Monday, September 15, 2008

Lehman Brothers: Bounce too close to a supernova

I have nothing to say about Lehman itself, except to say that I really and truly believe they could have remained solvent in a more normal market. I'll also say I'm surprised no deal emerged as it seemed to me like there were enough parts worth buying. But deep down, I think Barclays in particular was scared that if they bought "Lehman" assets, the market would have seen it as nothing more than "Lehman" assets. In other words, Barclays might have gotten away with buying the same assets from someone else, but the very fact that they were Lehman's would create a special stain. What would then stop them from coming for Barclays? Ultimately, it was too risky.

On the market overall, it should be lower. Goldman and Morgan Stanley are going to have to merge with a bank. Period. Even if its a bank that's smaller (say a U.S. Bank), it will have to be done to diversify their funding sources.

This also pushes back any kind of recovery for the economy for a long time. I was thinking 3Q 2009, but now I'm thinking at least a year beyond that. I could be convinced to move off that either way by incoming delinquency figures, but for now I'm thinking year-end 2010 before any improvement in the economy.

So I've further reduced my credit underweight and increased Treasury exposure. The risk on Treasuries is the dollar. Most of the Treasury rally in September was dollar related up to today. For the moment we're getting a big rally on fear, which makes sense. But if the dollar starts to get pushed around, the Treasury market won't hold up.

Right now I'm willing to bet on Treasuries because I don't think Europe is any better off, and in fact I'd expect interest rate differentials to favor the U.S. on the margins (i.e., Europe will cut rates). But the situation is fluid enough to where I'm watching everything very closely.

This is truly uncharted territory.


PNL4LYFE said...

I heard Barclays dropped out because their UK regulator objected to the deal. And now there are headlines that are still interested even as the office is emptying out...

I feel awful for the guys losing 6 years of comp in restricted stock.

Unsympathetic said...

When you get a moment, I'm non-snarkily interested in your post on why this is a question of liquidity rather than a systemic solvency issue.

Over-leveraging on the way up and not deleveraging on the way down is the recipe for many a financial institution's death over the years.. I find it hard to believe that the panic of 1907 was purely a liquidity concern, for example.

I'd agree with you that the macro financial issue was liquidity if this wasn't combined with consumer credit collapse. We haven't even begun to experience the impending Alt-A and commercial RE defaults.

What will the world of finance look like in 3 years?

Accrued Interest said...


Clearly this isn't about pure liquidity, so don't get me wrong. Lehman had some stuff on their balance sheet that was, at best, difficult to value.

But I think in a different market environment, when conditions overall were better (liquidity as well as macro economics), someone would have wanted Lehman's valuable business lines, and would have been willing to take the risk on their risky stuff.

As it is, no one believed they could make the combination work.

PNL: I heard the same thing, I just think its red herring. I mean, its all speculation anyway...

Accrued Interest said...


Also, its impossible to separate illiquidity from solvency. Obviously illiquidity didn't appear for no reason.

PNL4LYFE said...

The liquidity vs solvency problems are not mutually exclusive. The argument in favor of providing liquidity through the PDCF, TSLF, etc is that a lack of liquidity can cause failure where solvency is not an issue. Certainly it's true that liquidity will not save an insolvent institution, but lack of liquidity causes asset sales at non-economic prices which exacerabates the problem.

BM said...


I agree with overweight to Treasuries, but with breakevens so historically low TIPS are the better bet. Five year breakevens are just 1.2%.

cap vandal said...

Lehman is still selling Neuberger :

and their broker/dealer

Barklay's is interested in the broker/dealer and now it is potentially available without the bad holding company assets.

This is unprecedented, so no one knows exactly how it would work.

LEH equity is wiped out, and all its bonds are at risk, but I am trying to figure out why this will necessarily be a crisis.

People wanted Lehman with a fed backstop on the bad real estate assets. Now they can buy the pieces.

As far as the liquidity vs solvency, it seems like the issue was the impossibility of valuing the real estate. They already took one haircut and would have negative equity if they wrote it down to zero. I think it could have been sold if there had been a solid number. Any government backstop would have a big haircut on the assets factored in.

Obviously financial firms are a mess in BK, but sell the pieces vs sell the whole thing?

Plus, it is chapter 11 and they don't have to just dump all the dodgy assets on the market at once.

Plus all the derivative guys had 6 months to make sure their exposures netted out or that they had adequate collateral. I don't like the idea that the credit default swaps with huge notional amounts are *not* adding systemic risk, but we still have a fear of a meltdown if one of the players fails. If the system is that fragile, then it may as well blow up now as the next time a firm gets in trouble.

Sorry if this is too rambling or naive, but I am not getting why this has to have huge economic impacts outside of LEH equity and debt holders.

Michael Krause said...

With AIG looking on its way out, doesn't it appear that AIG + LEH's around 2T of assets coming for sale eventually is going to have a huge impact on anything corporate negatively to the point where it will make treasuries look unattractive as well?

With 30 yr t-bond at 3.92, I'm sure we'll start seeing triple A 350-500+ bp above treasuries in the coming months... Maybe I'm wrong, but is there enough capital out there to suck trillions of assets for sale *without* these spreads blowing out?

DAB said...

Looking from a distance the last few months, it has looked pretty clear that Wall Street really wasn't too interested in whether Lehman survived. I think Lehman has been the tree preventing people from seeing the forest (with Merrill possibly being a bigger tree). The forest is that the government has established Lehman is not too big to fail. The feds have also pretty well established that they aren't bailing out AIG. So, if you write them off, and just write off WaMu to get them out of the discussion, is there a next out there? Wachovia, the previously thought to be strong regionals such as PNC?

I disagree on Goldman. For some reason, corporations like to hire them for strategy. They have enough lines of business like that, and with littler competition, that I don't see why they can't stay independent. I chalk up todays news on them as with mark to market accounting, if you want to take a big bath, particularly when there is already blood in the water, why not?

Accrued Interest said...

As far as assets blowing out wider... I agree totally. No way it doesn't blow out wider. We'll get through it eventually, but things are going to remain very bad for a while now...

Goldman and Morgan Stanley need to find partners, and need to do it fast. If they can find those partners, then they will be the winners here. Because there will be such a thing as a brokerage business. Hell, maybe Barclays emerges a winner for buying Lehman's B/D ultra cheap.

If MS and GS don't find partners, I think they wind up losers here.

Dave Wright said...

What is going on with the unwinding of the LEH contracts in the CDS market? Any updates from the front lines?

That seems to be the big story that is not getting very much coverage at all.

Wells Fargo already came clean on some of their LEH exposure (non-CDS). But that was probably because they didn't have very much.

I think the long end of the curve will have to move dramatically higher when all this starts to sink in. Thinking about shorting the long end via some ETFs when sentiment shifts.

cap vandal said...

I have to say that I am still in shock that AIG is tanking. It looks like LEH is getting carved up and Barklay's is getting what it wants at an attractive price.

All of AIG's insurance except their small mortgage unit are solvent, functioning entities and could be sold for more then book value. The insurance won't be liquidated, so their assets and liabilities just move to new owners. This is a huge part of their balance sheet.

Unlike banking which repealed Glass-Steagall, insurance still has legacy regulation and the insurance company blance sheets are strictly segregated from the holding company. Hence the idea floated to allow the company to move around assets to help with their liquidity issues.

Paulson et all are already calling for unified Federal regulation, whereas the only thing between widows and orphans and their annuities are the state regulators.

The insurance portion should have no effect on the real economy. They will just have different owners.

I am assuming that Paulson has determined that the total capital of AIG is enough to prevent too much (if any) damage to the counter party of the credit guarantees.

This will suck some liquidity out of the system, but I suppose not as much as liquidating a trillion dollar balance sheet would imply.

I suppose Paulson just asked the US banks if they would be better off loaning AIG money or possibly taking a hit on credit guarantees. A lot of the exposure is to european banks, so the banks decided they would be better off to just let it go.

AIG also didn't get as large as it is by making a lot of friends on the way up.

I can't really see a bailout because management and equity is gone either way.

Meanwhile, letting LEH and AIG fail without a meltdown will be perceived as a victory for the system. Never mind all the behind the scenes Fed activities, liquidity facilities, etc.

Keith said...

Besides the price, what is up with 3mo treasuries. I saw it at less than a tenth-of-a-percent today!

Dave Wright said...

Everybody and their brother who has a clue is moving their reserves into short term Treasuries. This is due to the Reserve Primary Money Market fund "breaking the buck" yesterday.

That's why the short end is so low. It's also blowing out the TED spread to over 3, which is pretty unprecedented.

Still think the long end is going to see a prolonged move up when people realize what this means for the US Sovereign debt. It may take a while to begin, but once it starts...

Keith said...

Why no love for agency, especially as an alternative to trading treasury at negative yield (as some have done).

Michael Krause said...

Long treasury buyers still in denial... actually any treasury buyers (across the curve) aren't thinking, just buying.

Unknown said...

Lehman Brothers Investment Management Director George Herbert Walker IV, second cousin to U. S. President George Walker Bush, dismissed the proposal, going so far as to actually apologize to other members of the Lehman Brothers executive committee for the idea of bonus reduction having been suggested.


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