Lehman bailout by U.S. deemed unlikely
The stage was set Friday for America’s rattled financial system to face a possibility that Washington has so far sought to avoid: that one of the nation’s big investment houses would collapse without government aid to soften the blow.
Attempting to draw a line less than a week after the massive federal bailout of mortgage titans Fannie Mae and Freddie Mac, Treasury Secretary Henry M. Paulson Jr. and Federal Reserve Chairman Ben S. Bernanke have told executives and potential purchasers of Lehman Bros. Holdings Inc. that the government has no intention of using public funds or guarantees to pave the way for the troubled firm’s sale, according to people acquainted with the two men’s thinking.
By late Friday, new troubles loomed when it appeared that other financial giants -- including securities firm Merrill Lynch & Co. and insurance giant American International Group Inc. -- might fall prey to the same collapsing real estate market that has upended Lehman.
Representatives of about a dozen major financial firms were meeting Friday evening at the Federal Reserve Bank of New York to discuss the Lehman crisis. Government officials at the session included Paulson, New York Federal Reserve President Timothy F. Geithner and Securities and Exchange Commission Chairman Christopher Cox, people familiar with the talks said. Bank of America Corp., a leading candidate to purchase some or all of Lehman, was also represented. No details about the meeting or its outcome could be learned.
The fate of the 158-year-old Lehman could prove to be a crucial stress test of the country’s financial system. If a buyer is found for the firm, the whole system might calm. If the effort fails, the result could be a deeper and wider crisis.
“The pall that would be created over the marketplace would be frightening,” said Michael Madden, managing partner at BlackEagle Partners, a New York private equity firm.
The risk is nonetheless worth running, influential voices said, in part because the government is already over-stretched by the steps it has taken recently to bolster the financial sector, and in part because Lehman is still thought to be sufficiently valuable that it should attract a suitor without financial sweeteners from the government.
“If the financial system is so fragile that Lehman could [cause it to crater], then something else is going to do it, so we might as well face the problem now,” said William Poole, former president of the St. Louis Federal Reserve Bank.
Since the housing bubble burst and the nation’s financial sector began springing leaks last year, the Fed has slashed its key short-term interest rate from 5.25% to 2%, expanded the circle of companies to which it makes loans to firms other than banks for the first time since the Great Depression, and orchestrated the sale of investment bank Bear Stearns Cos. by agreeing to assume nearly $30 billion worth of the firm’s troubled mortgage-backed securities.
Only last weekend, Treasury and government regulators in effect took control of Fannie Mae and Freddie Mac by promising to buy as much as $200 billion of a special stock in the congressionally chartered but shareholder-owned firms and to purchase an unspecified amount of the pair’s mortgage-backed securities.
Separately, Congress and the nation’s Big Three automakers are hammering out what could ultimately be a $50-billion package of loans and loan guarantees aimed at helping the companies produce new fuel-efficient cars and rebound from their problems.
While ruling out public aid for Lehman, government officials remained deeply involved Friday in trying to orchestrate a speedy sale of the firm.
Among areas where the government might help: not rigidly enforcing disclosure rules that would apply to private equity firms interested in purchasing part or all of Lehman, and not requiring buyers to immediately write down the value of the Lehman assets they’d acquire.
Lehman executives reportedly have told the company’s 24,000 employees to be ready for news of a deal Sunday night in advance of the Monday opening of Asian financial markets. But given Lehman’s troubles, a deal remains far from certain and bargaining could slip into next week, people familiar with the talks said.
Lehman isn’t at immediate risk of bankruptcy because of its ability to borrow from the Fed, but without a quick sale the company’s clients and trading partners are likely to flee the firm, leaving it financially beached.
Paulson and Bernanke decided against offering public funds or guarantees as part of a sale, according to people acquainted with their thinking, because the two concluded that there were big differences between Lehman’s situation and that of Bear Stearns. The March takeover of Bear Stearns was orchestrated and partially financed by the Fed.
According to these people, rumors about Lehman’s shaky condition have been swirling for at least six months, giving investors plenty of time to sell their stock or make other adjustments, while the extent of Bear’s problem came as an unexpected shock to the market.
In addition, Lehman has a fallback source of funds that Bear did not have: a Fed program established in the aftermath of Bear’s collapse to lend to major financial firms. As of last Wednesday, Lehman had no outstanding loans under that program.
Diane C. Swonk, chief economist of Chicago-based Mesirow Financial, said government officials were treating the two cases differently because they thought Lehman retained enough value that it could attract a buyer without help.
Swonk said that if the pair were not confident Lehman could be sold, “I think you’d get a very different response,” including the use of government funds.
By contrast, Poole, the former St. Louis Fed president, believes that the two officials have decided that their rescue efforts to date have failed to stabilize the financial system, so they must stop them.
“If you reinforce the Bear Stearns precedent, there will always be another case where the Fed will have to bail somebody out,” he said. The central bank “has got to get out of the business of bailouts, and the best time is right now.”
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walter.hamilton@latimes.com
Gosselin reported from Washington, and Hamilton from New York. Times staff writer Maura Reynolds contributed to this report.
