as fast as the losses were mounting on Wall Street, and their commentaries followed a common theme: Brace yourselves.

"It is likely that all the bad news is not yet out with specific concerns around a large insurance entity and counterparty risks of various derivative products in which Lehman is involved," Citigroup's Tobias Levkovich cautioned on Monday.

Lehman Brothers' (LEH) bankruptcy filing, Merrill Lynch's (MER) takeover by Bank of America (BAC) and the uncertain fate of AIG (AIG) combined to drop the Dow Jones Industrial Average 504 points on Monday. It was the largest one-day percentage drop in over six years, according to Dow Jones Indexes, and the sixth-biggest point drop ever.

Ed Yardeni, founder of Yardeni Associates, was blunt about big-picture worries, which have shifted to something harder for ordinary investors to understand.

"Only a few months ago there was widespread concern that the global boom was driving oil prices to record highs," he wrote Monday. "Headline inflation was surely heading higher, and so would core inflation. The Fed might have to tighten sooner rather than later. A few weeks ago, there was increasing concerns about stagflation. Now, the mounting fear is that a depression is coming, along with deflation."

After the of rescue of Bear Stearns back in March, and more recently Fannie Mae (FNM) and Freddie Mac (FRE), Jeffrey Kleintop, at LPL Financial Services, noted the demise of Lehman marks a turning point in the government's stance on this financial crisis. "[N]ot much fundamentally has changed -- only the rules of the game," he wrote Monday. "The Treasury will no longer bail out troubled institutions and the industry must fend for itself driving a flurry of activity."

On an individual-investor level, Mark Riepe, head of the Schwab Center for Financial Research, counseled Lehman bondholders to understand where they stood in the pecking order of creditors as the logistics of bankruptcy grind through the investment bank's mess.

"The question facing bondholders is whether to sell now or simply hold on and see how the situation unfolds," he wrote Monday. "We believe selling right now is a difficult proposition as the market is thin and thus subject to an exceptionally wide bid-offer spread. If you need the money and believe you need it immediately, then selling now may be a reasonable course of action. If that is not your situation, then consider waiting to let events calm a bit in order to plan your next move."

Contrary to Kleintop's contention that the feds have drawn a line in the sand, the government may next need to tackle Lehman's chaotic credit derivative swaps, or CDS, portfolio, noted still-employed Merrill Lynch chief economist David Rosenberg, a longtime voice of concern over the underpinnings of the financial sector.

"Most people seem not to know the size of the CDS market, the loss potential and who owns what," he wrote Monday. "If there is a market maelstrom ahead, there is always the chance that the government is going to have its hand forced and become much more involved."

And as the Street waited, white-knuckled and hyperalert, for some resolution in AIG's struggle for liquidity, David Hendler, chief banking analyst at CreditSights, wrote that the Monday trio of debt ratings downgrades from Fitch, Standard & Poor's and Moody's didn't help matters much. According to Hendler, AIG is scrambling to find buyers for several business units, most notably International Lease Finance Corp., its aircraft leasing arm. With an $18 billion loss over the last three quarters and more expected for the third quarter, he wrote that "while we continue to believe AIG will survive in some more streamlined form, it is clear that the risk profile of the company has significantly deteriorated."

Hendler's view: Move fast on a sale, move faster on easing market fears. "Without further management clarity, we fear that the AIG franchise could be come impaired by the market selloff as customers become increasingly concerned regarding the company's financial health," he wrote. "While the company had planned to release details of new CEO Robert Willumstad's restructuring plan on Sept. 25, we believe that management needs to address investor concerns now before the market selloff becomes a self-fulfilling prophecy."

If there's a glimmer of optimism to be gleaned in the latest crop of commentaries, historical precedent augurs better times.

"No one knows when the market will bottom -- in fact, market bottoms are not made in a day -- they are processes," LPL Financial's Kleintop wrote. "It may be that once again that these events catalyze a positive market reaction after an initial selloff. This week the dissolving of Lehman Brothers, the announcement from AIG, earnings reports, and the Fed meeting will provide much needed added insight on the market's likely course."

Indeed.