Farrell: Parsing the Faltering Financials as the Week Begins
Chief Investment Officer, Soleil Securities
Some preliminary thoughts on the Lehman/AIG/financial crisis we'll discuss on the show tonight(8 p.m. ET Sunday, Sept. 14):
1) Bear Stearns failed because it didn't have enough liquidity to conduct its daily business. They had more in overnight loans (repos) than they had in cash on hand by about 4 to 1. When the loans were not renewed, their fate was sealed. Lehman has a far more liquid balance sheet and access to the Fed's borrowing window as well. What Lehman has is a balance sheet full of impaired assets and if their credit rating is lowered, they will have to post more collateral to support the trades/debt they have outstanding. Their issue is lack of capital. If we weren't in such a panic mode, they should be able to conduct daily business. But we are moving at internet speed and while counterparties to Lehman business stood ready to do transact business last week they could easily disappear this week.
The best solution would be a merger of Lehman into a sounder organization. As of this moment (early Sunday evening) that doesn't appear to be happening. The second idea would be for a split of Lehman to good bank/bad bank, with Wall Street being forced by the government to pony up capital to support the bad bank. Lehman's remaining capital would have to go in large measure to this bad bank and the common shareholder would be left with precious little. But the market has been saying that for weeks now as is evidenced by the collapse of the stock. The big issue as well is that Wall Street is capital constrained to say the least. Hello Private Equity firms ! They have got to be there with low ball bids looking to pick at the bones.
What would be left would be liquidation and I believe if the government stands by its statements last week to not come to the rescue, Wall Street will figure this out. Survival is a powerful motivator.
2) AIG , being an insurance company, won't suffer a Bear type run on the bank. They have a capital question (not a near term liquidity issue) but where Lehman needs outside capital to support its $600 billion in balance sheet assets, AIG has life insurance companies, property and casualty insurance companies both domestic and international, a consumer lending unit, a mortgage insurance unit, and the worlds premier aircraft leasing unit. Any or all could be sold or pledged. Not an easy task, but doable.
3) Rumor has it that Bank of America and Merrill Lynch are going to merge. It will probably be more a take-under than take-over, but this one makes sense and would go a long way to ease the panic mode on Wall Street.
4) The big unknown is the state of the interconnected credit default swap market. If Lehman is forced into bankruptcy, what are their credit default obligations, with whom, how much, how many and what are the implications. This is the argument for a government backed rescue. The unknown is always scary.