December 13, 2008
Fallout from Lehman Brothers collapse still spreading
Christine Seib in New York
When Dick Fuld left Lehman Brothers' headquarters at 745 Seventh Avenue for the last time on September 15, the broker-dealer he ran may have been defunct, but there were three like it still left. Three months after Lehman went bust, they are all gone and the reverberations of Lehman's collapse are still being felt across America.
All that remains of Lehman is bare bones. Two days after the bank declared itself bankrupt, Barclays bought Lehman's US investment banking business, its headquarters and two processing centres for $1.7 billion. Just over a week later, Nomura snapped up the European, Asian and Middle Eastern businesses. Last week, a management team gained control of the majority share of Lehman's coveted asset management arm.
The bank's fellow broker-dealers have also changed shape dramatically. On the day that Lehman went bust, Merrill Lynch announced that it would be bought by Bank of America in a $50 billion all-stock rescue deal. The so-called Thundering Herd had fallen into the hands of a conservative North Carolina-based financial behemoth.
The remaining two broker-dealers have become deposit-taking institutions. Fearful of another Lehman-style implosion, on September 22 the Federal Reserve gave Goldman Sachs and Morgan Stanley approval to morph into high street banks in the hope that a base of retail and commercial deposits would provide a much-needed cash buffer from the global financial storm
Lehman's surprise collapse - the market had expected the US Government to rescue the stricken bank just as it had organised the sale of Bear Stearns to JPMorgan six months earlier - set off a chain reaction around the world. The bank's default on $165 billion in unsecured debt hit investors with an estimated $120 billion in losses. The credit default swap (CDS) market, of which Lehman had been a major player, dried up. The commercial paper market, where investors had bought Lehman's debt, froze. Companies began eating up unused portions of credit lines and stashing the money away in fear that their lenders would pull their funding. As a result, banks quickly ran out of liquidity.
However, Lehman was not just Wall Street's problem. AIG teetered on the brink of collapse as investors and counterparties panicked about the insurance giant's own exposure to the estimated $60 trillion global CDS market. As a result the Federal Reserve was forced to abandon the moral-hazard high ground and hand over $85 billion in emergency money to AIG.
It took only a day for Lehman to infect mom-and-pop investors. Money market funds try to ensure that their net asset value (NAV) never slips below $1 so that they appeal to people wanting stable homes for retirement savings. But on September 16 the Primary Reserve Fund, the oldest money market fund in America, told its investors that its NAV had dropped to 97cents because of losses on $900 million worth of Lehman debt. When Primary “broke the buck”, slashing pension pots, the panic hit its zenith.
Henry Paulson, the Treasury Secretary, needed something to douse the flames in Wall Street. By September 21 Congress was considering his request for $700 billion to buy troubled assets from financial institutions. But during the two weeks that it took to approve the necessary legislation, the markets continued to fall. By October 3, when the bailout was approved, Mr Paulson said that buying assets would not be enough - the US Government needed to take equity stakes in banks to strengthen their balance sheets.
The Treasury Secretary has since used about $335 billion of the bailout fund, disbursing the cash to at least 52 companies in 25 states, including an agreement with Citi to inject an extra $20 billion, on top of the $25 billion the bank received in October.
The flight to quality has sent the income from Treasury bonds to record lows. Investors have piled more than $100million into money market funds in the past month, pushing up demand for Treasury bills which this week were trading at a negative implied yield for the first time since 1940.
Three months after Lehman, the market for some assets remains dead. Figures compiled by Thompson Financial show that there have been only two issues of high-risk, high-yield debt since the bank went bust. Mortgage-backed debt has continued to sell in the past three months, although with far fewer issues per week. The market for sub-prime and Alt-A mortgage-backed securities, however, is gone. No one is buying collateralised loan obligations (CLOs) and the CDS market remains in tatters. Issuance of asset-backed securities is patchy, with at least three weeks since September 15 in which there were no sales. Yet investment grade debt has continued to sell at relatively normal levels.
Commercial paper, an important source of short-term funding for many companies, has picked up in the past six weeks, largely because of a Federal Reserve funding facility that has bought $300billion worth of the assets over the past seven weeks. For non-financial companies, the cost of borrowing using commercial paper is at a ten-year low. US bank lending, including commercial and consumer credit, is at record highs, indicating that households and companies are not struggling across the board to get loans. Local governments are issuing municipal bonds at the same level as before the credit crunch. And real estate lending hit a record high in October.
Octavio Marenzi, the head of Celent, a financial services consultancy, said: “Markets are very resilient. When people see opportunities, they'll jump in. People are being more cautious but in aggregate, they'll still participate. People still think more money is better than less money.
http://business.timesonline.co.uk/tol/business/.../article5332752.ece |
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