From now on, this blog will be devoted entirely to answering questions from Bryan from Houston. The latest:
If the FNM/FRE deal was so successful, what is happening to Lehman? Further, who else is at risk still?
To me, this financial kryptonite hardly seems contained and the super powers of the Fed and Treasury seems rather impotent right now.
What’s happening to Lehman is the same thing that happened to Fannie and Freddie, and IndyMac: Their assets (real estate-related assets in particular) are worth whole lot less than they seemed to be a year or six months ago. And when that happens at a financial institution that’s relatively small (Lehman) or heavily concentrated in the particular sector that has gone bust (Frannie, IndyMac), and/or skimpily capitalized (Frannie), people start wondering about the continued solvency of the institution.
The view from my office of Lehman HQ
Lehman has been working pretty aggressively to address these solvency concerns by raising new money from investors back in June and selling off assets now. Thanks to that and the fact that the Fed now lends money to investment banks, I don’t get the sense that it’s in immediate danger of a Bear-style run on the bank (not that I would know if it were). But investors aren’t very impressed with its future earnings prospects, and the regulators appear to be looking for ways (thanks, Felix) not to bail it out if it did come to that. “You need a way to let big financial institutions, whether they’re depositary institutions or not, fail,” Hank Paulson told me a couple months ago. “Because you need that market discipline.”
Who else is at risk? Well, the one everyone has been talking about is Washington Mutual, which is down another 25% so far this morning (Lehman stock is up slightly after its earnings report and conference call). I have no idea if WaMu is actually at big risk of failure, but I figure there the government would also just let that happen–that is, let the FDIC take over and bail out insured depositors while letting other creditors squirm. This might wipe out the $45 billion FDIC insurance fund, but my old friend Bert Ely just reminded me that the fund is an accounting fiction and the loss would be made up by charging banks higher insurance fees over the coming years.
“It becomes an issue only if the banking industry can’t pay the bill,” Ely said. Ely has studied the banks that have failed so far and is convinced that they were all especially risky outliers. If he’s wrong, and people start worrying seriously about the solvency of Citi, BofA, Goldman and Morgan Stanley, then maybe we get a Sweden-style government takeover of almost the entire financial industry, with a price tag in the hundreds and hundreds of billions (at least). But we’re not there yet.