You are currently viewing the printable version of this article, to return to the normal page, please click here.

Lehman Brothers files for bankruptcy

Question of the Day

Is it still considered bad form to talk politics during a social gathering?

View results

Wall Street titan Lehman Brothers headed into bankruptcy Sunday after potential buyers Barclays Banks of Britain and Bank of America backed away, citing the Treasury's refusal to guarantee Lehman's toxic mortgage portfolio.

In weekend-long negotiations at the Federal Reserve Bank of New York, leaders of the Treasury, the Fed and the 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.

Separately late Sunday, a person briefed on the deal said Bank of America Corp. is buying Merrill Lynch & Co. for about $50 billion, the Associated Press reported. The deal will create a financial-services giant and lift the uncertainty that has shrouded the nation's biggest brokerage since the credit crisis began.

• Bank of America to acquire Merrill Lynch

• AIG looking at 'options' for businesses, capital

With no takers, the once-powerful Lehman planned to file for bankruptcy and liquidate its brokerage operations after 158 years in business 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.

Securities and Exchange Commission Chairman Christopher Cox said customers of the brokerage are protected from losses on their investment accounts under a federal insurance program. He urged any investors requiring help retrieving their money to contact the SEC.

"For several days, we have worked closely with regulators around the world, including [Britain, Germany and Japan] to coordinate our actions in the interest of orderly markets," he said. "We are committed to [reducing] the potential for dislocations from recent events and to maintain the smooth functioning of the financial markets."

The Fed also made an adjustment in its loan program for Wall Street firms to accommodate Lehman and other investment banks that are struggling to cope with mounting credit losses. It said it would accept lower-quality mortgage securities and credit instruments as collateral on the loans. Previously, the Fed would accept only the highest-rated securities in exchange for the loans.

The federal involvement appeared minimal, aimed mostly at facilitating the liquidation of Lehman. 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 adamantly 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 that 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 turmoil 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 Sen. Barack Obama said he is opposed to any government intervention to save Lehman and advocates a private-sector solution. Republican presidential candidate Sen. 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 if 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 was the reason behind Sunday's special session.

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 write-downs 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.

Comments
blog comments powered by Disqus