In a few tumultuous hours, the U.S. financial sector shrank significantly Sunday night. Efforts to prop up Lehman Brothers failed and Bank of America struck a deal to buy Merrill Lynch.
Capping a frenetic weekend of attempts to arrange a rescue for the foundering brokerage, Lehman Brothers said early Monday morning that it would file for Chapter 11 bankruptcy in a fashion that would allow many of its units to continue to operate for the time being.
Meanwhile, Merrill Lynch, one of the investment banks that considered being part of a consortium to rescue Lehman, agreed to be bought by Bank of America for $50 billion, or $29 a share. The agreed price is a healthy 70-percent premium to Merrill's closing share price Friday of $17.05, but far below the $100-plus level its stock traded at in early 2007. It's a 38-percent premium to Merrill's book value of $21 a share.
Merrill has been caught, like Lehman, with huge exposures to mortgages and mortgage securities, though it has aggressively moved to unload those from its books in recent weeks. A deal would help it escape the fate of Lehman, which sought bankruptcy protection after Barclays walked away from buying it. Bank of America was also in the running to buy all or part of Lehman and apparently decided Merrill was better prey.
Regulators and the banking industry took dramatic steps Sunday night to cushion the markets from the effects of Lehman's collapse: Major banks organized a $70 billion fund to help each other out; the Federal Reserve committed to accept lower-quality collateral for loans from its emergency window; and the SEC took steps to protect Lehman's brokerage customers.
Meanwhile, American International Group is expected to announce a sweeping reorganization Monday, with plans to sell off an array of assets and businesses.
Most Asian investors had a day's reprieve to digest the news, with stock markets in Hong Kong, China, Japan and South Korea closed for holidays. However, the benchmark indexes in Australia, Taiwan and Singapore lost more than 2 percent each, and analysts expressed concern over the impact the fresh turbulence in the United States could have on Asian banks. European markets opened sharply lower.
Hopes for a complete sale of Lehman faded Sunday as negotiations among top Wall Street bankers and regulators gathered at the Federal Reserve Bank of New York petered out. With the U.S. Treasury refusing to provide any financial backing to a takeover, as it did with Bear Stearns, potential buyers balked at the prospect of having to shoulder all its financial risks themselves.
With its holding company under court protection, Lehman said none of its broker-dealer subsidiaries would be included in the filing and that its Neuberger Berman and Lehman Asset Management units would continue to conduct business as usual. Lehman said that it was still seeking to sell its broker-dealer operations and investment management division.
Barclays was seen as one of the stronger contenders to take over a part of Lehman, but backed out. "In essence we were asked to look at the transaction—it would have been very attractive, but we're pretty strict about M&A, and if it doesn't meet our criteria, it doesn't do it for us, and in the case it didn't," a source said. "In this transaction we would have needed to guarantee the trading operations at Lehman. We just felt that we couldn't take on that sort of open-ended deal."
A plan for other Wall Street firms to inject capital into a proposed $85 billion-asset "bad bank" also stalled, in part because the federal government refused to chip in money, as it had with the seizure of Fannie Mae and Freddie Mac one week ago and as it did in the rescue of Bear Stearns in March. Not many firms would be able or willing to participate in capitalizing the bad bank without federal backing. Wall Street is still reeling from exposure to the mortgage markets, and many banks are struggling to raise capital for themselves, let alone a rival in need.
Bankers are also keenly aware of the difficulties facing each others' firms and other financial companies that have exposure to the mortgage markets. American International Group and Washington Mutual, like Lehman, were hammered in stock trading last week on concerns they would unearth more toxic assets that they need to write-down.
The meetings at the New York Fed began Friday evening and went on for much of the day Saturday. In addition to Treasury Secretary Henry Paulson, the meeting included Securities and Exchange Commission Chairman Christopher Cox, and New York Fed Chief Timothy Geithner. Bankers on hand include Goldman Sachs Chief Lloyd Blankfein, JPMorgan Chase's Jamie Dimon, Citigroup's Vikram Pandit, Morgan Stanley's John Mack and Merrill Lynch's John Thain, along with representatives of other major financial firms.
A source familiar with Paulson's thinking said Saturday that he still is adamant that there be no government money used in the resolution of the situation. A New York Fed spokesman wouldn't provide details of the meetings, except to say they focused on "recent market conditions." Lehman lost the confidence of the markets in the last few days and was pushing hard late in the week to find a buyer.
Ten years ago this month, the New York Fed orchestrated the orderly unwinding of hedge fund Long-Term Capital Management, which foundered on exposures to Russian government bonds. That rescue included capital injections from 14 Wall Street banks, Lehman among them. Bear Stearns refused to participate then. The banks put up $3.7 billion to prevent Long-Term Capital's immediate collapse. The fund was gradually unwound over the next two years.
Lehman is far and away larger than Long-Term Capital, but the capital markets have grown up since that episode a decade ago. Many see a collapse of Lehman as bad, but not apocalyptic. The tricky part is that many of the banks participating in this round of negotiations have been badly stung by the same mortgage-related exposures that are plaguing Lehman, and many are scrounging to raise capital for themselves.
Traders furiously tried Sunday to net out derivatives trades involving Lehman so they wouldn't be caught exposed to a trading maelstrom when the U.S. markets open on Monday. The International Swaps and Derivatives Association was holding a "netting trading session" Sunday afternoon. "The purpose of this session is to reduce risk associated with a potential Lehman Brothers Holdings Inc. bankruptcy filing," the trade group said, adding that trades conducted during this period "are contingent on a bankruptcy filing on or before 11:59 p.m. New York time."
6 months ago