Wall Street titan Lehman Brothers appeared headed toward bankruptcy Sunday as potential buyers Barclays Bank of Britain and Bank of America withdrew from the running after the Treasury refused to guarantee Lehman’s toxic mortgage portfolio.
In weekend-long negotiations at the Federal Reserve Bank of New York, leaders of the Treasury, Fed and Securities and Exchange Commission sought to persuade the two banks as well as other top Wall Street firms to step forward and acquire all or part of Lehman to avoid a major downturn that could be triggered by a Lehman collapse when stock and credit markets reopen Monday.
With no takers, the once-powerful Lehman appeared likely to have to file for bankruptcy after 158 years in business, possibly as early as Sunday night. In anticipation of that happening, Wall Street firms conducted an unusual Sunday trading session in the $62 trillion credit derivatives market to try to unwind sensitive credit insurance deals backed by Lehman and forestall a potentially monumental crunch in the credit market on Monday.
Federal officials and Wall Street leaders were at loggerheads all weekend over the critical issue of government involvement in the transactions. Treasury Secretary Henry M. Paulson Jr. was adamant against providing any guarantees on Lehman’s money-losing assets like the guarantee the Fed provided on $29 billion of Bear Stearns mortgages in March to facilitate Bear’s takeover by J.P. Morgan.
But Wall Street executives had little reason to put their own scarce capital into saving a competitor or backing its bad loans. In addition, political and financial leaders have been calling on the Treasury to draw the line and let the Lehman investment house fail to prevent any further unnecessary losses for taxpayers after the Treasury’s massive bailout of Fannie Mae and Freddie Mac only a week ago.
Former Federal Reserve Chairman Alan Greenspan told ABC’s “This Week” Sunday that not all major financial institutions can be saved and some are certain to fail in what he said may be the biggest credit crisis in a century.
“This is a once in a half century, probably once in a century type of event,” he said. “We shouldn’t try to protect every single institution. The ordinary cost of financial change has winners and losers.”
“What they are trying to do with Lehman is find a way in which there is no government money involved in this particular set of negotiations,” he said. “If they can’t, they have to make a very key decision as to whether they allow it to liquidate or support it.” Mr. Greenspan said the government should do what it can to ensure Lehman’s failure is orderly and does not cause great violence to financial markets.
“There are certain types of institutions which are so fundamental to the functioning of the movement of savings into real investments in an economy that on very rare occasions, and this is one of them, it’s desirable to prevent them from liquidating in a sharply disruptive manner,” he said.
Public opinion has come out strongly against another massive bailout only days after the government took responsibility for Fannie’s and Freddie’s gigantic debts.
Democratic presidential candidate Barack Obama said he is opposed to any government intervention to save Lehman and advocates a private sector solution. Republican presidential candidate John McCain has not taken a public position on the Lehman matter.
In the clearest sign that Lehman is headed for the bankruptcy courts in what would be the biggest Wall Street financial failure in decades, the International Swaps and Derivatives Association called for a special session Sunday to try to purge the intricately interconnected credit default swaps market of insurance deals that would become worthless in Lehman goes bankrupt.
“The purpose of this session is to reduce risk associated with a potential Lehman Brothers Holding Inc. bankruptcy,” the association said. But should bankruptcy be avoided, it added, any deals done during the Sunday session would “cease to exist.” How the markets would react to Lehman’s failure is the subject of much debate. Most analysts feared it could cause a major disruption in the credit insurance market, which is the reason behind Sunday’s special session.
Because the government failed to provide any financial backing for Lehman, the broader stock and credit markets also may react negatively. The one certain thing is that Lehman’s own stock will plummet, erasing what little value it had at the end of trading on Friday, when it closed at $3.65 a share.
One loose end from the fruitless weekend negotiations was the fate of an estimated $85 billion in bad loans Lehman has on its books. The company sought to separate those out and sell them, but found no buyers, and the government was unwilling to make them more salable by providing a guarantee.
Some analysts fear that if the loan portfolios are sold at fire sale prices in bankruptcy proceedings, that will lead to further steep writedowns of similar loans on the books of nearly every other U.S. bank and financial institution, possibly triggering another round of deep losses and bank failures.
But many other Wall Street analysts have concluded that a Lehman bankruptcy can be absorbed by the financial system without great damage.
“Six months after Bear, regulators should have ensured that a smallish investment bank could go under without systemic damage,” said Richard Beales, analyst at Breakingviews.com. “If Hank Paulson and company feels the need to step in, it suggests that years of deregulation have locked in a government backstop for Wall Street’s risk-taking.”
“Lehman has a negative net worth,” said Peter Morici, business professor at the University of Maryland. “Most other banks need all the cash they have to cover their own bad securities, and any money they put into a crippled holding company would likely just be lost.”
“It is time to toss in the towel on Lehman, unwind the counterparty trades and march it through Chapter 7,” he said.