It’s late on Sunday night in New York, at the end of three desperate days of talks and attempted deals that failed to save Lehman Brothers from collapse. Wall Street is in desperate survival mode. Some of the biggest names in world finance turned away from Lehman yesterday to do other deals, leaving it lonely and friendless.
The upshot of the weekend is the biggest failure in US history and upwards of $US58 billion in deals by financial groups desperate to survive. Lehman Brothers has a deadline of 1.59pm today (11.59pm Sunday in New York) to file for bankruptcy, otherwise confusion will reign.
In short, it’s the reshaping of Wall Street. In the space of seven months, two investment banks have gone in Bear Stearns and Lehman, while another in Merrill Lynch has been bailed out. The one time biggest insurer in the US, American International Group, is struggling having rejected private equity offers, according to the Wall Street Journal. UBS and Citigroup are mortally wounded. Fannie Mae and Freddie Mac were bailed out in a deal whose bill has yet to be produced, but could top $US200 billion by the end of next year-early 2010. All self-inflicted, mind you, and a host of other big names are still bleeding.
The outcome could be just two independent investment banks left standing: Goldman Sachs and Morgan Stanley and both report quarterly financial results this week that will shine a light on their futures.
The negotiations over Lehman were undertaken at the Wall Street offices of the New York Federal Reserve, the part of the Fed which interfaces daily with US financial markets and which has been driving the talks for an industry bailout of the bank, with no Government assistance.
The talks started Friday, continued Saturday with no joy and extended into Sunday. Barclays withdrew because of the lack of any Government guarantee and then Bank of America moved from Lehman to direct talks with Merrill Lynch.
An unprecedented Sunday afternoon trading session in the credit derivatives market, ordered by the US Federal Reserve, alerted markets to the possibility that Lehman Bros would be allowed to collapse, throwing into doubt billions of dollars in financial deals along with the jobs of over 25,000 Lehman employees in the US and around the world, including Australia.
The Fed ordered the session to allow the financial markets to start the process of unravelling credit derivates such as swaps and other transactions between Lehman and other counterparties. The Fed and the industry association that oversees this complex and huge market (the size is estimated at $US455 trillion worldwide) allowed two hours at first, but that was not enough, and it was extended until 8am our time.
Now, billions of dollars of deals have been unwound contingent on Lehman filing for bankruptcy in New York by the deadline. Failure to do so would see all these deals return to what they were before the Sunday trading session. If that was to happen, huge and continuing losses might be incurred by banks and other groups around the world.
Ominously, The International Swaps and Derivatives Association issued this statement overnight in New York:
ISDA confirms a netting trading session will take place between 2pm and 4pm New York time for OTC derivatives. Product classes involved are credit, equity, rates, FX and commodity derivatives. The purpose of this session is to reduce risk associated with a potential Lehman Brothers Holding Inc. bankruptcy filing. Trades are contingent on a bankruptcy filing at or before 11:59 pm New York time, Sunday, September 14, 2008. If there is no filing, the trades cease to exist.
In some ways it’s like laying out Lehman’s burial suit before it is actually dead. It’s all about trying to save stricken financial groups by saving the fittest and throwing Lehman Brothers to the wolves.
Fed and US Treasury abandon Lehman Bros. Potential buyers wanted support from the US Government, as happened with Bear Stearns, Fannie Mae and Freddie Mac.
But the Fed and US treasury secretary, Hank Paulson, drew the proverbial line in the sand and said “no more” after spending billions bailing out Bear Stearns ($US30 billion guarantee for Bear assets acquired by JPMorgan) and potentially $US200 billion plus bailing out Fannie Mae and Freddie Mac a week earlier, plus undertaking to help 12 federal Home Loan Bank and assisting small and medium banks damaged by the problems at Fannie and Freddie.
Bank of America abandons Lehman Bros, too. The Wall Street Journal reported that Bank of America switched its affections from Lehman Bros to broker/investment bank Merrill Lynch a few hours ago. If it happens, that merger could be announced in a few hours’ time. A Merrill deal could be worth up to $US38 billion.
The financial deal-making doesn’t end there. Shares in Washington Mutual, America’s biggest savings and loan with $US143 billion in retail bank deposits, fell 36% last week as investors wondered if it was strong enough to survive. US investment analysts say any move by the US Government to support it via a takeover or some other deal, could cost $US24 billion through the insurance of deposits by the key regulator, the Federal Deposit Insurance Corporation.
That would require the US congress to pump tens of billions of dollars into the FDIC’s deposit insurance fund to help refinance it. It has already been drained by the failure of 11 US banks this year. The Wall Street Journal reported that Bank of America had entered into merger talks with Merrills and Barclays had earlier confirmed that it was quitting the talks with Lehman.
A holiday in Japan, South Korea and China gave the Americans a few extra hours in which to negotiate. But with no resolution, plans were started to liquidate the parent of Lehman by moving it into bankruptcy protection and allowing its trading subsidiaries to continue trading while liquidation happens.
A group of 10 global commercial and investment banks say they will provide $US70 billion to help offset any credit squeeze on credit caused by the anticipated collapse of Lehman Brothers. Bank of America, Barclays, Citibank, Credit Suisse, Deutsche Bank, Goldman Sachs, JPMorgan Chase, Merrill Lynch, Morgan Stanley, and UBS, said in a joint statement they had “initiated a series of actions to help enhance liquidity and mitigate the unprecedented volatility and other challenges affecting global equity and debt markets.” It’s called pre-bankruptcy finance and is an unusual part of American finance. Various airlines, for instance, have used it when they file for Chapter 11 bankruptcy.
Yet, some of the banks are near basket cases themselves. UBS and Citigroup have already lost close to $US100 billion between them from the credit crunch and Merrill Lynch agreed to a merger with Bank of America earlier this morning to protect it from any backlash from Lehman’s failure.
Lehman’s bankruptcy still means that billions of dollars in financial deals across national borders will be affected. So too will Lehman Bros’ Australian operations. Lehman took over Grange Securities here several years ago.