'Growing sense of gloom' in Lehman rescue talks

It’s looking like a second straight weekend of no Sunday football-watching for Wall Street or Washington.

Federal regulators and Wall Street executives finished meeting today without hammering out a plan to either sell crumbling Lehman Bros. Holdings Inc. to a bigger financial institution or to foster the orderly liquidation of the 158-year-old investment bank.

The Wall Street Journal’s website reported shortly before 4 p.m. PDT that the talks had ended for the day, and would restart on Sunday: "A sense of optimism that a rescue could be arranged today dimmed as a growing sense of gloom descended on Wall Street," the Journal said.

A major sticking point continues to be that other investment banks want the government to provide a backstop for Lehman’s troubled real estate assets, so that the banks don’t have to absorb the full hit if they step in to rescue the firm.

From the Journal:

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.

Many banks are worried about shoring up their own balance sheets as defaults on real estate loans continue to rise, and so want the government to guarantee that a Lehman bad bank wouldn’t become a black hole for the rescuers.

But the Treasury and the Federal Reserve have said they won’t provide government aid for a Lehman deal. The government is drawing a line in the sand after committing up to $200 billion last weekend to keep mortgage giants Fannie Mae and Freddie Mac solvent.

If no agreement on a good bank/bad bank arrangement can be reached, Lehman could have to be liquidated beginning on Monday. That was the subject of a second meeting at the Fed’s New York branch, the Journal said:

On Saturday afternoon, the credit-trading heads of major investment banks gathered at the meeting to discuss how to deal with their exposures to Lehman in the intertwined credit-default-swap market. The lack of a central clearinghouse in this market means that dealers, hedge funds and others are directly facing each other in insurance-like contracts that are tied to trillions of dollars in debt instruments. Credit derivative traders at some firms were asked to come to work over the weekend to help quantify their exposures to Lehman and compile lists of outstanding contracts they have with the investment bank.

The potential for a cataclysm in the giant derivatives market has long been a major concern on Wall Street, and has been one key element over the years in the argument that some financial firms were "too big to fail," as I note in my column this weekend in the Times. (Read it here.)

Lehman is looking like it's going to be the biggest test case yet for dealing with a monumental disruption in derivatives trading.

Comments

[Aviv Shahar]

Yellowstone Fire On Wall street
On August 20, 1988, a day now referred to as “Black Saturday”, gigantic firestorms in Yellowstone sent flames as high as 200 feet into the air. These fires grew so large that they created their own wind. Smoke plumes pushed up to 30,000 feet. Many people, including leading ecologists thought that Yellowstone would never recover or that it would take hundreds of years for its fauna and flora to populate the park again. Here is what scientists learned and what it can teach us about the deleveraging fire storm on Wall Street.
1. Expect a lot more pain as a result of the great deleveraging of Wall Street – The Yellowstone fire burned more than half the total acreage of the park. 793,000 acres were affected by fire and bout 300 large mammals perished.
2. The Treasury efforts to contain the crisis will help some come out better but it’s overall impact will be limited - The 1988 firefighting efforts included 25,000 people, the largest in U.S. history. 120 million dollars were spent. This huge effort saved human life and property, but had little impact on the fire itself.
3. The natural cycle of deleveraging will run its natural course - The advance of the 1988 fire was finally stopped in September by rain and snow.
4. An amazing new cycle of innovation and opportunities will be unleashed - The Yellowstone fires created a mosaic of burned and unburned areas that provided new habitats for plants and animals and new realms for research.
5. When the deleveraging cycle has finally run its course and everybody is exhausted and depressed, recovery will be faster and stronger than anyone imagines – In Yellowstone Park, seeds released from pinecones took root almost immediately. Lodgepole pine seedlings began to grow at the rate of an inch or two per year. Wildflowers were abundant by the following spring, and the grasses and shrubs were green and flourishing.
6. Certain sectors and businesses will benefit from the deleveraging cycle and will come out on top – In Yellowstone some of the grasses that the elk needs were more nutritious after the fire. Bears grazed more frequently in burned sites than they did in unburned sites. The fires have had no observable impact on the number of grizzly bears in greater Yellowstone. Cavity-nesting birds, such as bluebirds, had more dead trees for their nests. Nutrients from the ash caused the vegetation to prosper and grasslands returned to pre-fire appearance within a few years. Aspen reproduction has increased because fire stimulated the growth of suckers from the aspen’s underground root system and left behind bare mineral soil that provided good conditions for aspen seedlings.
7. A major economical shift takes place every 60 to 80 years. Active earning and investing life spans usually average some 40 years. One and a half to twice this duration is enough to eradicate institutional memory. That’s when the system snaps and the rules of the game shift. This is part of the cycle of life – In Yellowstone, the fires turned out to be a necessary and beneficial part of the natural cycle of life, death, and re-birth.

www.avivconsulting.com Aviv

[thowze]

Guess time will tell. I think it is amazing that Paulson is asking the same players that he rode about shoring up their capital reserves to take part of their money and contribute to holding up Lehman. With the Credit Derivative situation spread out among many banks, insurance firms, savings and loans plus other non banking institutions, this "blow up" will end up taking place either through Lehman or someone else.

The Bank of International Settlement had estimates for derivative holdings for banks at $683 trillion worldwide. An estimate including non-banking firms to the mix increases the number to $1.4 quadrillion dollars. This market was not regulated and allowed to grow uncontrolled for years. It is a situation that the Fed cannot print their way out of. So unless the geniuses who created these bombs come up with a way of diffusing them, fasten your seatbelts because it's gonna be a bumpy ride!

[Robert in Pasadena]

A heaping serving of Shadenfreude for Wall Street! Once again the elite vultures have succeeded in destruction on a massive scale! How they could have the nerve to foist McCain/Palin on the ever suffering masses in this country beggars the imagination! I much prefer the other half of the 'party' that rules our empire -- you know, that guy from Chicago! (This is the real reason this country is headed to hell -- for the last several decades (if not longer) there has been only one party -- the Greed Party!) Maybe if the pain is great enough the people of this country will end their anesthetized trance! Maybe the elite suspected they might and in preparation built a lot of secret prisons! Where's the exit?

[Robert in Pasadena]

Please Mr. Shahar! This is not a natural disaster -- it is not a fire or storm! This was planned! By people! In the government and in corporate board rooms and elsewhere! It is the fulfillment of conservative ideology -- 'voodoo economics' -- to destroy the federal government and liberate capitalism from regulation! How many more bailouts before the Fed is insolvent? I am guessing we are already there -- that is why no bailout for Lehman Bros.!

[Jason]

If published reports about Uncle Sam refusing to assume any of LEH's portfolio risk are true, than I consider this a very promising chapter in the credit markets deterioration of the last year. I can't help but wonder what if the Treasury and the Fed had the courage to not backstop Bear Stearns' toxic portfolio? Sure it would've been messy, ugly, maybe even scary. But the healing process portrayed in Aviv's post might be occurring already.

Another tidbit to be gleaned by this weekend's event is this -- If the Treasury isn't willing to help out LEH, then there's no way I see them helping out Washington Mutual. Let the sell-off and capital impairment continue. Although politically unpalatable, economically, it's quite healthy and thoroughly justified. I'm sure we all recall the panic and despair during and immediately after the S&L crises. That of course was followed by a vigorous and long term economic expansion.

Regards

[David Schwartz]

What is this Communism? Where do I stand in line for free bail out money? This is outrageous! the onse getting the bail out are the ones that had been screwing clients out of millions for two decades and now getting a helping hand. I lost two major projects worth 1 Million last year and this and I have not received a single call to help me and my family out. The housing crisis was coming and everybody knew it. We have thieves running our financial institutions and all they get is a slap on a wrist or may be a couple year in a country club. On the other hand the American dream is being stolen by the likes of Mozillo and others who should be tried as criminals yet they are free and living like kings.

WAKE UP AMERICA! THIS IS OUR COUNTRY NOT THE GOVERNMENTS.IT'S IN OUR CONSTITUTION, BUT HURRY BEFORE THEY BURN IT AND REWRITE IT FOR US!