Wall Street Banking Crisis (Bear Sterns, Lehman, Merril Lynch, AIG etc)

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Ongoing thread to examine the many Wall Street banks facing financial crises.

Lehman Brothers in New York.
In Frantic Day, Wall Street Banks Teeter​

September 15, 2008
By ANDREW ROSS SORKIN, BEN WHITE and JENNY ANDERSON

In one the most extraordinary days in Wall Street’s history, Merrill Lynch is near an 11th-hour deal with Bank of America to avert a deepening financial crisis while another storied securities firm, Lehman Brothers, hurtled toward liquidation, according to people briefed on the deal.

The dramatic turn of events was prompted by the cataclysm of losses that has shaken the American financial industry over the last 14 months.

The moves came after a weekend of frantic negotiations between federal officials and Wall Street executives over how to avert a downward spiral in the markets. Questions still remain about how the market will react and whether other firms may still falter like A.I.G., the large insurer, and Washington Mutual, both of whose stocks fell precipitously last week.

Coming just a week after the government took control of mortgage lenders Fannie Mae and Freddie Mac, the magnitude of the industry’s reshaping is staggering: two of the most powerful firms on Wall Street, Merrill Lynch and Lehman, will disappear.

The weekend’s once unthinkable outcome came after a series of emergency meetings at the Federal Reserve building in downtown Manhattan in which the fate of Lehman hung in the balance. In the meeting Federal Reserve officials and the leaders of major financial institutions were trying to complete a plan to rescue the stricken investment bank.

But as the weekend unfolded, Barclays and Bank of America, which had both considered buying all or part of Lehman, decided that they could not reach a deal without financial support from the federal government or other banks.

As a result, people briefed on the matter said late Sunday that Lehman Brothers would file for bankruptcy protection, in the largest failure of an investment bank since the collapse of Drexel Burnham Lambert 18 years ago.

Lehman will seek to place its parent company, Lehman Brothers Holdings, into bankruptcy protection, as its subsidiaries remain solvent while the parent firm liquidates, these people said. A consortium of banks will provide a financial backstop to help provide an orderly winding down of the 158-year-old investment bank. And the Federal Reserve has agreed to accept lower-quality assets in return for loans from the government.

Lehman has retained the law firm Weil, Gotshal & Manges. The firm’s restructuring head, Harvey Miller, also spearheaded Drexel’s bankruptcy filing in February 1990.

As efforts to acquire Lehman faltered, Bank of America turned to Merrill Lynch and offered at least $38.25 billion in stock for that investment bank, people briefed on the negotiations said. The deal, valued at $25 to $30 a share, could be announced as soon as Sunday night, these people said. Merrill shares closed at $17.05 on Friday.

Merrill’s chief executive, John A. Thain, and Kenneth D. Lewis, Bank of America’s chief executive, initiated talks on Saturday, prompted by the reality that a Lehman bankruptcy would ripple through Wall Street and further cripple Merrill Lynch, people briefed on the negotiations said.

Merrill’s 15,000 brokers will be combined with Bank of America’s smaller group of wealth advisers. The entity will be run by Robert McCann, the head of Merrill’s global wealth management business.

Mr. Fleming, Merrill’s president, will be president of the combined bank’s corporate and investment bank while Thomas Montag, a former Goldman executive who started at Merrill in August, will head all the merged company’s all risk, trading and institutional sales.

The leading proposal to rescue Lehman had been to divide the bank into two entities, a “good bank” and a “bad bank.” Under that last scenario, Barclays would have bought the parts of Lehman that have been performing well, while a group of 10 to 15 Wall Street companies would agree to absorb losses from the bank’s troubled assets, according to two people briefed on the proposal. Taxpayer money would not be included in such a deal, they said.

But that plan fell apart on Sunday, all but assuring that Lehman would be forced to liquidate.

The overarching goal of the weekend talks had been prevent a quick liquidation of Lehman, a bank that is so big and so interconnected with others that its abrupt failure would send shock waves through the financial world. Of deep concern is what impact a Lehman failure would have on other securities firms, insurance companies and banks, which have come under mounting pressure in the markets.

Even as Lehman and Merrill played out, the insurance company, the American International Group, was planning a major reorganization and a sale of its aircraft leasing business and other units to stabilize its finances, a person briefed on the company’s strategy said on Sunday.

A.I.G. became one of the focuses at an emergency gathering of Wall Street executives over the weekend, and was trying to arrange a capital infusion in the face of possible credit downgrades.

It was unclear whether A.I.G. would succeed in its capital search, but a person briefed on the discussions said it was seeking more than $40 billion even as it tried to sell assets to shore up its financial footing.

Among the businesses likely to be sold is A.I.G.’s aircraft leasing business, the International Lease Finance Corporation. Founded in 1973, the business has nearly 1,000 planes in its fleet.

Investors, afraid that A.I.G. would have to absorb further write-downs in its already damaged mortgage securities and collateralized debt obligations, have driven down the company’s shares in recent days. The stock closed Friday at $12.14 a share, a decline of 46 percent for the week.

 

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Here is how it will affect other banks & NY.
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WINNERS
Goldman Sachs

As one of only four pure Wall Street brokerages - Lehman, Merrill and Morgan Stanley being the others - Goldman and the other two will benefit from having one rival removed, so channelling more work in their direction. This should allows fees to drift northwards due to lack of competition.

Morgan Stanley

Strong real estate franchise, and also strong in alternative investments. Likely to pick up dissatisfied Lehman clients if the sale process drags on too long.

Merrill Lynch

Merrill's strong private client broker arm is likely to benefit from continued fallout at Neuberger Berman, where performance is understood to have suffered in recent months in any case. Much of the incentives at Neuberger are based on Lehman's now valueless shares, meaning departure rate is likely to increase, particularly if the buyer is Bank of America, which is not seen as having an established high-end client brand.

Blackstone

If Lehman is weakened - either by a sale or by being split up - the multi-faceted offering that the bank once offered will be gone. This will be felt across the various divisions, but none more so than in advisory, which relies on the various parts of the bank referring it both clients and deals. Step forward Blackstone, which has become a tour de force in major M&A and strategic deals, and has a strong team under the leadership of John Studzinski.

LOSERS
Lehman staff

When it comes to losing out as the result of any deal to save Lehman, the bank's loyal 24,000 staff head the list. Not only do they face an uncertain future, but those who hold jobs where 75-80 per cent of their salary comes in share-based bonuses will be left with next to nothing. And given the state of the financial market, getting a job elsewhere won't be easy either

New York state

The state of New York is already facing a serious drop in taxes and a subsequent budget deficit as a result of the lack of profits from Manhattan's banks this year. But with the loss of Bear and now Lehman, probably, even when the markets rebound and taxes on profits return, they are unlikely to do so to previous levels in the short term.

Clients

For clients, the loss of two firms who specialised in the alternative asset space within six months of each other will reduce competition and increase fees.

 

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A.I.G. Seeks $40 Billion in Fed Aid to Survive

The American International Group is seeking a $40 billion bridge loan from the Federal Reserve, as it faces a potential downgrade from credit ratings agencies that could spell its doom, a person briefed on the matter said Sunday night.

Ratings agencies threatened to downgrade the insurance giant’s credit rating by Monday morning, allowing counterparties to withdraw capital from their contracts with the company. One person close to the firm said that if such an event occurred, A.I.G. may survive for only 48 hours to 72 hours.

A.I.G.’s sickly financial health emerged late into one of the most tumultuous days in Wall Street history. Lehman Brothers, the 158-year-old investment bank, is expected to file for bankruptcy protection Sunday night, while Bank of America has agreed to buy Merrill Lynch for $50.03 billion.

It has already raised $20 billion this year. But even that enormous capital raise may not be enough.

Though this past weekend was convened to focus on Lehman, the Wall Street chieftains who gathered at the Federal Reserve Bank of New York also pondered a solution for A.I.G. The firm had become one of the biggest underwriters of complex debt securities known credit default swaps, used as insurance for a wide range of products, including the mortgage instruments that have been the bane of Wall Street for the past year and a half.

A.I.G.’s stock has fallen 79 percent over the past year, closing on Friday at $12.14.

Eric Dinallo, the New York state insurance superintendent, has been deeply involved in discussions about A.I.G.’s survival, this person said.

The firm had planned to move $20 billion from its regulated insurance business to its holding company and to sell assets and a stake in the company to private equity firms. But A.I.G. has ruled out the capital shift because of the time and complexity involved.

J. C. Flowers & Company, a buyout firm focused on financial services firms, offered $8 billion for a stake in the business that would have given it an option to buy all of A.I.G. down the road. Kohlberg Kravis Roberts and TPG also said they would bid.

But all three withdrew at the last minute, citing anxiousness over the company’s precarious financial health.

A.I.G.’s extraordinary move of reaching out to the Fed for help may spur other non-investment banks to try a similar move. Companies ranging from General Electric to GMAC have been hurting badly and would desperately love the liquidity that the Fed would provide.

Yet it isn’t clear whether the Fed would acquiesce to A.I.G.’s request.

The firm had earlier been reported to be interested in selling its aircraft leasing business. But people briefed on the matter said that unit bore special tax advantages that A.I.G. had decided would be lost on any other owner.

 

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Ultimatum by Paulson Sparked Frantic End

By DEBORAH SOLOMON, DENNIS K. BERMAN, SUSANNE CRAIG and CARRICK MOLLENKAMP
September 15, 2008

One of the most tumultuous weekends in Wall Street's history began Friday, when federal officials decided to deliver a sobering message to the captains of finance: There would be no government bailout of Lehman Brothers Holdings Inc.

Officials wanted to prepare the market for the possibility that Lehman could simply fail. The best way to do that in an orderly way would be to get everyone together in a room.

Treasury Secretary Henry Paulson, Federal Reserve Chairman Ben Bernanke and his top New York lieutenant, Timothy Geithner, summoned some 30 Wall Street executives for a 6 p.m. Friday meeting at the Fed's offices in Lower Manhattan.

"There is no political will for a federal bailout," Mr. Geithner told the assembled executives, according to a person familiar with the matter. "Come back in the morning and be prepared to do something."

Over the next 48 hours, these marching orders developed into a nerve-wracking test of the ability of the U.S. financial system to hold itself together amid the worst series of shocks it has faced in decades.

By taking the rescue option off the table, the U.S. government was declaring that there are limits to its role as backstop-in-chief. A week earlier it had seized mortgage giants Fannie Mae and Freddie Mac, and months prior had brokered the sale of Bear Stearns & Co. to J.P. Morgan Chase & Co. But now, Washington appears to want Wall Street to largely fix its own problems, and feels that flailing institutions shouldn't expect the government to commit money to save them.

"We've re-established 'moral hazard,'" said a person involved in the talks, referring to the notion that the government should eschew bailouts, since financial firms might take more risks if they're insulated from the consequences. "Is that a good thing or a bad thing? We're about to find out."

One immediate impact: As Lehman's future darkened, Merrill Lynch & Co., another vulnerable firm, raced into the arms of Bank of America Corp.

This account of the weekend's events was compiled from interviews with Wall Street executives, traders, government officials and other participants in the talks.

Barring some last-minute, late-night alternative, Lehman will likely file for liquidation, people familiar with the situation said.

The storied firm's decline occurred in slow motion this year. Heavily exposed to troubled real-estate investments, the firm tried to raise fresh capital, only to be thwarted. The most recent disappointment came last Monday when a possible deal with a Korean bank faded, sending Lehman's shares down 45% the next day. They had already fallen 80% since the start of 2008.

On Tuesday and Wednesday, when Mr. Paulson called Wall Street CEOs to give them early notice of his no-bailout stance, some argued to him that the government needed to structure a rescue like that of Bear Stearns, according to people familiar with the matter. To prevent Bear Stearns's collapse in March, the Fed agreed to put up $30 billion to help complete the acquisition of the failing bank by J.P. Morgan Chase.

Repeating that move with Lehman, however, would create a terrible precedent, Mr. Paulson worried. Which other firms would take that as a cue to ask for U.S. government help -- and from what other industries? Detroit auto makers were already knocking at the door.

Mr. Paulson was also irked that Wall Street saw him as someone who would always ride to the rescue. And because Lehman's troubles have been known for a while, Mr. Paulson felt the market had had time to prepare.

In addition, Lehman had access to special emergency lending from the Fed -- something Bear Stearns didn't have when it was struggling. This was another reason Mr. Paulson there shouldn't be a Bear-like rescue for Lehman.

The government's no-bailout decision emerged as serious obstacle for Lehman's two most likely buyers, Bank of America and Barclays PLC. Indeed, this past Friday, federal officials monitoring talks to sell Lehman to Bank of America realized that deal probably wouldn't be consummated without federal backing.

That triggered the call for the Friday-evening meeting of financial titans. The gathering was attended by at least 30 executives, a Who's Who of Wall Street.

Mr. Geithner laid out two potential scenarios. One involved an orderly dismantling of Lehman that would essentially end its existence. But he also suggested that Wall Street firms come up with their own solution -- perhaps by joining forces among themselves to remove Lehman's riskiest and most toxic assets. That move would make Lehman more attractive to potential buyers, but would also require Wall Street firms to commit their own scarce money to the cleanup.

Mr. Paulson told the group it was in their interest to find a solution. "Everybody is exposed" to Lehman, Mr. Paulson said, according to two people in attendance.

Most of the Wall Street executives present at the meeting listened and asked questions, but didn't show what hand they might play. The meeting broke up just after 8 p.m. Friday.

Finding a Buyer

Saturday morning, the CEOs and their closest advisers reconvened at about 9 a.m. and broke into groups to discuss various scenarios. Lehman representatives weren't present.

One group focused on the possible dismantling of Lehman; it included both government officials and Wall Street representatives. Among the things the group discussed was having every bank borrow from the Fed under an emergency lending provision it has offered since the collapse of Bear Stearns. With that borrowed money, the banks would buy up Lehman's assets, preventing it from filing for bankruptcy.

The other main track focused on finding a buyer. Either Barclays or Bank of America would buy Lehman's "good assets," such as its stock-trading and analysis business, people familiar with the matter say. Lehman's more toxic real-estate assets would be placed in a "bad" bank containing about $85 billion in souring assets. Other Wall Street firms would inject some capital into the bad bank to keep it afloat. The goal would be to avoid a flood of bad assets pouring into the market, pushing prices even lower.

But getting Wall Street firms to cooperate among themselves, without government assistance, was proving tough. Several CEOs openly questioned why they should bear the cost of Lehman's problems when others who also face exposure -- such as institutional investors, hedge funds and foreign investors -- aren't being asked to do the same.

Morgan Stanley CEO John Mack raised serious questions, saying that this time it was Lehman and next time it would be Merrill, according to people in attendance. "If we're going to do this deal, where does it end?" he said, according to a person familiar with the matter. Other bankers in the room felt the same way, this person added.

By noon on Saturday, Bank of America hadn't budged from its position that it needed government support to consummate a deal. The bottom line: It was effectively out of the running.

Outside the Fed's downtown New York headquarters, a fortress-like building of stone and iron, a fleet of black limousines waited for the bankers inside. At one point, they blocked the narrow streets around the building, causing a traffic jam that had to be broken up by the Fed's uniformed guards.

Bankers and Fed staffers milled outside, smoking cigarettes and talking on their cell phones about subjects such as counterparty risk, a normally arcane matter of contract law, suddenly front and center. On one occasion, in the men's bathroom, a trio of bank CEOs debated the merits of a rescue plan.

The bond- and derivative-trading heads of major investment banks, assuming that a deal to save Lehman was a diminishing possibility, gathered to discuss how to deal with their exposure to minimize havoc Monday when markets opened.

Shortly after 5 p.m., a clutch of Fed staffers left the building. The day hadn't gone well. The government and potential buyers remained miles apart, mainly due to the bailout issue. Wall Street executives left in cars parked in a garage to avoid being photographed by the waiting press.

One person in the Fed meetings Saturday night described them as "the world's biggest game of poker."

With different doomsday scenarios being batted around the meeting rooms, some participants felt the government would blink and do a bailout. "This is going to go down to the last second," one participant said.

With Bank of America backing away from a deal, the enormity of a potential bankruptcy filing by Lehman started settling in. Even understanding Lehman's current trading positions was tough. Lehman's roster of interest-rate swaps (a type of derivative investment) ran about two million strong, said one person familiar with the matter.

Overnight, the outlines of possible deals started to crystallize. The idea that Wall Street firms would fund a "bad bank" full of Lehman's problematic assets was dead. Unlike when Wall Street firms stepped in to bail out hedge fund Long-Term Capital Management a decade ago, today's banks are much weaker. Some were loathe to provide support when a rival like Barclays might still buy Lehman.

By Sunday morning, the U.K.'s Barclays looked like the sole potential buyer. That further minimized the chances of a government bailout: If the Bush administration wouldn't help to fund a Wall Street solution, aiding a foreign buyer was even less likely.

Lehman employees followed their firm through news reports. One manager said he was encouraging his staff to show up Monday and hang tough for a few more days. "It is not like there are a million jobs to go to," he said.

The Chance to Transform

Barclays pushed ahead, eager at the chance to transform itself into a U.S. powerhouse at potentially a fire-sale price. Its advisers thought the U.S. Treasury could be persuaded to support a foreign buyer. By Sunday morning in London, after working around the clock for three days, the British bank -- whose roots date to the late 1600s as a goldsmith banker in London -- thought it had a shot. Documents were drawn up to pitch the deal to investors and journalists.

During the afternoon on Sunday, two Fed policeman wheeled a large, double-decker cart filled with cakes, cookies, sandwiches, chips and bottles of water into the Fed building.

But soon after, Barclays was threatening to walk as it argued with the Fed and Treasury over seemingly mundane matters, such as whether it would have to hold a shareholders' meeting to ratify any deal. Barclays was still insisting on some kind of federal financing.

By the middle of Sunday afternoon, Barclays was out. Its plan -- to buy Lehman's subsidiaries -- was contingent on government support, which wasn't coming.

At a meeting held at the Fed offices, Mr. Paulson, Mr. Geithner and Securities and Exchange Commission Chairman Christopher Cox addressed a group of about one dozen banking chiefs. Their message was steadfast: They would not put up money to assist in salvaging Lehman. In the meetings with Mr. Paulson were his chief of staff, Jim Wilkinson, and two advisers, Dan Jester and Steve Shafran, both of whom used to work at Goldman Sachs.

Somber Mood

The mood turned somber as it became clear that the group would have to turn its attention to dismantling Lehman in a way that didn't seriously disrupt the financial system. Soon the group began discussing the mechanics of such a plan.

A sense of foreboding descended over the rival bankers. They focused on the fear that drove down shares in Lehman, worried that would now spread to Merrill, another storied name facing losses from mortgage-related holdings, despite the reputation of its wealth-management business.

"I think the government is playing with fire," said a top executive of a big bank.

The worry for Merrill, said people briefed on the conversations, was that as its stock tumbles, its credit rating could change, increasing its cost of borrowing. Faced with rising borrowing costs -- a key expense for giant Wall Street financial firms -- its business might be severely crimped. As well, as concerns mount, its trading partners might stop doing business with it.

Many in the room began to wonder when Merrill would sell itself. "Tonight, or tomorrow?" said one of these people in an interview. In fact, within a few hours, the bankers learned that Merrill was in talks to be acquired by Bank of America.

As word that a Barclays deal was off filtered across Wall Street, traders scrambled to extricate themselves their various financial transactions with Lehman. Traders at many Wall Street firms were told to come to work immediately.

The European Central Bank was also in a state of high alert on Sunday, with employees in divisions from money-market operations to financial stability camped out in the bank's 37-story glass-and-steel tower in Frankfurt, preparing for what Monday might bring. "We are in the hands of the Americans," said one employee.

 

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Its official:

Troubled Investment Bank Lehman Brothers To File for Bankruptcy

By Heather Landy and Neil Irwin
Washington Post Staff Writers
Monday, September 15, 2008; A01

NEW YORK, Sept. 15 -- Lehman Brothers announced early Monday morning that it will file for bankruptcy, becoming the largest financial firm to fail in the global credit crisis, after federal officials refused to help other companies buy the venerable investment bank by putting up taxpayer money as a guarantee.

The failure of the nation's fourth-largest investment firm offers a profound test of the global financial system, and government and private officials had been bracing Sunday night for an upheaval in a range of financial markets that have never before experienced the bankruptcy of such a large player. To keep cash flowing normally through these markets, the Federal Reserve announced new lending procedures, while 10 major banks combined to create a new $70 billion fund.

After a marathon series of negotiations over the weekend, Federal Reserve and the Treasury stepped aside to allow a wrenching transformation of Wall Street to proceed. After galloping to the rescue of other major financial institutions in recent months, the federal government drew the line with Lehman Brothers, ignoring pleas from would-be buyers of the company who insisted on receiving federal backing for its troubled assets.

Leaders of the Federal Reserve and Treasury Department decided that Lehman was unlike the investment bank Bear Stearns, whose sudden collapse in March threatened the world financial system, or Fannie Mae and Freddie Mac, whose potential insolvency did the same.

In betting that Lehman could be allowed to fail without catastrophic consequences, New York Federal Reserve President Timothy F. Geithner, Fed Chairman Ben S. Bernanke, and Treasury Secretary Henry M. Paulson Jr. were making it clear that struggling financial firms cannot count on a bailout.

The decision not to intervene carries the risk that the ripples of Lehman's failure will prove impossible to contain. What worries regulators and Wall Street is a massive, multitrillion-dollar lattice of interlocking financial instruments known as derivatives. The most worrisome to bankers are "credit default swaps," in essence a form of insurance against corporate failures. If the financial firms themselves fail, the value of the insurance they have written will be tested as never before.

So would the market for "triparty repo" -- a form of debt that funds all sorts of financial firms and is held in the money market mutual funds of ordinary Americans -- which is also looking at potential losses from the Lehman bankruptcy.

It was that fear that led the Fed specifically to broaden the types of collateral it will accept at its lending window for investment banks, so that cash can keep flowing through the repo market. Even with that move, they are were steadying themselves for a tumultuous week in that market.

The steps the Fed announced last night, Bernanke said in a statement, "are intended to mitigate the potential risks and disruptions to markets."

"Bankruptcy is a perfectly natural thing, but you hope that the firm is in a position so that it can be an orderly bankruptcy and not cause other problems," said Susan Phillips, dean of the George Washington University School of Business and a former Federal Reserve governor.

Government officials drew a sharp contrast with the threat posed by the difficulties of Bear Stearns. In that situation, in March, Fed and Treasury leaders were convinced that its abrupt demise would have caused extensive damage across the financial system resulting in economic distress in the United States and beyond. For that reason, senior federal officials strongly encouraged J.P. Morgan Chase to buy Bear Stearns and backed $29 billion worth of its risky assets to make the deal happen.

Several firms, especially Bank of America and the British bank Barclays, wanted control of Lehman's investment banking and asset management businesses. However, they wanted no part of billions in shaky real estate and other investments on Lehman's books, and wanted either taxpayers or other financial firms to assume part of that risk.

But other companies decided they didn't want to take over the distressed assets, leaving only the good ones for Bank of America or Barclays. They concluded that they would rather risk potential problems in the financial markets on Monday than plow their limited cash into a venture that would be expected to have poor returns. And the Fed and Treasury refused to make government money available.

On Capitol Hill, key lawmakers either declined to comment on the Lehman's fate or did not return calls. A spokesman for Sen. Charles E. Schumer (D-N.Y.), for whom the day's events represent a hometown crisis, said Schumer, who chairs the Joint Economic Committee, was withholding comment until the status of Lehman Brothers became clear.

Lehman confirmed early Monday that its holding company intends to file for Chapter 11 with the U.S. bankruptcy court for the Southern District of New York, and will make motions that would allow the firm to continue to pay employees and to keep its operations running.

Lehman also said it is exploring a sale of its broker-dealer operations, and confirmed it remains in advanced talks with "a number of potential purchasers" for its investment-management division, which includes Neuberger Berman and Lehman Brothers Asset Management. Those two subsidiaries will conduct business as usual and will not be subject to the bankruptcy case, Lehman said. Customers of Lehman and Neuberger Berman can continue to trade in their accounts, the company said.

Lehman's rank-and-file employees were unsure what they would find when they went to their offices Monday morning. "There's no word. It's not clear what's happening or what's going to happen," said a Lehman bond trader who spoke on condition of anonymity because of the sensitivity of the situation. On Friday, "we thought the options were clear, that either we got bought or we got sold off in small pieces. Nobody thought it was actually going to go to bankruptcy."

Lehman's dissolution has been gradual, over several months. If Bear Stearns experienced a run on the bank, Lehman has experienced a walk on the bank. That means that its various business partners have had time to bolster themselves for potential losses, and, in the view of these government officials, the risks to the system as a whole are therefore less.

It likely means the end of a Wall Street titan, a firm with 24,000 employees and 158 years of history. Lehman Brothers dates back to 1850, to a general store that Henry Lehman and two siblings opened in Montgomery, Ala. The brothers accepted cotton for cash and started a trading business on the side.

A century ago, the firm helped arrange financing for Sears Roebuck. It expanded globally through the twentieth century and became one of the top investment banks. A decade ago, chief executive Richard S. Fuld Jr. faced down rumors that the firm was on the brink of insolvency and put Lehman on an aggressive expansion course. In 2001, with its trading floors destroyed by the terrorist attacks in New York, he regrouped quickly, and the firm managed the first initial public offering to come to market after the attacks.

Fuld's aggressive and competitive nature is not uncommon on Wall Street, but friends and rivals have said the intensity with which Fuld expresses those traits are unmatched.

Lehman, which was outmuscled in merger advising and other traditional investment banking businesses, seized on the mortgage market as an area it could dominate in recent years.

Lehman, the number one underwriter of mortgage-backed bonds last year, amassed a giant portfolio of properties and mortgage-related securities. But the value of the assets began to sink last year amid a spike in mortgage defaults by homeowners with subprime credit.

Lehman shares have fallen from a high of $86.18 in February 2007, when the company's stock market value was approaching $50 billion, to Friday's closing price of $3.65, which left the firm with a market capitalization of $2.5 billion.

"Six months to the day since Bear Stearns went under, I'm viewing our experience in a whole new light," said John Ryding, a former Bear Stearns economist. "We were lucky to be first. We got out with $10 a share, which looked really bad at the time, but it looks a whole lot better than what Lehman shareholders are likely to get."

Staff writers David Cho, Binyamin Appelbaum and Lori Montgomery contributed to this report.

 

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And they bitch at broke folk for asking for $200 a week cash assistance

 

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And they bitch at broke folk for asking for $200 a week cash assistance

And expect the same people who ask for assistant to be denied yet still take upon the debt of these billion dollar failures.

The US taxpayers will be paying, literally, for the mistakes of Bear Stearns and Fannie Mae & Freddie Mac since the Fed decided to help bail them out.

 

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<font size="6"><center>Nightmare on Wall Street</font size><font size="4">
A weekend of high drama reshapes American finance</font size></center>

Economist.com
NEW YORK AND WASHINGTON,DC
Sep 15th 2008

EVEN by the standards of the worst financial crisis for at least a generation, the events of Sunday September 14th and the day before were extraordinary. The weekend began with hopes that a deal could be struck, with or without government backing, to save Lehman Brothers, America’s fourth-largest investment bank. It ended with Lehman’s set for Chapter 11 bankruptcy protection and the bank preparing to wind itself up after those efforts failed. Other vulnerable financial giants scrambled to sell themselves or raise enough capital to stave off a similar fate. Merrill Lynch, the third-biggest investment bank, sold itself to Bank of America (BofA), an erstwhile Lehman suitor, in a $50 billion all-stock deal. American International Group (AIG) brought forward a potentially life-saving overhaul and went cap-in-hand to the Federal Reserve.

On Sunday night the situation was still fluid, with bankers and regulators working to limit the fallout. They were girding themselves for a dreadful Monday in the markets. Australia’s stockmarket opened sharply lower on Monday (most other Asian bourses were closed). American stock futures were deep in the red too, and the dollar weaker. Spreads on risky credit, already elevated, widened further.

With these developments the crisis is entering a new and extremely dangerous phase. If Lehman's assets are dumped in a liquidation, prices of like assets on other firms' books will also have to be marked down, eroding their capital bases. The government's refusal to help with a bail-out of Lehman will strip many firms of the benefit of being thought too big to fail, raising their borrowing costs. Lehman’s demise highlights the industry’s inability, or unwillingness, to rescue the sick, even when the consequences of inaction are potentially dire.

The biggest worry is the effect on derivatives markets, particularly the giant one for credit-default swaps. Lehman is a top-ten counterparty in CDS, holding contracts with a notional value of almost $800 billion. If it were to cease trading, chaos could ensue. On Sunday, banks called in their derivatives traders to assess their exposures to Lehman and work on mitigating risks. In a highly unusual, hastily convened weekend trading session, the market’s main players sought to reduce the risk hanging over Lehman’s outstanding trades by matching buyers of its swaps directly with sellers, thus cutting Lehman out of the equation. But only $1 billion-2 billion of trades were executed. The Securities and Exchange Commission, Lehman’s main regulator, said it is working with the bank to protect clients and trading partners and to “maintain orderly markets”.

Government officials believed they had persuaded a consortium of Wall Street firms to back a new vehicle that would take $40 billion-70 billion of dodgy assets off Lehman’s books, thereby facilitating a takeover of the remainder. But the deal died when the main suitors, BofA and Barclays, a British bank, walked away on Sunday afternoon. Both were unwilling to buy the firm, even shorn of the worst bits, without some sort of government backstop.

But Hank Paulson, the treasury secretary, decided to draw a line and refuse such help. After the Fed had bailed out Bear Stearns in March and the Treasury had taken over Fannie Mae and Freddie Mac last weekend, expectations were high that they would do the same for Lehman. And that was precisely the problem: it would have confirmed that the federal government stood behind all risk-taking in the financial system, creating moral hazard that would take years to undo and expanding taxpayers’ liability almost without limit. Conceivably, Congress could have denied Mr Paulson the money he needed even if he had been inclined to bail Lehman out.

This left Lehman with no option but to prepare for bankruptcy. Though the bank has access to a Fed lending facility, introduced after Bear’s takeover by JP Morgan Chase, the collapse of its share price left it unable to raise new equity and facing crippling downgrades from rating agencies. Moreover, rival firms that had continued to trade with it in recent weeks—at the urging of regulators—had begun to pull away in the past few days. The inability to find a buyer is a huge blow to Lehman’s 25,000 employees, who own a third of the company’s now-worthless stock; in such a difficult environment, most will struggle to find work at other financial firms. It also makes for an ignominious end to the career of Dick Fuld, Lehman’s boss since 1994, who until last year was viewed as one of Wall Street’s smartest managers.

Merrill’s rush to sell itself was motivated by fear that it might be next to be caught in the stampede. Despite selling a big dollop of its most rotten assets recently, the market continued to question its viability. Its shares fell by 36% last week, and hedge funds had started to move their business elsewhere. Its boss, John Thain, concluded that it needed to strike a deal before markets reopened. It approached several firms, including BofA and Morgan Stanley, but only BofA felt able to conduct the necessary due diligence in time.

Not only has Mr Thain managed to shelter his firm from the storm, but he has also secured a price well above its closing price last Friday, $29 per share compared with $17. How he managed that in such an ugly market is not yet clear. Ken Lewis, BofA’s boss, is no fan of investment banking, but he is a consummate opportunist, and he has coveted Merrill’s formidable retail brokerage. Still, the deal carries risks. It will be a logistical challenge, all the more so since BofA is in the middle of digesting Countrywide, a big mortgage lender. Commercial-bank takeovers of investment banks have a horrible history because of the stark cultural differences. And it is not clear if BofA has a clear picture of Merrill’s remaining troubled assets.

The takeover of Merrill leaves just two large independent investment banks in America, Morgan Stanley and Goldman Sachs. Both are in better shape than their erstwhile rivals. But this weekend’s events cast a shadow over the standalone model, with its reliance on leverage and skittish wholesale funding.

Wall Street has company in its misery. Washington Mutual, a big thrift, is fighting for survival under a new boss. Even more worryingly, so is AIG, America’s largest insurer, thanks to a reckless foray into CDS of mortgage-linked collateralised-debt obligations. Investors have fled, fearing the firm will need a lot more new capital than the $20 billion raised so far. Prompted by the weekend bloodletting, AIG brought forward to Monday a restructuring that was to have been unveiled on September 25th. This was expected to include the sale of its aircraft-leasing arm and other businesses. It is also reported to be seeking a $40 billion in bridge loan from the Fed, to be repaid once the sales go through, in the hope that this will attract new capital, possibly from private-equity firms.

With Lehman left dangling, official attention is now turning to putting more safeguards in place to soften the coming shock to markets and the economy. The first step has been to encourage Lehman’s counterparties to get together and try to net out as many contracts as possible. On Sunday the Fed also expanded the list of collateral it will accept for loans at its discount window, to include even equities; and dealers may lend any investment-grade security, not just triple-A rated, to the Fed in exchange for Treasury bonds.

Markets are also pricing in some possibility that the Fed will cut its short-term interest rate target from 2% when it meets for a regularly scheduled meeting on Tuesday. That would be an abrupt turnaround from August, when officials figured their next move would be to raise rates, not lower them.

In a sign of how bad things are, even straitened banks are stumping up cash to help the stabilisation efforts. On Sunday, a group of ten banks and securities firms set up a $70 billion loan facility that any of the founding members can tap if it finds itself short of cash.

Even if markets can be stabilised this week, the pain is far from over—and could yet spread. Worldwide credit-related losses by financial institutions now top $500 billion, of which only $350 billion of equity has been replenished. This $150 billion gap, leveraged 14.5 times (the average gearing for the industry), translates to a $2 trillion reduction in liquidity. Hence the severe shortage of credit and predictions of worse to come.

Indeed, most analysts think that the deleveraging still has far to go. Some question how much has taken place. Bianco Research notes that while the credit positions of the 20 largest banks have fallen by $300 billion, to $1.3 trillion, since the Fed started its special lending facilities, the same amount has been financed by the Fed itself through these windows. In other words, instead of deleveraging, the banks have just shifted a chunk of their risk to the central bank. As spectacular as this weekend was, more drama is on the way.


http://www.economist.com/finance/displayStory.cfm?story_id=12231236&source=features_box_main

 

[thoughtone]

keysersoze, don't you think this belongs in the US Economy thread? There is a nice time lime of posts that illustrate the workings of this issue.

 

[keysersoze]

keysersoze, don't you think this belongs in the US Economy thread? There is a nice time lime of posts that illustrate the workings of this issue.

I would have put it in that thread but this focuses on a particular aspect - the banking crisis - If Que Ex wants to merge it. I have no argument.

 

[hoodedgoon]

Anybody hear of an Chinese or Canadian bank going under?

 

[Non-StopJFK2TAB]

Anybody hear of an Chinese or Canadian bank going under?

yeah a couple canadian banks.

 

[nittie]

Newsweek

Is Morality Natural?
Science is tracing the biological roots of our intuitive sense of what is right and what is wrong.

On Jan. 2, 2007, a large woman entered the Cango caves of South Africa and wedged herself into the only exit, trapping 22 tourists behind her. Digging her out appeared not to be an option, which left a terrible moral dilemma: take the woman's life to free the 22, or leave her to die along with her fellow tourists? It is a dilemma because it pushes us to decide between saving many and using someone else's life as a means to this end.

A new science of morality is beginning to uncover how people in different cultures judge such dilemmas, identifying the factors that influence judgment and the actions that follow. These studies suggest that nature provides a universal moral grammar, designed to generate fast, intuitive and universally held judgments of right and wrong.

Consider yourself a subject in an experiment on the Moral Sense Test (moral .wjh.harvard.edu), a site presenting dilemmas such as these: Would you drive your boat faster to save the lives of five drowning people knowing that a person in your boat will fall off and drown? Would you fail to give a drug to a terminally ill patient knowing that he will die without it but his organs could be used to save three other patients? Would you suffocate your screaming baby if it would prevent enemy soldiers from finding and killing you both, along with the eight others hiding out with you?

These are moral dilemmas because there are no clear-cut answers that obligate duty to one party over the other. What is remarkable is that people with different backgrounds, including atheists and those of faith, respond in the same way. Moreover, when asked why they make their decisions, most people are clueless, but confident in their choices. In these cases, most people say that it is acceptable to speed up the boat, but iffy to omit care to the patient. Although many people initially respond that it is unthinkable to suffocate the baby, they later often say that it is permissible in that situation.

Why these patterns? Cases 1 and 3 require actions, case 2 the omission of an action. All three cases result in a clear win in terms of lives saved: five, three and nine over one death. In cases 1 and 2, one person is made worse off, whereas in case 3, the baby dies no matter what choice is made. In case 1, the harm to the one arises as a side effect. The goal is to save five, not drop off and drown the one. In case 2, the goal is to end the life of the patient, as he is the means to saving three others.

Surprisingly, our emotions do not appear to have much effect on our judgments about right and wrong in these moral dilemmas. A study of individuals with damage to an area of the brain that links decision-making and emotion found that when faced with a series of moral dilemmas, these patients generally made the same moral judgments as most people. This suggests that emotions are not necessary for such judgments.

These are moral dilemmas because there are no clear-cut answers that obligate duty to one party over the other. What is remarkable is that people with different backgrounds, including atheists and those of faith, respond in the same way. Moreover, when asked why they make their decisions, most people are clueless, but confident in their choices. In these cases, most people say that it is acceptable to speed up the boat, but iffy to omit care to the patient. Although many people initially respond that it is unthinkable to suffocate the baby, they later often say that it is permissible in that situation.

Why these patterns? Cases 1 and 3 require actions, case 2 the omission of an action. All three cases result in a clear win in terms of lives saved: five, three and nine over one death. In cases 1 and 2, one person is made worse off, whereas in case 3, the baby dies no matter what choice is made. In case 1, the harm to the one arises as a side effect. The goal is to save five, not drop off and drown the one. In case 2, the goal is to end the life of the patient, as he is the means to saving three others.

Surprisingly, our emotions do not appear to have much effect on our judgments about right and wrong in these moral dilemmas. A study of individuals with damage to an area of the brain that links decision-making and emotion found that when faced with a series of moral dilemmas, these patients generally made the same moral judgments as most people. This suggests that emotions are not necessary for such judgments.

Trickle down economics, de-regulation, pretty much relieves business of it's moral obligations. The only thing it has to worry about is profits. There has to be oversight, a morality or ethics code, big business will not regulate itself.

 

[keysersoze]

The scene Tuesday outside American International Group's building in Lower Manhattan.
Fed Readies A.I.G. Loan of $85 Billion for an 80% Stake​

By MICHAEL J. de la MERCED and ERIC DASH

In an extraordinary turn, the Federal Reserve was close to a deal Tuesday night to take a nearly 80 percent stake in the troubled giant insurance company, the American International Group, in exchange for an $85 billion loan, according to people briefed on the negotiations.

All of A.I.G.’s assets would be pledged to secure the loan, these people said, and in return, the Fed would receive warrants that could be exchanged for an ownership stake. Stock of existing shareholders would be diluted, but not wiped out.

A person briefed on the matter said the agreement does not require shareholder approval.

A.I.G.’s board approved the proposal at a meeting Tuesday night, the same individual said.

If the Fed takes a controlling stake, it is likely that it would want to replace A.I.G.’s board as well as its chief executive and chairman, Robert B. Willumstad.

The Fed’s action came after Treasury Secretary Henry M. Paulson and Ben S. Bernanke, president of the Federal Reserve, went to Capitol Hill on Tuesday night to meet with House and Senate leaders. Mr. Paulson called the Senate majority leader, Harry Reid, Democrat of Nevada, about 5 p.m. and asked for a meeting in the Senate leader’s office, which began about 6:30 p.m.

The Federal Reserve had asked the investment banks Goldman Sachs and JPMorgan Chase to evaluate whether a banking consortium could be assembled to arrange a $75 billion loan for A.I.G. But the Federal Reserve and the two banks agreed late Tuesday that the plan could not be completed in time to rescue the insurance company.

Without the help, A.I.G. was expected to be forced to file for bankruptcy protection.

The need for the loans became necessary after the major credit ratings agencies downgraded A.I.G. late Monday, a move that likely to have forced the company to turn over billions of dollars in collateral to its derivatives trading partners worsening its financial health.

Until this week, it would have been unthinkable for the Federal Reserve to bail out an insurance company, and A.I.G.’s request for help from the Fed of just a few days ago was rebuffed.

But with the prospect of a giant bankruptcy looming — one with unpredictable consequences for the world financial system — the Fed abandoned precedent and agreed to let the money flow.

Attending the meeting on the Capitol Hill were Democratic Senate leaders that included Charles E. Schumer of New York, Richard Durbin of Illinois, Christopher J. Dodd of Connecticut and Kent Conrad of North Dakota A contingent of Republicans was led by Mitch McConnell of Kentucky, the minority leader, and included Richard Shelby of Alabama, John Kyl of Arizona and Judd Gregg of New Hampshire. House leaders included John Boehner of Ohio, the Republican leader; Spencer Bachus, Republican of Alabama; and Barney Frank, Democrat of Massachusetts. Members of the leaders’ staffs were asked to leave the meeting shortly after it began.

 

[QueEx]

The ramifications of an AIG failure are huge.

 

[J-BOOGIE]

Barclay's has agreed to buy Lehman for $250million...

Also buying some of the office facilities/ properties...

http://news.yahoo.com/s/ap/lehman_barclays_deal

NEW YORK - Barclays says it will acquire Lehman Brothers' North American investment banking and capital markets businesses for $250 million in cash.
ADVERTISEMENT

Lehman filed for bankruptcy protection Monday after it was unable to find financing or fresh capital to shore up its balance sheet amid the continued downturn in the credit markets.

Barclays said Tuesday it will acquire Lehman's North American banking operations, which include Lehman's fixed income and equities sales, trading and research and investment banking business. About 10,000 employees work in the divisions.

Barclays will also purchase Lehman's New York headquarters and its two data centers in New Jersey for $1.5 billion.

 

[keysersoze]

The ramifications of an AIG failure are huge.

But should the Fed get involved with an insurance company? Does it even have authority to do this since its AIG is not even a bank.

 

[QueEx]

Legally? - I don't know. Do we save it because to do so is necessary to prevent serious damage/harm to our economy? - probably. I know, where does it stop? If you save one, why not another, etc. How many institutions can we the people bail out ??? Tough questions; and tough consequences.

QueEx

 

[Greed]

But should the Fed get involved with an insurance company? Does it even have authority to do this since its AIG is not even a bank.

Fine time to ask that question. No one cares if the Fed or the feds has the authority to do anything, just as long as they do it on your behalf.

There is no debate in Washington on whether the government can do such things, but only when and how much money should be involved. You can look at Congress currently debate an auto industry loan. The debate is 25 billion or 50 billion, not do we have the authority.

That is essentially the Democratic and Republican parties. The parties of 25 or 50 billion. Both parties know the question of "what the Constitution says" never has to be brought up again.

 

[keysersoze]

Fine time to ask that question. No one cares if the Fed or the feds has the authority to do anything, just as long as they do it on your behalf.

There is no debate in Washington on whether the government can do such things, but only when and how much money should be involved. You can look at Congress currently debate an auto industry loan. The debate is 25 billion or 50 billion, not do we have the authority.

That is essentially the Democratic and Republican parties. The parties of 25 or 50 billion. Both parties know the question of "what the Constitution says" never has to be brought up again.

It seems like they have found the easiest way to kill the constitution - simply ignore it.

 

[keysersoze]

Q&A
Leonhardt Discusses the Economic Turmoil

David Leonhardt, the Economic Scene columnist, answers readers' questions on the implications of the A.I.G. rescue and the road ahead for the beleaguered financial system and the economy. Ask a question.

Q. Now that the government has control over A.I.G., what does this mean and what do we expect over the next few months? Also, where is the government getting the money to help A.I.G.? Isn’t the U.S. already in deficit? What would this mean from a taxpayer’s point of view? Would we expect taxes to increase over the next few years?

— James Hershberger
A. At the end of all this, the actions by the Federal Reserve and the Treasury are likely to increase the deficit. They’re trying to solve big problems, which usually costs money. There is always a chance that the government will make money on the stakes it is taking in these troubled businesses, as it did when it bailed out Chrysler in 1979. But it’s not the most likely outcome.

And will taxes have to increase? Almost certainly. The government is already running a significant deficit, and it is facing big future commitments, mainly in the form of Medicare. As nice as it would be if we could get rid of the deficit by cutting taxes, we now have 30 years of evidence suggesting otherwise.

Q. Is there more to come?

— Betsy Peyton
A. You have to assume that there is more to come. The main cause of all these problems is the decline in house prices, which has led to a collapse in the value of mortgage securities. House prices almost certainly have further to fall. Relative to the fundamentals — rents, for instance, or incomes and interest rates — prices are still 5 percent to 10 percent too high, on average, across the country.

As Alex Berenson pointed out in The Week in Review on Sunday, Wall Street has been predicting the imminent end of this crisis practically since it began. So far, every one of those predictions has been wrong.

Q. What would have been the best way to prevent the subprime crisis from happening?

— Mark
A. At the top of the list is more serious government oversight. Regulators assumed the market would police itself. It didn’t. I’ve written a couple columns on this subject, for readers who are interested in more.

Q. What is the impact on money market accounts (those offered by commercial banks) and those provided by money market mutual funds ( e.g. Vanguard, Dreyfus).

Are these accounts safe, especially those of money market accounts by commercial banks that do not have the objective of maintaining share/unit value at $1.00?

— T. Kosky
A. I forwarded this question to Ron Lieber, who writes the Your Money column for The Times. Here’s what he says:

So far, it appears that all money market mutual funds save for one, The Reserve, have covered any losses so that investors don’t lose money.

The mutual fund industry’s main trade group issued a statement yesterday expressing confidence in the funds in general.

Money market accounts at banks are subject to F.D.I.C. insurance (and its limits). It is not yet clear whether their underlying investments are running into the same kind of trouble that The Reserve’s did. We’re reporting this out today and in coming days and will know more soon.

 

[QueEx]

<IFRAME SRC="http://www.atimes.com/atimes/Global_Economy/JI18Dj03.html" WIDTH=780 HEIGHT=1500>
<A HREF="http://www.atimes.com/atimes/Global_Economy/JI18Dj03.html">link</A>

</IFRAME>

 

[QueEx]

- Robert Ariail / The State (Columbia, S.C.) (September 18, 2008)

`

 

[keysersoze]

Crisis Endgame​

By PAUL KRUGMAN
Published: September 18, 2008
On Sunday, Henry Paulson, the Treasury secretary, tried to draw a line in the sand against further bailouts of failing financial institutions; four days later, faced with a crisis spinning out of control, much of Washington appears to have decided that government isn’t the problem, it’s the solution. The unthinkable — a government buyout of much of the private sector’s bad debt — has become the inevitable.

The story so far: the real shock after the feds failed to bail out Lehman Brothers wasn’t the plunge in the Dow, it was the reaction of the credit markets. Basically, lenders went on strike: U.S. government debt, which is still perceived as the safest of all investments — if the government goes bust, what is anything else worth? — was snapped up even though it paid essentially nothing, while would-be private borrowers were frozen out.

Thus, banks are normally able to borrow from each other at rates just slightly above the interest rate on U.S. Treasury bills. But Thursday morning, the average interest rate on three-month interbank borrowing was 3.2 percent, while the interest rate on the corresponding Treasuries was 0.05 percent. No, that’s not a misprint.

This flight to safety has cut off credit to many businesses, including major players in the financial industry — and that, in turn, is setting us up for more big failures and further panic. It’s also depressing business spending, a bad thing as signs gather that the economic slump is deepening.

And the Federal Reserve, which normally takes the lead in fighting recessions, can’t do much this time because the standard tools of monetary policy have lost their grip. Usually the Fed responds to economic weakness by buying up Treasury bills, in order to drive interest rates down. But the interest rate on Treasuries is already zero, for all practical purposes; what more can the Fed do?

Well, it can lend money to the private sector — and it’s been doing that on an awesome scale. But this lending hasn’t kept the situation from deteriorating.

There’s only one bright spot in the picture: interest rates on mortgages have come down sharply since the federal government took over Fannie Mae and Freddie Mac, and guaranteed their debt. And there’s a lesson there for those ready to hear it: government takeovers may be the only way to get the financial system working again.

Some people have been making that argument for some time. Most recently, Paul Volcker, the former Fed chairman, and two other veterans of past financial crises published an op-ed in The Wall Street Journal declaring that the only way to avoid “the mother of all credit contractions” is to create a new government agency to “buy up the troubled paper” — that is, to have taxpayers take over the bad assets created by the bursting of the housing and credit bubbles. Coming from Mr. Volcker, that proposal has serious credibility.

Influential members of Congress, including Hillary Clinton and Barney Frank, the chairman of the House Financial Services Committee, have been making similar arguments. And on Thursday, Charles Schumer, the chairman of the Senate Finance Committee (and an advocate of creating a new agency to resolve the financial crisis) told reporters that “the Federal Reserve and the Treasury are realizing that we need a more comprehensive solution.” Sure enough, Thursday night Ben Bernanke and Mr. Paulson met with Congressional leaders to discuss a “comprehensive approach” to the problem.

We don’t know yet what that “comprehensive approach” will look like. There have been hopeful comparisons to the financial rescue the Swedish government carried out in the early 1990s, a rescue that involved a temporary public takeover of a large part of the country’s financial system. It’s not clear, however, whether policy makers in Washington are prepared to exert a comparable degree of control. And if they aren’t, this could turn into the wrong kind of rescue — a bailout of stockholders as well as the market, in effect rescuing the financial industry from the consequences of its own greed.

Furthermore, even a well-designed rescue would cost a lot of money. The Swedish government laid out 4 percent of G.D.P., which in our case would be a cool $600 billion — although the final burden to Swedish taxpayers was much less, because the government was eventually able to sell off the assets it had acquired, in some cases at a handsome profit.

But it’s no use whining (sorry, Senator Gramm) about the prospect of a financial rescue plan. Today’s U.S. political system isn’t going to follow Andrew Mellon’s infamous advice to Herbert Hoover: “Liquidate labor, liquidate stocks, liquidate the farmers, liquidate real estate.” The big buyout is coming; the only question is whether it will be done right.

 

[keysersoze]

The last article I posted is just sign that this will not end until the government makes some sort of mega-takeover of the financial services industry.

If this happens under the Bush admin, does that mean that it will mark the end of Republicans saying that 'government is the problem, not the solution' since it clearly seems that the free market let alone to its devices would kill itself off without government intervention.

 

[keysersoze]

This one below is the best I've read so far and fully explains the current banking/financial crisis since its written by an economist who asks other economists, unlike most articles which are written by journalists who don't have much economic knowledge and ask "market analysts" aka Wall Street talking heads.

Diamond and Kashyap on the Recent Financial Upheavals

By STEVEN D. LEVITT
September 18, 2008, 10:04 am
As an economist, I am supposed to have something intelligent to say about the current financial crisis. To be honest, however, I haven’t got the foggiest idea what this all means. So I did what I always do when something related to banking arises: I knocked on the doors of my colleagues Doug Diamond and Anil Kashyap, and asked them for the answers. What they told me was so interesting and insightful that I begged them to write their explanations down for a broader audience. They were kind enough to take the time to do so. In what follows, they discuss what has happened in the financial sector in the last few days, why it happened, and what it means for everyday people.

The F.A.Q.’s of Lehman and A.I.G.
By Douglas W. Diamond and Anil K. Kashyap
A Guest Post

For most of the last 20 years we have been studying banks, monetary policy, and financial crises. So for us the events of the last year have been especially fascinating.

The last 10 days have been the most remarkable period of government intervention into the financial system since the Great Depression. In talking with reporters and our noneconomist friends, we have been besieged with questions about several aspects of these events. Here are a few of the most frequently asked questions with our best answers.

1) What has happened that is so remarkable?

This episode started when the Treasury nationalized Fannie Mae and Freddie Mac on September 8. Their combined assets are over $5 trillion. These firms help guarantee most of the mortgages in the United States. The Treasury only got authority from Congress to take this action in July, and in seeking the authority had insisted that no intervention would be needed.

The Treasury has replaced the management of both companies and will presumably oversee their operation. This decision marked an acknowledgment by the government that the mortgage market and the institutions to make it operate in the U.S. are broken.

On Monday, the largest bankruptcy filing in U.S. history was made by Lehman Brothers. Lehman had over $600 billion in assets and 25,000 employees. (The largest previous filing was WorldCom, whose assets just prior to bankruptcy were just over $100 billion.)

On Tuesday, the Federal Reserve made a bridge loan to A.I.G., the largest insurance company in the world; perhaps best known to most of the world as the shirt sponsor of Manchester United soccer club, A.I.G. has assets of over $1 trillion and over 100,000 employees worldwide. The Fed has the option to purchase up to 80 percent of the shares of A.I.G., is replacing A.I.G.’s management, and is nearly wiping out A.I.G.’s existing shareholders. A.I.G. is to be wound down by selling its assets over the next two years. (Don’t worry, Man U will be fine.) The Fed has never asserted its authority to intervene on this scale, in this form, or in a firm so far removed from its own supervisory authority.

2) Why did these things happen?

The common denominator in all three cases was the ability of the firms to secure financing. The reasons, though, differed in each case.

The Fannie and Freddie situation was a result of their unique roles in the economy. They had been set up to support the housing market. They helped guarantee mortgages (provided they met certain standards), and were able to fund these guarantees by issuing their own debt, which was in turn tacitly backed by the government. The government guarantees allowed Fannie and Freddie to take on far more debt than a normal company. In principle, they were also supposed to use the government guarantee to reduce the mortgage cost to the homeowners, but the Fed and others have argued that this hardly occurred. Instead, they appear to have used the funding advantage to rack up huge profits and squeeze the private sector out of the “conforming” mortgage market. Regardless, many firms and foreign governments considered the debt of Fannie and Freddie as a substitute for U.S. Treasury securities and snapped it up eagerly.

Fannie and Freddie were weakly supervised and strayed from the core mission. They began using their subsidized financing to buy mortgage-backed securities which were backed by pools of mortgages that did not meet their usual standards. Over the last year, it became clear that their thin capital was not enough to cover the losses on these subprime mortgages. The massive amount of diffusely held debt would have caused collapses everywhere if it was defaulted upon; so the Treasury announced that it would explicitly guarantee the debt.

But once the debt was guaranteed to be secure (and the government would wipe out shareholders if it carried through with the guarantee), no self-interested investor was willing to supply more equity to help buffer the losses. Hence, the Treasury ended up taking them over.

Lehman’s demise came when it could not even keep borrowing. Lehman was rolling over at least $100 billion a month to finance its investments in real estate, bonds, stocks, and financial assets. When it is hard for lenders to monitor their investments and borrowers can rapidly change the risk on their balance sheets, lenders opt for short-term lending. Compared to legal or other channels, their threat to refuse to roll over funding is the most effective option to keep the borrower in line.

This was especially relevant for Lehman, because as an investment bank, it could transform its risk characteristics very easily by using derivatives and by churning its trading portfolio. So for Lehman (and all investment banks), the short-term financing is not an accident; it is inevitable.

Why did the financing dry up? For months, short-sellers were convinced that Lehman’s real-estate losses were bigger than it had acknowledged. As more bad news about the real estate market emerged, including the losses at Freddie Mac and Fannie Mae, this view spread.

Lehman’s costs of borrowing rose and its share price fell. With an impending downgrade to its credit rating looming, legal restrictions were going to prevent certain firms from continuing to lend to Lehman. Other counterparties that might have been able to lend, even if Lehman’s credit rating was impaired, simply decided that the chance of default in the near future was too high, partly because they feared that future credit conditions would get even tighter and force Lehman and others to default at that time.

A.I.G. had to raise money because it had written $57 billion of insurance contracts whose payouts depended on the losses incurred on subprime real-estate related investments. While its core insurance businesses and other subsidiaries (such as its large aircraft-leasing operation) were doing fine, these contracts, called credit default swaps (C.D.S.’s), were hemorrhaging.

Furthermore, the possibility of further losses loomed if the housing market continued to deteriorate. The credit-rating agencies looking at the potential losses downgraded A.I.G.’s debt on Monday. With its lower credit ratings, A.I.G.’s insurance contracts required A.I.G. to demonstrate that it had collateral to service the contracts; estimates suggested that it needed roughly $15 billion in immediate collateral.

A second problem A.I.G. faced is that if it failed to post the collateral, it would be considered to have defaulted on the C.D.S.’s. Were A.I.G. to default on C.D.S.’s, some other A.I.G. contracts (tied to losses on other financial securities) contain clauses saying that its other contractual partners could insist on prepayment of their claims. These cross-default clauses are present so that resources from one part of the business do not get diverted to plug a hole in another part. A.I.G. had another $380 billion of these other insurance contracts outstanding. No private investors were willing to step into this situation and loan A.I.G. the money it needed to post the collateral.

In the scramble to make good on the C.D.S.’s, A.I.G.’s ability to service its own debt would come into question. A.I.G. had $160 billion in bonds that were held all over the world: nowhere near as widely as the Fannie and Freddie bonds, but still dispersed widely.

In addition, other large financial firms — including Pacific Investment Management Company (Pimco), the largest bond-investment fund in the world — had guaranteed A.I.G.’s bonds by writing C.D.S. contracts.

Given the huge size of the contracts and the number of parties intertwined, the Federal Reserve decided that a default by A.I.G. would wreak havoc on the financial system and cause contagious failures. There was an immediate need to get A.I.G. the collateral to honor its contracts, so the Fed loaned A.I.G. $85 billion.

3) Why did the Treasury and Fed let Lehman fail but rescue Bear Stearns, Fannie Mae, Freddie Mac, and A.I.G.?

We have already explained why Fannie, Freddie, and A.I.G. were supported. In March, Bear Stearns lost its access to credit in almost the same fashion as Lehman; yet Bear was rescued and Lehman was not.

Bear Stearns was bailed out for two reasons. One was that the Fed had very imperfect information about what was going on at Bear. The Fed was not Bear’s regulator, the amount of publicly available information was limited, and its staff was not versed in all of the ways in which Bear might have been connected to other parts of the financial system.

The second problem was that Bear’s counterparties in many transactions were not prepared for the sudden demise of Bear. A Bear bankruptcy might have triggered a wave of forced selling of collateral that Bear would have given its counterparties. Given the potential chaos that would have resulted from Bear Stearns filing for bankruptcy, the Fed had little choice but to engineer a rescue. In doing so, the Fed argued that the rescue was a rare, perhaps once-in-a-generation, event.

When Bear was rescued, the Fed created a new lending facility to help provide bridge financing to other investment banks. The new lending arrangement was proposed precisely because there were concerns that Lehman and other banks were at risk for a Bear-like run. Since March, the Fed had also studied what to do if this were to happen again; it concluded that if it modified its lending facility slightly, it could withstand a bankruptcy; it made these changes to the lending facility on Sunday night.

Once the Fed had made these changes and determined that it and the others in the market had an understanding of the indirect or “collateral damage” effects of a bankruptcy, it could rely on the protections of the bankruptcy code to stop the run on Lehman, and to sell its operating assets separately from its toxic mortgage-backed assets.

Against this backdrop, if the government had rescued Lehman, it would have repudiated the claim that the Bear rescue was extraordinary; it would have also conceded that in the six months since Bear failed, neither the new facility that it set up nor the other steps to make markets more robust were reliable. Essentially, the Fed and the Treasury would have been admitting that they had lied or were incompetent in stabilizing the financial system — or both.

It was not surprising that they drew the line at helping Lehman. Based on all the publicly available information, this was clearly the right thing to do.

4) I do not work at Lehman or A.I.G. and do not own much stock; why should I care?

The concern for the man on Main Street is not the bankruptcy of Lehman, per se. Rather, it is the collective inability of major financial institutions to find funding.

As their own funding dries up, the remaining financial firms will be much more cautious in extending credit to normal firms and individuals. So even for people whose own circumstances have not much changed, the cost of the credit is going to rise. For an individual or business that falls behind on payments or needs an increase in short-term credit because of the slowing economy, credit will be much harder to obtain than in recent years.

This is going to slow growth. We have not seen this much stress in the financial system since the Great Depression, so we do not have any recent history to rely upon in quantifying the magnitude of the slowdown. A recent educated guess by Jan Hatzius of Goldman Sachs suggests that G.D.P. growth will be just about 2 percentage points lower in 2008 and 2009. But as he explains, extrapolations of this sort are highly uncertain.

5) What does it mean for the Fed and Treasury going ahead?

A reasonable reading of the recent bailouts suggests a simple rule: if a firm is on the verge of collapse and its ties to the financial system will lead to a cascade of chaos, the firm will be saved. A bankruptcy will be permitted only if the failure can be contained.

Assuming the level of chaos is sufficiently high, this dichotomy is probably consistent with the mandate of the Federal Reserve. The rescue of A.I.G., however, raises some major challenges.

One is where to draw the line. A.I.G. was an insurance company, not a bank or a broker dealer, so the Fed had no special relationship with A.I.G. Presumably, if a very large airline or automaker had been involved in the C.D.S. market, the same reasoning that led to the rescue would apply.

A second challenge comes with defining the acceptable level of chaos. We will never be able to find out what would have happened if A.I.G. had been allowed to fail. Furthermore, there are some reasons to believe that even if A.I.G. continues to operate, the fundamental stress in the financial system will remain. If the rescue does not mark a turning point, the bailout may be viewed quite differently down the road.

Should the government intervene if it merely postpones an inevitable adjustment? Creditor runs can make adjustment too fast; blanket bailouts can make adjustment too slow. Has the Fed found the speed that is just right?

Third, now that A.I.G. has been lent to, how will regulation have to be adjusted? Surely the Fed cannot be called upon to provide backstop financing whenever a large member of the financial system runs into trouble. How does it prevent a replay of this scenario, and can it be done without stifling innovation?

6) What does this mean for the markets going ahead?

Letting Lehman go means that the remaining large financial services firms now must understand that they need to manage their own risks more carefully. This includes both securing adequate funding and being prudent about which counterparties to rely upon. Both of these developments are welcome.

If the remaining investment banks, Goldman Sachs and Morgan Stanley, do not get more secure funding in place, they may be acquired or subject to a run too. In the current environment, relying almost exclusively on short-term debt is hazardous, even if a firm or bank has nothing wrong with it.

7) When will the turmoil end?

The inability to secure short-term funding fundamentally comes from having insufficient capital. There are many indicators that the largest financial institutions are collectively short of capital.

One signal is that there were apparently only two bidders for Lehman, when the ongoing value from operating most of the bank was surely far above the $3.60 share price from Friday. Another is the elevated cost of borrowing that banks are charging each other. A third indicator is the reluctance to take on certain types of risk, such as jumbo mortgages, so that the cost of this type of borrowing is unusually high.

The fear of being the next Lehman ought to convince many of the large institutions that, despite however much they already raised, more is needed. It may be expensive to attract more equity financing, but the choice may be bankruptcy or sale. The decision by the Federal Reserve to not cut interest rates suggests the Fed also recognizes that the short-term interest rate is a very inefficient way to address this problem.

 

[water]

bump for knowledge.......

 

[Makeherhappy]

One thing for sure, we have several more banks and financial institutions that will collapse before it's all said and done. We still have a couple of more years of shitty market conditions. Hope you aren't retiring within the next 5 years.

 

[Greed]

Economist suggest turning all the debt into equity

I'm for no bailout, but if the government is going to bailout these people then turn the $700 billion of bad debt into equity held by the Treasury. That way the current shareholders are totally wiped out as punishment. Also, put the equity in the form of 5-10 yr warrants that the government would have to sell when they exercised them.


http://faculty.chicagogsb.edu/luigi.zingales/Why_Paulson_is_wrong.pdf

 

[African Herbsman]

Stop delaying the inevitable. Let the shit hit the fan already. No more bailouts.

 

[keysersoze]

Goldman to Raise Capital, With $5 Billion From Buffett​

September 24, 2008
By BEN WHITE

The billionaire Warren E. Buffett will invest $5 billion in the investment bank Goldman Sachs as part of the bank’s efforts to raise $7.5 billion in fresh capital, a Goldman spokesman said Tuesday.

In return, Berkshire Hathaway, the conglomerate run by Mr. Buffett, will receive perpetual preferred shares in Goldman, said the spokesman, Lucas Van Praag. The preferred stock will pay a 10 percent dividend.

Goldman will also issue $2.5 billion in common shares.

In addition, Berkshire Hathaway will receive warrants to buy $5 billion in common stock at a strike price of $115 a share, which are exercisable at any time in a five-year period. Goldman shares closed Tuesday at $125.05, up $4.27.

Goldman’s move came a day after a rival investment bank, Morgan Stanley, raised about $8 billion by selling up to a 20 percent stake to Mitsubishi UFJ Financial Group, Japan’s largest commercial bank. Both Morgan and Goldman Sachs on Sunday transformed themselves into bank holding companies in an effort to broaden their foundation.

“This investment will further bolster our strong capitalization and liquidity position,” the chairman and chief executive of Goldman, Lloyd C. Blankfein, said in a statement.

“We are pleased that given our longstanding relationship, Warren Buffett, arguably the world’s most admired and successful investor, has decided to make such a significant investment in Goldman Sachs,” Mr. Blankfein said. “We view it as a strong validation of our client franchise and future prospects.”

Mr. Buffett, also in the statement, called Goldman Sachs an exceptional institution.

“It has an unrivaled global franchise,” Mr. Buffett said, “a proven and deep management team and the intellectual and financial capital to continue its track record of outperformance.”

For Mr. Buffett, the move marks a long-awaited investment in a major financial firm, but is only the latest in a string of transactions he has participated in over the last year. Last December, Mr. Buffett 78, stunned Wall Street by announcing that he would enter the troubled bond insurance business. He also spent about $440 million for a unit of ING Groep, the Dutch financial giant.

Last week, a division of Berkshire Hathaway, MidAmerican Energy Holdings, agreed to pay $4.7 billion for Constellation Energy, a wholesale supplier of power. In December, Berkshire paid $4.5 billion for Marmon Holdings, the huge holding company of the Pritzker family. And Berkshire also provided nearly $10 billion in financing for the Mars acquisition of the Wrigley Company and Dow Chemical’s merger with Rohm & Haas.

Mr. Buffett’s views on the hard-to-value assets that have plagued investment banks and insurance companies are well known. He has derided derivatives as ”financial weapons of mass destruction.” And for the most part, he has hewed closely to that view.

With about $47 billion in cash on hand, Berkshire still has plenty of money for acquisitions. At the company’s annual meeting in May, Mr. Buffett said he would consider a deal as large as $60 billion.

For Goldman and Morgan, the investments are the latest indication of the changing financial landscape. A week ago, both Morgan Stanley and Goldman Sachs were insisting that their fundamental strategies were fine. And as a punishing market took down their competitors one by one, executives of the two investment firms had resisted calls to become more like banks. Doing so, they warned, might make them and the entire American financial system less nimble, less creative and less willing to take the big risks that reaped big rewards.

But the weekend metamorphosis of both into regulated bank holding companies capable of acquiring other banks has transformed Wall Street into an arena of greater stability, less complexity and smaller profits, at least compared with the eye-popping standards that had created a golden era of $50 million bonuses for top traders and bankers.

 

[keysersoze]

Stopping a Financial Crisis, the Swedish Way


September 23, 2008
By CARTER DOUGHERTY
A banking system in crisis after the collapse of a housing bubble. An economy hemorrhaging jobs. A market-oriented government struggling to stem the panic. Sound familiar?

It does to Sweden. The country was so far in the hole in 1992 — after years of imprudent regulation, short-sighted economic policy and the end of its property boom — that its banking system was, for all practical purposes, insolvent.

But Sweden took a different course than the one now being proposed by the United States Treasury. And Swedish officials say there are lessons from their own nightmare that Washington may be missing.

Sweden did not just bail out its financial institutions by having the government take over the bad debts. It extracted pounds of flesh from bank shareholders before writing checks. Banks had to write down losses and issue warrants to the government.

That strategy held banks responsible and turned the government into an owner. When distressed assets were sold, the profits flowed to taxpayers, and the government was able to recoup more money later by selling its shares in the companies as well.

“If I go into a bank,” said Bo Lundgren, who was Sweden’s finance minister at the time, “I’d rather get equity so that there is some upside for the taxpayer.”

Sweden spent 4 percent of its gross domestic product, or 65 billion kronor, the equivalent of $11.7 billion at the time, or $18.3 billion in today’s dollars, to rescue ailing banks. That is slightly less, proportionate to the national economy, than the $700 billion, or roughly 5 percent of gross domestic product, that the Bush administration estimates its own move will cost in the United States.

But the final cost to Sweden ended up being less than 2 percent of its G.D.P. Some officials say they believe it was closer to zero, depending on how certain rates of return are calculated.

The tumultuous events of the last few weeks have produced a lot of tight-lipped nods in Stockholm. Mr. Lundgren even made the rounds in New York in early September, explaining what the country did in the early 1990s.

A few American commentators have proposed that the United States government extract equity from banks as a price for their rescue. But it does not seem to be under serious consideration yet in the Bush administration or Congress.

The reason is not quite clear. The government has already swapped its sovereign guarantee for equity in Fannie Mae and Freddie Mac, the mortgage finance institutions, and the American International Group, the global insurance giant.

Putting taxpayers on the hook without anything in return could be a mistake, said Urban Backstrom, a senior Swedish finance ministry official at the time. “The public will not support a plan if you leave the former shareholders with anything,” he said.

The Swedish crisis had strikingly similar origins to the American one, and its neighbors, Norway and Finland, were hobbled to the point of needing a government bailout to escape the morass as well.

Financial deregulation in the 1980s fed a frenzy of real estate lending by Sweden’s banks, which did not worry enough about whether the value of their collateral might evaporate in tougher times.

Property prices imploded. The bubble deflated fast in 1991 and 1992. A vain effort to defend Sweden’s currency, the krona, caused overnight interest rates to spike at one point to 500 percent. The Swedish economy contracted for two consecutive years after a long expansion, and unemployment, at 3 percent in 1990, quadrupled in three years.

After a series of bank failures and ad hoc solutions, the moment of truth arrived in September 1992, when the government of Prime Minister Carl Bildt decided it was time to clear the decks.

Standing shoulder-to-shoulder with the opposition center-left, Mr. Bildt’s conservative government announced that the Swedish state would guarantee all bank deposits and creditors of the nation’s 114 banks. Sweden formed a new agency to supervise institutions that needed recapitalization, and another that sold off the assets, mainly real estate, that the banks held as collateral.

Sweden told its banks to write down their losses promptly before coming to the state for recapitalization. Facing its own problem later in the decade, Japan made the mistake of dragging this process out, delaying a solution for years.

Then came the imperative to bleed shareholders first. Mr. Lundgren recalls a conversation with Peter Wallenberg, at the time chairman of SEB, Sweden’s largest bank. Mr. Wallenberg, the scion of the country’s most famous family and steward of large chunks of its economy, heard that there would be no sacred cows.

The Wallenbergs turned around and arranged a recapitalization on their own, obviating the need for a bailout. SEB turned a profit the following year, 1993.

“For every krona we put into the bank, we wanted the same influence,” Mr. Lundgren said. “That ensured that we did not have to go into certain banks at all.”

By the end of the crisis, the Swedish government had seized a vast portion of the banking sector, and the agency had mostly fulfilled its hard-nosed mandate to drain share capital before injecting cash. When markets stabilized, the Swedish state then reaped the benefits by taking the banks public again.

More money may yet come into official coffers. The government still owns 19.9 percent of Nordea, a Stockholm bank that was fully nationalized and is now a highly regarded giant in Scandinavia and the Baltic Sea region.

The politics of Sweden’s crisis management were similarly tough-minded, though much quieter.

Soon after the plan was announced, the Swedish government found that international confidence returned more quickly than expected, easing pressure on its currency and bringing money back into the country. The center-left opposition, while wary that the government might yet let the banks off the hook, made its points about penalizing shareholders privately.

“The only thing that held back an avalanche was the hope that the system was holding,” said Leif Pagrotzky, a senior member of the opposition at the time. “In public we stuck together 100 percent, but we fought behind the scenes.”

 

[keysersoze]

Re: Economist suggest turning all the debt into equity

I'm for no bailout, but if the government is going to bailout these people then turn the $700 billion of bad debt into equity held by the Treasury. That way the current shareholders are totally wiped out as punishment. Also, put the equity in the form of 5-10 yr warrants that the government would have to sell when they exercised them.


http://faculty.chicagogsb.edu/luigi.zingales/Why_Paulson_is_wrong.pdf

The article is posted above this speaks about how the Swedes' essentially did what your talking about the came out as winners. I don't know if this has been discussed by the Bush Admin so far.

Should be interesting to see how it all ends.

 

[thesenator20904]

40 Billion more... MSNBC

DAMN how much more money do we have to give AIG???

Who the heck is the CEO Jack from Jack in the Box???

 

[histick]

Re: 40 Billion more... MSNBC

DAMN how much more money do we have to give AIG???

Who the heck is the CEO Jack from Jack in the Box???

We would be better off with Jack from Jack n Box as AIG's CEO: Jack n Box has been pulling in steady profits.

I just read a few articles about the extra cash for AIG. They mentioned that taxpayers now own part of AIG. Where the fuck are my shares? I pay more in taxes than most households make in gross salary.

Let AIG and Wall St. burn IMO.