Wednesday, September 10, 2008

Wall Street's Fears on Lehman Bros. Batter Markets

September 10, 2008

Wall Street’s Fears on Lehman Bros. Batter Markets

New York Times

Only days after the Bush administration assumed control of the nation’s two largest mortgage finance companies, Wall Street was gripped by fears that another big financial institution, the investment bank Lehman Brothers, might founder — and that this time, the government might not come to the rescue.

Waves of selling wiped out nearly half of Lehman’s value in the stock market on Tuesday, leaving the firm, one of the nation’s oldest and largest investment banks, in an all-out fight for survival.

The plunge fanned worries about the troubles plaguing the broader financial industry and sent the Standard & Poor’s 500-stock index tumbling 3.4 percent. The decline more than wiped out the market’s rally on Monday, when stocks surged after the weekend rescue of Fannie Mae and Freddie Mac, the government-chartered mortgage giants.

Lehman’s future as an independent firm now seems more uncertain than ever, and many analysts fear that the bank is running out of time and options.

Confronting gaping losses stemming from the credit crisis, the once-proud firm is racing to secure a financial lifeline, possibly including the sale of its prized money management division or an investment from an outside investor.

Lehman, which has about 24,700 employees around the world, is expected to announce a big quarterly loss on Wednesday morning, and the bank is expected to discuss its plans at that time.

Lehman has survived for 157 years, through wars, the Depression and the vagaries of the markets, but got into trouble by buying and financing commercial and residential real estate, including subprime mortgages.

On Wall Street, there is a growing sense that Lehman may have to solve its problems on its own, without drastic help from the government, which in March brokered the rescue of another Wall Street bank, Bear Stearns.

“Some may worry that Treasury has taken on so much taxpayer burden they don’t have any remaining capacity more to take on the burdens of Lehman,” said David Trone, an analyst at Fox-Pitt Kelton.

Authorities helped arrange and finance the sale of Bear because they feared that the collapse of that firm might cascade through the financial system.

But unlike Bear Stearns, which seemed to crater overnight, Lehman’s fortunes have been dimming for months. Since February 2007, its stock price has plunged 91 percent, wiping out $40 billion in shareholder value.

On Monday, as other financial shares surged after the government takeover of Fannie Mae and Freddie Mac, Lehman’s shares sank. Adding to that sell-off was concern that an investment in Lehman by a government-owned bank in Korea would fall through after Korean regulators threw cold water on the idea.

Standard & Poor’s, the ratings agency, warned on Tuesday that it might cut one of Lehman’s primary credit ratings, citing concern about the firm’s ability to raise capital.

Even as Lehman’s stock price plunged anew on Tuesday, however, some questioned whether the government could let a global financial institution like Lehman fail.

Vincent R. Reinhart, a top former Fed official who has repeatedly criticized the shotgun takeover of Bear Stearns by JPMorgan Chase, said it would be very difficult for the Federal Reserve to let Lehman collapse.

“The plain fact about financial crises is that policy makers are unwilling to test the resilience of markets,” said Mr. Reinhart, now a senior fellow at the American Enterprise Institute.

Financial institutions have been closely measuring their exposure to Lehman. On Tuesday, commercial and investment banks said they continued to do business with Lehman, and hedge funds did not appear to be pulling their accounts with the firm, events that helped precipitate the fall of Bear Stearns.

Since March, Lehman has been in a fight for its life, as some investors, including prominent short-sellers betting against the bank’s stock, questioned how the firm was valuing some of its assets. Lehman lost $2.8 billion in the second quarter and was forced to raise $6 billion in new capital. But investors were not placated, and the firm was compelled to explore more extreme measures.

For months, it has tried to raise capital, sell its asset management division and examined spinning off of its commercial mortgage assets into a new company.

Richard S. Fuld Jr., Lehman’s hard-charging chief executive, has replaced virtually every major division head, including the firm’s president and chief financial officer.

During that time he has replaced the global head of fixed income — the division from which most of Lehman’s problems have arisen — twice.

But with every measure taken, Lehman’s stock price has fallen further.

“Clearly the company does not believe that it has a serious balance sheet problem, and it simply refuses to take what it believes are fire sale prices for its key assets,” said Richard X. Bove, an analyst at Ladenburg Thalmann.

While the bank has talked to many prospective investors, its most serious discussions appeared to be with Korea Development Bank, a state-run institution that is moving toward privatization. But on Monday, K.D.B.’s top regulator cast further doubt on prospects of an investment in Lehman.

“It should take a cautious approach toward taking over Lehman, at a time when its privatization is not accomplished, and given the current conditions in domestic and foreign financial markets,” said Jun Kwang Woo, chairman of the Financial Services Commission.

“The focus now should be on stabilizing the Korean markets,” Jun told lawmakers.

He said it would be “inappropriate for a state-owned company to pursue such an acquisition at this time.”

To some observers, Mr. Fuld has waited too long to take the major steps needed to shore up Lehman. A market veteran with almost four decades of experience, he seemed more optimistic than many of his peers that the market had gone too far and would come back, a strong case against selling. Bids for the company’s investment management division are due on Friday.

“It is certainly the case that had Lehman seen this problem evolving as it has, then they could have and should have done something many, many months ago,” said Joseph A. Grundfest, professor of law and businesses at Stanford.

Waiting has proved to be a dangerous gamble. Sovereign wealth funds, once eager to invest in troubled financial companies, have been burned by losses. American investors who bought shares of Lehman in June when it raised $6 billion have also lost billions.

“He is dealing as if he has a whole deck of cards, when he has none,” said one banker who has had recent dealings with Lehman, representing a potential foreign buyer.

Unlike Bear Stearns, which effectively collapsed when customers fled for the exits and the firm could not finance itself, Lehman Brothers has more sources of long-term financing and like other broker-dealers, access to emergency financing from the Federal Reserve. Mr. Fuld said that the existence of that lending facility should take any question of Lehman facing a liquidity crisis “off the table.”

But with the stock price in free fall and the cost of buying protection against Lehman defaulting on its bonds skyrocketing, far surpassing the levels reached when Bear went under, it is clear Lehman is not immune to the kind of panic that can put a financial institution, which depends on confidence, at risk.

“No bank or broker can withstand a strong panic by customers, clients or counterparties,” said Mr. Trone. “Even the best liquidity profile gets you only so far,” though he said that the existence of the emergency lending facility means that Lehman will have more flexibility and time than Bear did.

Turmoil at the firm has led some to question whether Mr. Fuld should remain at the helm.

“He’s been getting a lot of extra credit and good will based on his reputation and disposition as an honorable leader and as a smart, likable guy, but that’s not enough right now,” said Jeffrey A. Sonnenfeld, associate dean of the Yale School of Management.

Edmund L. Andrews contributed reporting from Washington.

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