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But in the multi-trillion dollar world of global finance, Lehman is pretty small potatoes. It’s a mid-size U.S.-focused investment bank with a market cap of around $5 billion. There are a score of billionaires in Russia alone worth more than that.
September 10, 2008, 4:19 pm
Mean Street: Why Lehman Brothers Doesn’t Matter Anymore
Posted by Deal Journal
Yesterday’s precipitous 45% decline in the shares of Lehman Brothers took the broader U.S. stock market down by almost 3.5%
Today in the papers and on TV, it’s wall-to-wall Lehman Brothers.
So it would be easy to think the fate of our financial system revolves around the fate of Lehman Brothers. But it doesn’t. Far from it.
In the scheme of things, Lehman Brothers doesn’t matter much anymore.
And judging by today’s trading action, Wall Street may finally be figuring that out.
What is Lehman Brothers today?
It is, of course, one of Wall Street’s legendary brands with a storied history. And it’s a vehicle for more than 25,000 employees and their families to make a living.
But in the multi-trillion dollar world of global finance, Lehman is pretty small potatoes. It’s a mid-size U.S.-focused investment bank with a market cap of around $5 billion. There are a score of billionaires in Russia alone worth more than that.
Lehman has a reputable corporate finance practice and a decent asset-management business in Neuberger Berman. But at its core, Lehman has been a bond trading house. And poor trading decisions have left Lehman with a crummy balance sheet stuffed with over $50 billion in assets it can’t easily get rid of.
Today’s much-anticipated announcement of its strategic restructuring suggests there are no takers for the whole of Lehman. And that the only way to salvage the business is to sell off a chunk of Neuberger Berman and spin-off illiquid real estate assets to the current Lehman shareholders who already own them.
Lehman’s plan is a Wall Street version of three-card monte — lots of shuffling but the cards remain the same. Who knows? It might work. In today’s trading, Lehman shares held steady until a late-day sell off pushed them lower.
But the vultures are circling. A five-year credit-default swap on Lehman debt now costs almost 600 basis points. Bear Stearn’s spreads traded at 400 basis points last March. The credit markets at least believe Lehman is on the road to bankruptcy.
There must be a hope among shareholders that they won’t lose it all — and that a Bear Stearns-like bailout can be manufactured. But the Treasury’s takeover of Fannie and Freddie this past weekend has almost certainly put the kibosh on that.
Fannie and Freddie carry $5 trillion in mortgage debt. They matter a lot. Lehman matters only a little. Total losses at Lehman in a worst-case liquidation would number in tens of billions of dollars.
Eventually, the Treasury is going to have to pick and choose which bailouts are worth it. Washington Mutual, the largest S&L in the US, would probably qualify but Lehman almost certainly won’t.
The Treasury needs to show that it can walk away. And with the Fed’s financing window in place, and eager buyers like KKR, Blackstone and distressed debt funds waiting in the wings to pick up pieces, a wind-down of Lehman would be relatively orderly — should it ever come to that.
This marks a big change from the Bear Stearns crisis. The Bear near-bankruptcy took everyone by surprise and risked taking down all of Wall Street. Seven months later, Wall Street has had plenty of time to isolate and manage its counter-party risk with Lehman. That’s good for Wall Street, but bad for Lehman shareholders.
The sad reality is that Wall Street is an awfully competitive place. Of the top ten global investment banks ranked by 2008 revenues, Lehman sits at number nine. There are still plenty of other banks and boutiques to chase the meager scraps on Wall Street’s table.
So Wall Street really doesn’t need Lehman Brothers. And neither does the stock market. It traded well today despite an unenthusiastic response to Lehman’s announcement.
Over the past year, Wall Street has gotten so caught up in the plight of its own failing institutions that it has lost focus on other important things.
Do you want to understand what’s really going on in the economy? Better to look at global shipper FedEx. Yesterday, it boosted its first quarter forecast. If you want to understand the consumer, look at Disney. Earlier today, Disney’s CEO talked up the resiliency of his business.
That isn’t to say, that all is hunky dory in the global economy, but the case of Lehman may mark a turning point for Wall Street.
Once it is clear that Lehman Brothers doesn’t matter anymore, Wall Street can better focus on the things that do.
September 14, 2008
Banks and U.S. Map Out Options in Lehman Crisis
By VIKAS BAJAJ
Fearing that Lehman Brothers is only days away from collapse, government officials and senior Wall Street executives met on Saturday to try to arrest a downward spiral that might imperil other financial institutions.
For a second day, the group convened at the Federal Reserve Bank of New York in Lower Manhattan, but the situation remained fluid, and the talks were set to resume on Sunday morning .
Adding urgency to the meeting were growing concerns that other big financial institutions like the insurance giant American International Group and the nation’s largest brokerage firm, Merrill Lynch, might face a similar crisis and also need billions of dollars in capital to strengthen their businesses. The group discussed the financial condition of other firms beyond Lehman and the overall state of the markets.
The spreading troubles were the latest sign that even the government’s extraordinary interventions into private enterprise during the last year have not been enough to halt the unraveling of storied companies that were widely viewed as unassailable until recently.
In fact, Lehman and other companies have said for months that they had a handle on their troubled assets tied to real estate. But their share prices have continued to sink. As a result, many investors are no longer sure what these financial companies are worth, and they do not want to invest in them until they do. At the same time, many hedge fund managers and other traders have profited handsomely from bets that these stocks would fall in value.
Companies that took the biggest risks and used debt aggressively to build their businesses were the first to stumble as the credit market began to sink, and now healthier companies are coming under pressure. Loans that were considered far better than the subprime mortgages, which kicked off the panic, turned out to be only marginally safer.
“You have to think of this like there is an epidemic going on — an epidemic of capital destruction,” said James L. Melcher, president of the hedge fund Balestra Capital, who has been bearish on the stock market.
The federal government has taken an unusually activist role in the ongoing crisis. This spring, the Federal Reserve arranged a hasty rescue of Bear Stearns, the wobbly investment bank. Then last week, federal regulators took over the country’s two largest mortgage finance companies.
At every turn, officials hoped that they had done what was needed to restore confidence in the markets, only to be greeted with another crisis.
Policy makers have signaled that they are not willing to provide financial support for a takeover of Lehman, as they did with Bear Stearns. Unlike Bear Stearns, which lost many clients and its access to money markets in just a few days, Lehman has been able to finance its business, especially after investment banks were allowed to borrow directly from the Fed. But the quality of the securities it owns are still in question.
The Fed and Treasury continue to insist that Wall Street firms find a way to rescue Lehman because their own companies might be next. But the Lehman crisis comes at a time when many of them are also short on capital. Entities that do have cash ready to invest, namely private equity firms, are not at the table.
That is because regulators do not want those firms, which borrow money to buy companies, controlling major financial institutions that provide the financing for their acquisitions. Many foreign investors, for their part, are reluctant to buy now after having seen earlier investments drop sharply in value.
The decision by policy makers sets up a crucial test for the financial system: Can the market resolve the panic by pairing Lehman with a willing and strong suitor, or will the company be forced to liquidate?
Whatever the outcome, there is a growing consensus on Wall Street that the government may not be able to save every big firm whose failure would pose a risk to the system.
“The too-big-to-fail mantra or concept or government policy is, in my opinion, off the table and we have to deal with that,” said David H. Ellison, president and chief investment officer at FBR Funds, a mutual fund company. “They are not going to save these companies.”
Analysts say many financial companies, including the insurer A.I.G., need to raise capital. But every time their stock prices fall, raising capital becomes harder. And when that happens, bondholders and credit rating companies start worrying too. Stock prices fall even further — and the whole cycle repeats again.
On Friday afternoon, for example, Standard & Poor’s warned that it might lower A.I.G.’s credit rating because the drop in the company’s share price — 45.7 percent last week alone — could make it even harder for the company to raise capital.
That partly explains why markets in general, and financial shares in particular, are gyrating ever more wildly. Even after the Bush administration took control of the mortgage finance giants Fannie Mae and Freddie Mac last week, a step many thought might calm investors, trading remained volatile.
“Investors are like hyperactive first graders playing musical chairs,” said Sam Stovall, chief investment strategist at Standard & Poor’s Equity Research.
The government, for all its activism, has been unable to stabilize the markets for long — though policy makers would argue that their interventions have prevented failures from cascading through the financial system.
After the Federal Reserve arranged the emergency sale of Bear Stearns to JPMorgan Chase in March, the stock market rallied and many strategists and executives on Wall Street declared that the deal was a turning point.
Stocks also rallied on Monday after the Treasury Department and federal regulators took over Fannie Mae and Freddie Mac, only to sink the next day as investors grew more concerned about Lehman, A.I.G. and Washington Mutual, the nation’s biggest savings and loan.
Downturns are typically more volatile than the booms that precede them, strategists say. Investors try to anticipate the recovery, though the actual turning point is often visible only in hindsight. But after a lot of bad news, some investors usually dive in, believing that the markets have reached a cathartic, cleansing moment.
“There are lots of investors that don’t want to miss the absolute bottom,” said Allen Sinai, a former chief economist at Lehman Brothers who now has his own research firm, Decision Economics. “Unless you are a professional trader, and even then, it’s a very dangerous philosophy.”
Many of the fundamental forces in the economy remain worrying. Home prices are still falling, though their rate of decline appears to have slowed in recent months. Defaults on all kinds of loans are rising. In the broader economy, the unemployment rate is rising and consumer spending has been faltering.
The losses created by rising defaults have impaired the ability and confidence of banks to lend to one another and to consumers. As financial institutions rein in risk-taking to protect themselves and preserve their dwindling capital, interest rates go up, lending standards tighten and credit lines are capped or severed.
“Every time there is another problem, it causes lenders to become that much more conservative, which then puts the squeeze on someone else,” said David A. Levy, the chairman of the Jerome Levy Forecasting Center, a research firm in Mount Kisco, N.Y.
Many analysts believe that for the downward spiral to be broken, home prices must fall to a level that can be supported by factors like household income that have traditionally had a strong relationship to prices. Also, the government has to determine how it will restructure Fannie Mae and Freddie Mac, which own or guarantee half of the nation’s home loans, said Thomas F. Cooley dean of the Stern School of Business at New York University.
“We have to hit the bottom in housing prices,” he said, “and we have to just sort out how housing will be financed in future.”
Jenny Anderson contributed reporting.
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