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Last-ditch efforts to save Lehman brothers before markets open

Latest update : 2008-09-14

Regulators and bankers resumed a third day of talks on Sunday in a desperate attempt to reach a deal to sell Lehman Brothers and prevent the struggling investment bank from flooding jittery financial markets with toxic assets at fire-sale prices.

Regulators and bankers resumed a third day of talks on Sunday in a desperate attempt to reach a deal to sell Lehman Brothers and prevent the struggling investment bank from flooding jittery financial markets with toxic assets at fire sale prices.

 

Britain's Barclays Plc appeared to be the frontrunner to take over Lehman, excluding the bad mortgage-related assets that have crippled the 158-year-old firm, according to a person briefed on the matter.

 

Among those arriving at the fortress-like headquarters of the New York Federal Reserve in downtown Manhattan early Sunday were Citigroup CEO Vikram Pandit and Steve Black, who is co-CEO of JPMorgan Chase & Co's investment bank.

 

Security outside the building was even tighter on Sunday than on Saturday, with five vans in front of the entrance and uniformed officers preventing reporters from getting close.

 

Saturday's talks ended without an announcement, but the outcome is likely to include hiving off Lehman's bad assets into a "bad bank", in which rivals would acquire stakes, people briefed on the matter said.

 

If a deal can't be struck, bankruptcy is possible.

 

A sale would be a huge blow to Lehman Chief Executive Dick Fuld, who has been adamant that the bank can survive as an independent entity and is blamed by some for being too slow to realize the depth of the crisis faced by the firm.

 

There were conflicting reports on Sunday about what kind of deal might surface or if talks could still fail.

 

The Wall Street Journal reported in its online edition that Barclays was emerging as a leading contender to buy Lehman but that a deal was still dependent on government support.

 

U.S. Treasury Secretary Henry Paulson is adamant that taxpayer funds not be used again to bail out a financial firm, a source familiar with his thinking said on Friday.

 

The Dealbreaker.com website said that Bank of America Corp would take most of Lehman's good assets, with Barclays and Japan's Nomura Holdings also playing a role.

 

Britain's Sunday Express newspaper said Bank of America, Barclays and Goldman Sachs were expected to agree to divide up Lehman, with Barclays taking its asset management arm.

 

BALANCING ACT

 

The crisis presents a delicate balancing act for Paulson and the Federal Reserve, who have urged Wall Street chiefs to come up with their own solution.

 

So far this year, the government has sponsored rescues of Lehman rival Bear Stearns and mortgage lenders Freddie Mac and Fannie Mae.

 

The authorities don't want to be accused of encouraging excessive risk-taking by bailing out another yet another investment bank.

 

But they also cannot afford to let a blow-up of Lehman paralyze the financial system and deepen the credit crisis.

 

Investors said that if nothing is done by Monday, global financial markets could plunge, because of fear that the U.S. government will have to prop up more financial institutions.

 

Fed Chairman Ben Bernanke remained in Washington but was in close contact with officials in New York and briefed fellow central bankers on Saturday by telephone about the talks.

 

The U.S. Securities and Exchange Commission and the Fed have had conference calls with Lehman's counterparties in major markets to discuss the implications of various scenarios for the firm, a source familiar with the situation said.

 

Underscoring the markets' fragility, shares of Merrill Lynch tumbled 12 percent on Friday, while those of insurer American International Group Inc fell more than 30 percent. Shares of Washington Mutual Inc, the largest U.S. savings and loan, have declined 80 percent this year.

 

All three companies have varying degrees of exposure to the mortgages and other toxic assets that appear to have been Lehman's undoing.

 

SYSTEMIC ISSUE?

 

Some analysts have downplayed the impact of Lehman's woes on broader markets, arguing that signs of the bank's trouble have been emerging for weeks and that clients, banks and other market players have had ample time to limit their exposure.

 

"Lehman can fail and it won't pose a systemic issue. Anyone who bet that Lehman would be bailed out by government made a silly bet," said William Smith, CEO of Smith Asset Management.

 

The meetings with the CEOs of Wall Street's top banks were reminiscent of the 1998 bailout of hedge fund Long-Term Capital Management (LTCM), two sources familiar with the situation said.

 

With LTCM, major banks each contributed to a $3.65 billion bailout of the hedge fund, allowing it to be wound down in an orderly way.

 

But this time may be different. The capital of many top banks is already strained by the credit crisis, making them reluctant to fork over funds to help Lehman, whose problems are largely a result of bad bets on the U.S. mortgage market.

 

"The big concern here is, that the system is short on capital in a big way," said Dan Alpert, banker at Westwood Capital in New York.

 

"That's a problem -- there could be another half a trillion dollars in writedowns, and you have to find that somewhere."

 

Also, while LTCM was a client of most Wall Street firms, Lehman is a competitor.

 

"I'm not sure why Goldman Sachs would want to keep Lehman in business," said Charles Peabody, analyst at independent research firm Portales Partners in New York.

 

He called a "pre-packaged bankruptcy" the best possible scenario for Lehman since it would keep the bank's broker-dealer operating subsidiary intact even if largely wiping out equity holders and hurting bondholders.

 

Lehman has hired law firm Weil Gotshal & Manges to prepare a potential bankruptcy filing, the Wall Street Journal reported on Saturday, citing a person familiar with the matter.

 

Credit derivatives traders for major banks met on Saturday to talk about how Lehman's woes could affect them.

 

Dealers were considering showing one another their exposure to Lehman, which might allow a dealer that sold a credit derivative to the firm, and another that took an opposing position with the bank, to cut it out of the middle, a person briefed on the matter said.

 

These efforts may help make any wind-down of Lehman's trading books more orderly, the person said.

 

Most dealers in the $62 trillion credit derivatives market have extensive exposure to one another, because there is no central clearinghouse or exchange.

 

RATINGS PRESSURE

 

Dealers so far have continued trading with Lehman, which has about $46 billion of commercial and residential real estate on its books.

 

Although the bank has reduced its leverage, or debt relative to assets, it still has about $600 billion of assets supported by some $30 billion of equity, meaning the value of its assets need only decline by 5 percent to make the company worthless.

 

In a world where financial institutions are reducing their leverage globally, many different asset prices are falling.

 

One key source of pressure on Lehman is its debt ratings.

 

All three rating agencies said ratings cuts for Lehman were a possibility, as confidence in the firm erodes.

 

Such a ratings cut would make it difficult for Lehman to compete in businesses such as long-term interest-rate derivatives. Ratings downgrades could force the firm to post billions of dollars of additional collateral with its trading partners, further straining the bank's balance sheet.

 

One potential lifeline for the bank could come from a sale of a stake in its investment management unit, which Lehman has put on the block.

 

Sources said various private equity firms had bid for the stake, and one said the offers were valued at around $5 billion.

Date created : 2008-09-14

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