Emergency talks were extended after regulators and bankers failed to reach a deal to end the crisis at investment bank Lehman Brothers. US Treasury Secretary Henry Paulson refuses to use taxpayers' funds to bail out yet another bank.
Regulators and bankers failed on Saturday to reach a deal to end the crisis at investment bank Lehman Brothers, and emergency talks were extended to a third day as authorities seek to calm jittery financial markets.
So far this year, the government has sponsored rescues of Lehman rival Bear Stearns and mortgage lenders Freddie Mac and Fannie Mae.
But this time, U.S. Treasury Secretary Henry Paulson is adamant that taxpayer funds not be used, a source familiar with his thinking said on Friday.
The talks on Saturday ended without an announcement, but the final outcome could include hiving off Lehman's bad assets into a "bad bank", in which rival banks would acquire stakes, or even allowing it to file for bankruptcy, people briefed on the matter told Reuters earlier.
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.
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.
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.
Some downplayed the impact of Lehman's woes on broader markets, arguing that signs of the bank's trouble have been emerging for weeks, and clients, banks, and other participants have had ample opportunity 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, chief executive officer of Smith Asset Management.
Lehman Chief Executive Dick Fuld has looked at selling the entire company to banks including Bank of America Corp, the No. 2 U.S. bank by assets, and Britain's No. 3 bank Barclays, a person briefed in the matter said.
The banks are reluctant to buy the 158-year-old firm without government backing similar to that received by JPMorgan when it took over Bear Stearns in March, media reports said.
The Sunday Telegraph newspaper reported that Barclays was considering a direct plea from Paulson to assemble a cut-price rescue bid for Lehman. The paper said people close to the bank were uncertain whether a deal would be achievable.
The CEOs of Goldman Sachs Group, Merrill Lynch, JPMorgan Chase and Citigroup were all at Friday's and Saturday's meetings, in a scene reminiscent of the 1998 bailout of hedge fund Long-Term Capital Management (LTCM), two sources familiar with the situation said.
Late Saturday afternoon JPMorgan CEO Jamie Dimon, Merrill CEO John Thain and Citi CEO Vikram Pandit were seen leaving the New York Fed's headquarters in downtown Manhattan in separate cars within minutes of each other.
A spokesman for the New York Fed confirmed that the meeting had broken up and was to continue on Sunday.
Earlier, about 100 people from the government and several banks had been in the building, thrashing out possible solutions for Lehman.
Goldman Sachs, Citigroup, JPMorgan, Lehman, Merrill, and Morgan Stanley declined to comment.
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, citing a person familiar with the matter.
A Weil Gotshal representative could not immediately be reached for comment.
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.
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.
(Additional reporting by Megan Davies, Phil Wahba and Juan Lagorio in New York, Rachelle Younglai, Jeff Mason, Caren Bohan and Richard Cowan in Washington and Paul Carrell in Nice,
Date created : 2008-09-14