A perfect Storm.. Return of the Black Monday...Wall Street Hurricane.. Financial Tsunami..
These are some of the terms that are being coined to describe the unprecedented chain of events that have occurred over the last 24 hours. Lehman Brothers has collapsed and Merrill Lynch has agreed to be taken over by Bank of America. The events of Sunday September 14th and the day before were extraordinary. The weekend began with hopes that a deal could be struck to save Lehman. However, as the weekend progressed, it looks like the fed drew a line in the sand citing moral hazard and BOA and Barclays balked at the idea of having to takeover Lehman with no Fed backstops.
Around Sunday evening the chatter began that Lehman would not survive and late Sunday came the stunning news on the Lehman website that it had filed for Chapter 11. Though founded in 1800's, Lehman is not 158 years old as many people believe. Lehman is a 14 year old investment bank with a 158 year old name. Though the bank has access to a Fed lending facility which was introduced after Bear’s takeover by JP Morgan Chase, the collapse of its share price left it unable to raise new equity. At the end of August, Lehman had $600 billion of assets financed with just $30 billion of equity. Even a 5% decline in assets would wipe out the value of the company, which investors saw as a real risk due to the company's billions of dollars of mortgage securities. S&P lowered its long-term counterparty credit rating on Lehman to 'SD' (selective default, meaning payments may not be made on some financial obligations), from 'A'. The rating actions followed Lehman Brothers Holdings Inc., the parent/holding company of the Lehman Brothers group, filing for Chapter 11. At this time, it is not clear whether Lehman will default on its holding company senior and subordinated debt obligations. It is also uncertain whether the proceedings will ultimately include some of Lehman's affiliates in the U.S. and in other countries or whether regulators will take over those entities. Where bankruptcy protection leaves Lehman employees remains unclear. Although some are thought likely to pack their stuff up and ship out Monday, the fact is that the broker-dealer and investment management units are not included in the filing. Lehman has also filed motions to continue paying its employees in the meantime, though large scale layoff's are expected anytime.
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 and with these developments the crisis is entering a new and extremely dangerous phase. The biggest worry now is the effect on derivatives markets particularly the credit-default swaps. Lehman is a top-ten counterparty in CDSs and holds contracts with a notional value of almost $800 billion. 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. It also has over 100,000 creditors. 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; 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.
Merrill’s rush to sell itself was motivated by fear that it might be next to be caught in the stampede. Despite selling a most of its 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. John Thain went right ahead and struck a deal before markets reopened. Despite what people say, I think it’s a smart move as Mr Thain has not only 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 close. How he managed that in such an ugly market is not yet clear. Ken Lewis, BofA’s boss, is no fan of investment banking after he was stung by losses and openly declared he is pulling back. Having failed to build his own investment banking unit, he coveted Merrill’s formidable retail brokerage and got it all. 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 seem to be in better shape but this weekend’s events has undoubtedly cast a shadow over the standalone model.
Even if markets can be stabilized this week, the pain is far from over—and could yet spread. The foreign markets are in the red and the Dow has crashed more than 500 points as I write this – its worst performance in 7 years. 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.
As spectacular as this weekend was, more drama is on the way as a Category 5 hurricane is testing the strength of the Financial levees.
These are some of the terms that are being coined to describe the unprecedented chain of events that have occurred over the last 24 hours. Lehman Brothers has collapsed and Merrill Lynch has agreed to be taken over by Bank of America. The events of Sunday September 14th and the day before were extraordinary. The weekend began with hopes that a deal could be struck to save Lehman. However, as the weekend progressed, it looks like the fed drew a line in the sand citing moral hazard and BOA and Barclays balked at the idea of having to takeover Lehman with no Fed backstops.
Around Sunday evening the chatter began that Lehman would not survive and late Sunday came the stunning news on the Lehman website that it had filed for Chapter 11. Though founded in 1800's, Lehman is not 158 years old as many people believe. Lehman is a 14 year old investment bank with a 158 year old name. Though the bank has access to a Fed lending facility which was introduced after Bear’s takeover by JP Morgan Chase, the collapse of its share price left it unable to raise new equity. At the end of August, Lehman had $600 billion of assets financed with just $30 billion of equity. Even a 5% decline in assets would wipe out the value of the company, which investors saw as a real risk due to the company's billions of dollars of mortgage securities. S&P lowered its long-term counterparty credit rating on Lehman to 'SD' (selective default, meaning payments may not be made on some financial obligations), from 'A'. The rating actions followed Lehman Brothers Holdings Inc., the parent/holding company of the Lehman Brothers group, filing for Chapter 11. At this time, it is not clear whether Lehman will default on its holding company senior and subordinated debt obligations. It is also uncertain whether the proceedings will ultimately include some of Lehman's affiliates in the U.S. and in other countries or whether regulators will take over those entities. Where bankruptcy protection leaves Lehman employees remains unclear. Although some are thought likely to pack their stuff up and ship out Monday, the fact is that the broker-dealer and investment management units are not included in the filing. Lehman has also filed motions to continue paying its employees in the meantime, though large scale layoff's are expected anytime.
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 and with these developments the crisis is entering a new and extremely dangerous phase. The biggest worry now is the effect on derivatives markets particularly the credit-default swaps. Lehman is a top-ten counterparty in CDSs and holds contracts with a notional value of almost $800 billion. 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. It also has over 100,000 creditors. 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; 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.
Merrill’s rush to sell itself was motivated by fear that it might be next to be caught in the stampede. Despite selling a most of its 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. John Thain went right ahead and struck a deal before markets reopened. Despite what people say, I think it’s a smart move as Mr Thain has not only 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 close. How he managed that in such an ugly market is not yet clear. Ken Lewis, BofA’s boss, is no fan of investment banking after he was stung by losses and openly declared he is pulling back. Having failed to build his own investment banking unit, he coveted Merrill’s formidable retail brokerage and got it all. 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 seem to be in better shape but this weekend’s events has undoubtedly cast a shadow over the standalone model.
Even if markets can be stabilized this week, the pain is far from over—and could yet spread. The foreign markets are in the red and the Dow has crashed more than 500 points as I write this – its worst performance in 7 years. 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.
As spectacular as this weekend was, more drama is on the way as a Category 5 hurricane is testing the strength of the Financial levees.
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