FYI | Sep 15 2008
By Greg Peel
The latest news on the Lehman Bros front is that a consortium of US and foreign banks is preparing an emergency pool aimed at providing funding for those institutions about to experience fallout from Lehman’s demise. In so doing, the banks are assuming the worst.
Talks broke down on the weekend between the US Treasury and at least two global banks – Bank of America and Barclays – on a Lehman rescue plan. Neither bank was prepared to commit funds to the purchase of Lehman assets without a guarantee of protection against losses from the government or Fed, a la Bear Stearns.
The problem global banks face is that all have their own balance sheet difficulties, so while picking up Lehman at a fire sale rate might be enticing there still is a likelihood more write-downs in the value of those assets would transpire, making a difficult situation even worse. On the flipside however, so interwoven are credit derivative deals amongst the global banking fraternity that a failure of Lehman would have ramifications for all.
Thus it’s not just as simple as letting a competitor go to God.
The consortium of unnamed banks are planning to put up a US$50bn pool, Associated Press reports, aimed at providing funding for those banks who may need it in the fallout, and thus “inoculating” the global financial system, at least to some extent.
In the meantime, the US Treasury and Fed are said to be prepared to expand their own emergency facility to US commercial and investment banks, otherwise known as the “discount window”. The Fed opened up its discount window to investment banks when Bear Stearns went under. The fact the window has been open ever since – and underutilised by the investment banking fraternity – is one reason the government sees no reason why it should put up loans to help bail out Lehman.
Were they to do so, one might ask: where does this all stop? There is little doubt there will be more failures before too long, both small and large. And the rescue of Fannie and Freddie has already stretched the government’s own balance sheet.
One contender for “the next to go under” has always been third largest investment bank Merrill Lynch, but Bank of America is now believed to be in merger talks with Merrills, having pulled out of any Lehman deal. This is at least good news in the bigger picture, for Merrills’ share price had also reached the slippery slope and it might have only been a matter of time. It leaves Lehman stranded.
As the Australian financial sector takes another nervous tumble again this morning the best that can be said is that we are largely in new territory here. The extent of interwoven positions in the global credit market is just not known or fully understood, and Lehman’s bankruptcy could be a trip into the great unknown.
