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Sunday, September 14, 2008


lehman likely to be liquidated

per the wsj:

With Barclays ending talks and the government balking at putting any taxpayer money at risk for Lehman, the likelihood of a transaction was dimming. That would leave an orderly liquidation as the most likely scenario, a dramatic outcome for a once-powerful firm.

The apparently insurmountable obstacle to a deal was reluctance by U.S. regulators to financially back an acquisition or the creation of a so-called "bad bank" to wind down Lehman's assets.

Bank of America Corp., the other leading bidder on Friday, had indicated by Sunday morning that it wasn't interested in a transaction without government support.

fears of the credit default consequences spurred highly unusual weekend trading in the CDS market.

As word that a Barclays deal was off filtered across Wall Street, credit derivative traders scrambled to unwind their outstanding contracts with Lehman and shift their positions to other banks. CDS traders at many Wall Street firms were told to come to work immediately.

With many trading desks open, investors rushed to buy credit default swaps tied to other brokerages and corporations, sending the cost of protection on investment banks such as Goldman Sachs and others sharply higher. One senior trader said Bank of America is offering to face Lehman's counterparties in CDS trades, as long as the swaps don't reference Lehman's own debt.

It is not known how much in CDS contracts Lehman has. In a survey last year by Fitch Ratings, Lehman was listed among the 10 largest CDS counterparties by number of trades and the amount of debt to which the contracts were tied.

... One trader said conditions in the credit default swap market and the short-term repo markets are more stable today than they were in March, when Bear Stearns nearly collapsed, but still, "if they go into liquidation," it is going to be a bad situation on Monday.

A disorderly unwind of Lehman's derivatives trades is only one worry. Another worry is that if Lehman collapses, its distressed assets -- such as commercial real estate -- could suddenly hit Wall Street for sale, forcing prices even lower and potentially forcing other dealers to mark down once again the value of their own holdings.

more via yves smith. as said the ft: the end is nigh.

meanwhile, in a surprise bid, bank of america is pitching a bailout purchase of merrill lynch. this could be seen as an attempt to firewall a run on the entire broker/dealer business model and worse, as seen by nouriel roubini.

It is now clear that we are again — as we were in mid- March at the time of the Bear Stearns collapse — an epsilon away from a generalized run on most of the shadow banking system, especially the other major independent broker dealers (Lehman, Merrill Lynch, Morgan Stanley, Goldman Sachs). If Lehman does not find a buyer over the weekend and the counterparties of Lehman withdraw their credit lines on Monday (as they all will in the absence of a deal) you will have not only a collapse of Lehman but also the beginning of a run on the other independent broker dealers (Merrill Lynch first but also in sequence Goldman Sachs and Morgan Stanley and possibly even those broker dealers that are part of a larger commercial bank, I.e. JP Morgan and Citigroup). Then this run would lead to a massive systemic meltdown of the financial system. That is the reason why the Fed has convened in emergency meetings the heads of all major Wall Street firms on Friday and again today to convince them not to pull the plug on Lehman and maintain their exposure to this distressed broker dealer.

insurer AIG will announce a radical restructuring involving asset liquidation to compund the potential dumping of lehman's book of assets. it's not hard to envision bone-chilling scenarios as the prospects for disorderly, competitive liquidation increase.

stocks will be hit. alea calls the early trade in the dow futures way down. i wouldn't personally be surprised to see the fed issue an emergency rate cut of 25 or even 50 basis points; commodity declines and strengthening recession indicators have opened a window for such a move.

however -- i speculated last week on the inavailability of good collateral at lehman, rendering its liquidity defense at the discount window null. no one in the press seems to know, but a more likely variation comes again from the journal:

There could be many other reasons why Lehman didn’t borrow. Any borrower to the discount window must put up collateral that the Fed values on its own before making the loan. The Fed could decide not to put government money at risk by lending to a seriously troubled firm even against collateral. Members of the Senate Banking Committee, at a hearing in early April, asked about the suggestion on Wall Street that discount window availability would’ve prevented Bear’s liquidity crisis. New York Fed President Timothy Geithner explained to lawmakers that the Fed, in lending to commercial banks, only allows “sound institutions to borrow against collateral.” He added: “And I can only speak personally for this, but I would think I would have been very uncomfortable lending to Bear, given what we knew at that time, if you could walk back the clock and think about what would happen if that facility had been in place before.”

the government may finally be drawing a line in the sand. it refused to offer itself to the first loss position in the lehman negotiations as it did for bear stearns. it may have shut the window on lehman this week. could it be that bernanke, geithner and the fed crowd have experienced an epiphany? that they now see that liquidity is not the issue at hand?

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