Lehman Brothers Holdings, looking to raise cash, packaged $2.8 billion of unsold loans into bonds, then used some of the securities as collateral to borrow from the Federal Reserve, people familiar with the deal said Friday.
Lehman transferred loans that included some risky leveraged buyout debt into a new investment entity called Freedom, which then issued securities, about $2.26 billion of which were rated investment-grade, they said.
The bank used a relatively small amount of those securities as collateral for a low-interest, short-term cash loan from the Federal Reserve.
The move should give Lehman more money to finance its activities but also raises questions about the quality of the collateral the Federal Reserve is receiving from dealers to which it lends money.
"There's a significant hazard to the Federal Reserve taking poor assets onto its balance sheet," said James Ellman, president of hedge fund Seacliff Capital in San Francisco.
At this point, it's not clear how many of the Fed's loans to investment banks have been collateralized by assets like subprime mortgage bonds or loans used to finance leveraged buyouts.
But if the perception arose that the Federal Reserve's balance sheet featured too many bad assets, the dollar could weaken.
And banks might be emboldened to take more risks if they believed the Fed would bail them out.