Wall Street on alert: Lehman endgame
By David Ellis, CNNMoney.com staff writer
Last Updated: September 14, 2008: 11:56 PM EDT
NEW YORK (CNNMoney.com) -- Wall Street remained on alert late Sunday as hopes for a buyout of beleaguered Lehman Brothers faded and following extensive efforts by both executives and regulators to stave off a broader financial crisis.
As the weekend drew to a close, the Federal Reserve announced plans to expand its lending to the banking industry in an effort to calm the markets. In addition, a consortium of 10 top domestic and foreign banks agreed to create a $70 billion fund that would serve as a lifeline for troubled financial firms.
The fate of Lehman, following weeks of speculation about its health, appeared grim after Bank of America (BAC, Fortune 500) and British bank Barclays (BCS), both viewed as potential "white knights," pulled out of deal talks as of Sunday afternoon, according to sources.
A Lehman executive, who declined to be identified, told Fortune "this looks like the end."
Instead, Bank of America was reportedly in merger talks with Merrill Lynch (MER, Fortune 500), according to news reports. Both the Wall Street Journal and the New York Times reported that a deal, which could be worth about $40 billion, could come as early as Sunday night.
Hours before Bank of America pulled out, Barclays had abandoned talks to buy Lehman (LEH, Fortune 500), a source close to the situation told CNNMoney.com.
Top Wall Street officials and federal regulators, who began meeting Friday, spent much of their Sunday at the Federal Reserve Bank of New York in the hopes of devising a plan to save Lehman and allay fears that threatened to roil U.S. financial markets Monday.
Meanwhile, broader efforts to tackle problems plaguing the entire industry are underway.
The Federal Reserve announced a series of steps to support the financial markets. The Fed said it would expand its short-term lending to banks by starting to take all investment-grade debt as collateral - instead of just Treasurys and other high-grade securities.
"The steps we are announcing today, along with significant commitments from the private sector, are intended to mitigate the potential risks and disruptions to markets," said Fed Chairman Ben Bernanke.
Similarly, a group of 10 commercial and investment banks including, among others, Goldman Sachs (GS, Fortune 500), Citigroup, Barclays and Morgan Stanley, agreed to pony up $7 billion each to create a $70 billion lending facility that institutions facing liquidity issues could tap.
The measure would also help resolve exposure between Lehman Brothers and its counterparties, the companies said.
Treasury Secretary Henry Paulson, who has led efforts to help get the U.S. housing market and the broader economy back on track, applauded the plan and steps taken by regulators.
"These initiatives will be critical to facilitating liquid, smooth functioning markets, and addressing potential concerns in the credit markets," Paulson said in a statement.
Yet the last-minute efforts provided little comfort to financial markets around the globe. As of Sunday evening, U.S. markets were headed for a steep selloff at the start of Monday's session.
Futures in the Dow Jones industrial average, as well as the broader Nasdaq composite and the Standard & Poor's 500 were as much as 3% lower, before paring some of their losses.
Investors already started piling into safe-haven Treasuries as the yield on the benchmark 10-year note dipped to 3.565% from 3.72% late Friday.
That nervousness also spread to the currency markets as the dollar eased against both the euro and the yen.
Adding to those concerns was news that insurance giant AIG (AIG, Fortune 500) planned to unveil a restructuring plan that will include the sale of part of its business to raise cash and boost investors' confidence, according to a published report.
Investors are also likely to await more data about troubled savings and loan Washington Mutual (WM, Fortune 500), which sought to provide assurance about capital levels on Thursday.
What could help temper a market selloff is the widely-anticipated Bank of America-Merrill deal, said one expert.
"This sort of offsets the Lehman thing," said Dan Alpert, managing director of the boutique New York City-based investment bank Westwood Capital. "But the reality is that it is just a short-term impact."
Lehman dark and light
Still, much of the market's focus ahead of Monday was on the endgame for Lehman. The hope is that some solution can be agreed upon by early Monday morning in the U.S. - before financial markets open in Europe. Most Asian markets are closed for a holiday Monday.
But the abandonment of Barclays and Bank of America left a Lehman Brothers bankruptcy a very real threat. As of Sunday evening, the Wall Street firm was reportedly on the verge of filing for protection.
Separately, the International Swaps and Derivatives Association staged a special trading session so that big brokers could limit their Lehman Brothers risks.
The session was called "to reduce risk associated with a potential Lehman Brothers Holding Inc. bankruptcy," according to a statement on the ISDA's Web site.
Lehman - one of the nation's largest and oldest investment banks - has suffered a dramatic and rapid descent. Its shares, which sold for as much as $67 in the past 12 months, have plummeted 94% this year and now trade at $3.65.
In the past six months, the company has reported $6.7 billion in losses due largely to bad bets on real estate. At the same time, concern is growing about problems throughout the financial sector.
Race against the clock
A source with knowledge of this weekend's meetings told CNN that representatives of several major financial institutions met with Paulson, Securities and Exchange Commission Chairman Christopher Cox and New York Federal Reserve Bank President Timothy Geithner to discuss Lehman and the volatile state of the financial markets.
On Saturday, several heads of big Wall Street banks, including Merrill Lynch CEO John Thain, were seen entering and leaving the offices of The Federal Reserve Bank of New York.
According to several reports, other financial firms were said to be reluctant to contributing their own funds to help keep Lehman's more toxic assets afloat without the assurance that the government would backstop Lehman's bad loans.
However, a source close to the situation told CNN Friday that the Treasury Department was adamantly against using any government money to help finance a takeover, restructuring or bailout of Lehman.
Top banking regulators, including the Federal Reserve, faced heavy criticism from lawmakers following the bailout of Bear Stearns in mid-March.
The Fed helped engineer a fire sale of the firm to JPMorgan Chase (JPM, Fortune 500), agreeing to put taxpayer funds at risk by guaranteeing $29 billion's worth of potential losses on Bear Stearns' portfolio.
A chaotic week for Lehman and Wall Street
The talks continued after what has been one of the most tumultuous weeks ever on Wall Street.
Things first started to unravel at Lehman Tuesday following reports that talks between the state-run Korea Development Bank, who was rumored to be interested in buying a stake in Lehman, had ended.
That, combined with the threat of a downgrade by some of the credit ratings agencies, led to a bloody sell-off in the firm's stock.
Hoping to finally put all the rumors to rest, the company released its third-quarter results more than a week in advance on Wednesday, booking a nearly $4 billion loss and announcing a drastic restructuring plan. Investors were unconvinced though and the sell-off in Lehman shares continued, with the stock plunging 42% on Wednesday.
By Thursday evening, it was widely reported that Lehman was actively seeking a buyer for the entire firm. The company reportedly reached out to a number of suitors, including Bank of America and Barclays.
Speculation also surfaced Friday that J.C. Flowers & Co. and other private equity firms may bid for all or parts of Lehman. Current regulatory restrictions prevent buyout firms from owning a bank outright, although the Federal Reserve has eyed loosening those restrictions as bank failures pile up.
But as Friday wore on without any news of a deal, Lehman's stock wound up falling another 13.5%. Shares plunged 77% over the course of the week, setting the stage for regulators to call upon banking executives to get together Friday night and begin talking about ways to hash out an end to the Lehman crisis.
End of an era for Wall Street icon
If Lehman is sold or broken up, it would mark the end for one of Wall Street's oldest and most well-known firms. Getting its start as a modest cotton-trading firm in Montgomery, Ala., in 1850 by German immigrant brothers Henry, Emanuel and Mayer Lehman, the firm saw its fortunes rose and fell along with the rest of Wall Street.
After World War II, Lehman's profile grew as it advised such household American companies as Ford, Campbell Soup and Philip Morris on deals, before expanding overseas into Europe and Asia in the 1960s and 1970s.
The firm also became a breeding ground for high-profile dealmakers. Both Steve Schwarzman and Pete Peterson, co-founders of the private equity giant Blackstone Group, worked for Lehman in the early 1980s.
But Lehman's rise was cut short in April of 1984, when the company agreed to be purchased by Shearson/American Express for $360 million. The company emerged independent just seven years later, albeit in much weaker shape than it was before.
It was around that time, however, that CEO Richard Fuld Jr., assumed the helm at Lehman and the firm went public after splitting off from American Express.
Known for his direct approach and staunch loyalty to the firm, Fuld transformed Lehman in the decade that followed from a lowly bond trading house into a worthy adversary of larger investment banks Goldman Sachs and Morgan Stanley.
Still there were bumps along the way for the long-time Lehman chief, including the Russian credit crisis and the painful collapse of the hedge fund Long-Term Capital Management in the late 1990s.
Fuld was quick to remind investors of those painful days and subsequent comeback during a conference call Wednesday, just after the company revealed its nearly $4 billion third-quarter loss.
"This firm has a history based on adversity and delivering," said Fuld. "We have a long track record of pulling together when times are tough."
But the obstacles Lehman faced this time around may prove too tough for Fuld to overcome.
