Many U.S. and European banks are reportedly considering divesting certain units in order to recapitalize for the tough times ahead, according to the Wall Street Journal. Banks considering such drastic moves are Citigroup (NYSE:C) and HSBC Holdings (NYSE:HBC) among others. Shareholders are hoping that these moves could help recapitalize the firms enough to avoid any further share dilution or worse.

Citigroup may shed or shut down several of its mid-sized units valued at around $12 billion while HSBC could exit all or parts of its $13 billion U.S. automotivd financing division, the Journal reported today. Citigroup units that may be shed include Student Loan Corp, its North American auto lending business, Redecard SA (its Brazilian credit card company stake), and its Japanese customer finance business. Meanwhile, HSBC is considered well capitalized but has experienced many issues with its automotive business that has been lagging behind.

One of the larger rumors circulating is that Citigroup may be considering a sale of Smith Barney, which could approach $10+ billion in value alone. Citigroup has a business that is fairly independent of its retail banking, commercial banking, and investment banking operations. And Smith Barney has about 9.3 million client accounts with around $1.6 trillion in total assets. Whether or not parting with Smith Barney would cause any real harm is uncertain, but it is a huge business that certainly could be sold in order to preserve liquidity.

Many are anticipating any units put up on the block to be acquired by Asian banks or sovereign wealth funds looking to build their portfolio of cheap dollar assets. Meanwhile, if Citigroup decides to sell its stake in Smith Barney, it is likely that a well-capitalized bank like Wachovia may consider acquiring it. Regardless, this is a situation that is definitely worth watching closely!

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Hedge funds are starting to feel the effects of the credit crunch as getting credit from lenders becomes increasingly difficult. Many investment banks are cutting back on loans to hedge funds by eliminating some clients and raising borrowing fees for others after heavy losses forced them to slim down their balance sheets. This could put pressure on both banks and hedge funds that rely on each other to boost their profits and returns.

Many hedge funds, known as quants, use computerized models designed to spot and take advantage of small pricing inefficiencies in the marketplace. These funds rely on a massive amount of leverage to drive their returns, and trouble borrowing could soak up their profits. Meanwhile, activist hedge funds and private equity funds rely on large amounts of debt and credit in order to finance M&A deals that they have used to bolster their returns during the past few years.

Hedge funds often borrow through a “repo” operation whereby the hedge fund sells securities to banks in exchange for cash, while entering into an agreement to buy them back at a later date when they pay the money back. These rates are skyrocketing, however, as banks are increasingly worried that hedge funds won’t be able to repay the loans. Morgan Stanley, for example, has been asking for one percentage point over LIBOR to enter into a repo agreement using junk bonds as collateral, according to the Wall Street Journal.

Problems in the hedge fund industry could cause problems in the larger markets too. Many public institutions, high net worth individuals and retirement funds have large investments in hedge funds that have traditionally returned healthy profits. Any limits in lending could adversely impact the returns for these hedge funds. Meanwhile, hedge funds that are forced to abandon deals or liquidate large positions may also prove to be a drag on the market. In the end, this is a significant event worth watching!

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Warren Buffett plans to carve out his own niche to profit from the nation’s credit market turmoil. The billionaire’s Berkshire Hathaway (NYSE:BRK) announced his intentions to start up a bond insurer that aims to make it cheap for local governments to borrow and may prove to be a tough competitor for the trouble existing insurers. Shareholders are bullish on the developments that promise to put more of the firm’s massive cash reserves to work.

Berkshire Hathaway Assurance Corporation is set to open for business today in New York and will focus on guaranteeing bonds for cities, counties, and states to finance sewer systems, schools, hospitals and other public projects. Berkshire’s solid AAA rating, which is held by very few companies, is likely to go a long way in a market that has many people unsure of who they can trust. After all, firms like Ambac Financial and MBIA are now seen as at risk of losing their AAA ratings due to the increased risk of mortgage-related bonds that they insure.

Warren Buffett said in an interview that there appears to be a high interest in a new company to seek permission in other states that account for a large chunk of municipal-debt issuance. After New York, the firm will likely seek to do business in California, Puerto Rico, Texas, Illinois and Florida. The billionaire said they would move prudently but would commit quite a bit of capital if they like the business. And in the end, focusing on municipal debt is a relatively safe bet when compared to asset backed securities!

In the end, this is more great news for Berkshire Hathaway shareholders who are seeing Buffett partake in a buying spree into the market decline. Recently acquisitions combined with this new business should help the firm put some of its massive capital reserves to use. Combined, these factors make BRK a stock worth watching!

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