As of Saturday evening, Lehman's fate has yet to be determined. There are several options on the table, and an outright sale to Bank of America or Barclays seems less likely than it did yesterday afternoon. A "Good Bank / Bad Bank" plan is now said to be the leading solution. It has some serious flaws, however.
The heads of the five families met again today at the New York Fed to try to craft a solution. The combination of self-interest and widespread financial weakness across the industry has gotten in the way, but they'll be back at it tomorrow.
The options:
- "Good bank, bad bank." The leading plan. Barclays buys Lehman's equity business, other Wall Street firms inject some $30 billion into a "bad bank" containing $85 billion in assets. Main problem is that other banks can't afford to do this. (See full description below).
- Outright sale. Looking less likely because buyers don't want to assume balance sheet risk and government not stepping up (which it shouldn't)
- Chop up, sell for scrap. More likely, but begs question who will take the balance sheet crap. (Or will it just be dumped on market, clobbering asset prices even more?).
- Orderly wind-down. Same problem of asset sales, though if they're fed onto the market slowly, the impact might be less severe.
- Capital injection from rest of Wall Street, at least into the "bad bank". Wall Street doesn't have the capital to spare.
- Bankruptcy. Would lead to orderly wind-down scenario above, but could happen at slow pace.
Specific issues:
- Bank of America, et al, don't want to buy Lehman without a Federal guarantee. Hank Paulson is still unwilling to provide one. This is understandable given that he gave Lehman seven months to get its act together (and it didn't), and Merrill, WaMu, Wachovia, et al, are just behind Lehman in the potential bailout queue.
- Other Wall Street banks don't want to finance a "bad bank" spinout of Lehman's crap assets only to watch BOFA or Barclays run off with the good parts of the firm at a fire-sale price (and, besides, they don't have cash to spare).
- The fear of "winding down" Lehman is bad assets hitting the market all at once will knock prices down to extremely low levels and force other firms to take mark-to-market writedowns of their own real-estate junk (thus putting them in the same position Lehman is in.
Good Bank / Bad Bank description from NYT:
The leading proposal would divide Lehman into two entities, a “good bank” and a “bad bank.” Barclays of Britain would buy the parts of Lehman that have been performing well, while a group of 10 to 15 Wall Street companies would agree to absorb losses from the bank’s troubled assets, according to two people briefed on the proposal. Taxpayer money would not be included in such a deal, they said.
Under that plan, the Wall Street banks would agree to provide up to $30 billion of support to absorb the losses of the bad bank. That is roughly the same amount of money that the government agreed to commit to support JPMorgan Chase’s emergency takeover of Bear Stearns in March.
The assets of the bad bank would be sold over time as the market for mortgage-related assets recovers and buyers emerge. If the assets appreciate, the bank consortium would share in the profits. But they would also be responsible for any losses.
None of the banks involved, however, have committed to any rescue plan, and talks could still fall apart. The talks will take on even greater urgency on Sunday as government officials push for a deal before the Asian markets open on Monday morning.
More general coverage from the WSJ:
A sense of optimism that a rescue could be arranged today dimmed as a growing sense of gloom descended on Wall Street. Executives from top banks in the U.S. and Europe huddled with federal regulators in an attempt to come up with plans to either buy pieces of Lehman or prepare for an orderly winding down of the firm in a manner that would minimize the collateral damage for the ailing global financial system.
Under one plan, either Barclays PLC or Bank of America Corp. would buy Lehman's "good assets", such as its equities business, people familiar with the matter say. Lehman's more toxic, real-estate assets would be ring-fenced into a "bad" bank that would contain about $85 billion in souring assets. Other Wall Street firms would try to inject some capital into the bad bank to keep it afloat for a period of time so that a flood of bad assets don't deluge the market, damaging the value of similar assets held by other banks and insurers. The banks are also looking for the government to somehow financially backstop the bad bank.
The problem, though, is getting enough banks to back that plan. While teams of bankers are working through structures, it's clear that only a handful of banks are in a position to provide enough funding. Many banks are inclined to preserve capital ahead of third-quarter and year-end cash preservation moves. Also, banks aren't keen to see a big rival such as Barclays or Bank of America walk away with valuable assets by only paying a pittance.
As of Saturday afternoon, Barclays, the U.K.'s third-largest bank in terms of market value, appeared to have more interest in pulling off a deal for Lehman's good assets. At about 3 p.m. on Saturday, Barclays President Robert E. Diamond Jr. was seen entering the New York Fed's employee entrance on Maiden Lane, carrying a briefcase.
Bank of America, an obvious buyer, appeared to be cooling toward a deal, people familiar with the matter. Of course, some of this could be the posturing that happens in any auction. Neither Barclays nor Bank of America wants to buy all of Lehman without some government assistance, and so far the government has been reluctant to do so.
See Also: LEHMAN DEATH THROES (Complete)
