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Merrill Lynch, Wachovia and other financial companies are at risk of failure as the cost of raising capital soars at a time when the banks need to pay settlements over auction rate securities, David Kotok, chairman & chief investment officer from Cumberland Advisors, told CNBC Monday.
"I think the financial problem is half way through the cycle … there's another shoe to drop ahead of us and it could be more severe," Kotok told "Worldwide Exchange." (Watch the video at the left to hear Kotok's views on where oil and the dollar are heading.)
The cash companies need to shore up bad investments, "is up to about $50 billion and will probably top $100 billion before it's over," he added.
"Those firms -- Merrill, [MER
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] Wachovia [WB
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] and others -- are going to have to raise that cash," he said. "They are either going to have to get it from the Federal Reserve, through some direct or indirect means, which means more leverage, more Fed balance sheet, more regularly oversight or they're going to have to get it in the capital markets."
"The price in the Federal Reserve is about 2 plus percent, in the capital markets it's four times as high," Kotok said. "If they pay the higher price, there is no profitability for them so their franchises are jeopardised. This is a serious developing issue as we cure years of overleveraging."
The amount of cash written off Merrill Lynch and Wachovia's balance sheets since the onset of the credit crisis still far outweighs the amount of cash they have raised, suggesting the need for fresh capital injections.
"Wachovia is a strong and stable company on solid footing," a spokeswoman for the bank said, referring to the company's statement on Friday that it "does not currently expect that the purchase of ARS under the agreement in principle will have a material effect on capital, liquidity or overall financial results."
Merrill Lynch didn't immediately comment.
Fannie Mae [FNM
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] and Freddie Mac [FRE
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] are also in jeopardy, Kotok said.
"Were it not for government aid and backing they would have already had to declare bankruptcy. Their portfolios have problems," he said.
"You see one brick at a time in the financial problem area become addressed. Here's Lehman [LEH
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] trying to divest real estate holdings in a falling real estate market," he added.
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