CNBC: Lehman Bad Bank Deal Drafted; Firms Expected to Kick in $3 Billion Each

A few hours ago, we went over the most recent report on the Lehman talks sponsored by the Fed (the Wall Street Journal had a remarkably detailed account), and it seemed as if the obstacles to getting a deal done were considerable. Although there was discussion of forming a “good bank/bad ban” structure, it sounded unlikely to fly. One of the suitors, meaning Barclays or Bank of America, winds up with the good part, and the Wall Street firms (which may include BofA0 pony up some equity to capitalize the bank bank.

One didn’t have to read much into the Journal story to see the idea faces obstacles that may prove insurmountable.

The problem, though, is getting enough banks to back that plan. While teams of bankers are working through structures, it’s clear that only a handful of banks are in a position to provide enough funding. Many banks are inclined to preserve capital ahead of third-quarter and year-end cash preservation moves. Also, banks aren’t keen to see a big rival such as Barclays or Bank of America walk away with valuable assets by only paying a pittance.

Yet that idea is going forward, at least as CNBC tells it. However, this may be a matter of form, to present the assembled bankers with more fleshed-out versions of their options as a preliminary to trying to force a resolution.

From CNBC:

A deal has been drafted to buy Lehman Brothers’ bad assets and clear the way for an eventual sale of the troubled firm….

Under the terms of the proposal, which could still blow up, all the major Wall Street firms would pitch in $30 billion total to purchase Lehman’s bad real estate assets and create what’s knows as a “bad bank.”

The proposal is being drafted Saturday night and will be discussed Sunday morning, according to sources close to CNBC. If Wall Street agrees on the terms, which would amount to around $3 billion per firm, it would clear the way for the sale of Lehman Brothers itself to one of several suitors, including Bank of America, Barclays Plc and HSBC.

Executives remained less than pleased with the proposal as they left the New York Federal Reserve around 6 p.m. to convene again Sunday morning….

“Why should we give up capital so Barclays and Bank of America can buy a clean bank,” said one Wall Street executive.

Despite the grumbling, those in the know expect the deal to get done Sunday….

One Wall Street executive involved in the meetings put it this way: “I’m thinking logically; if they do nothing it’s Armageddon. That means they do a deal. It will be announced at 6 p.m. (ET) Sunday.”….

But with firms like Bank of America and Barclays refusing — at least so far — to budge on their position that they will only buy Lehman without the beaten down real estate assets, and the street balking on the government plan, which calls on the big firms to chip in a total of around $3 billion to purchase the Lehman assets, people with direct knowledge of the meeting say a deal may not get done.

The complicating factor here is that the participation of all (presumably ten) banks is crucial. In the LTCM rescue, the number of firms involved was much larger (my recollection is 24), so the defection of one would not greatly increase the burden on the rest. Even so, Bear Stearn’s refusal to participate was widely resented and many believe it contributed to the firm’s failure. Here, one holdout could produce a deadlock.

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16 comments

  1. doc holiday

    Synthetic rescue versus the reality of armageddon?

    This race, conditioned on duress, conditioned by a state of chaos, is a race to manipulate some unknown outcome in casinos generally located near Japan. What exactly is being prevented or preserved, and what action has to be forced into another exercise of extortion and blackmail? Is there something the market in japan represents other than it being a symbolic casino that manages speculation for people that make bets? Is Japan just a way to set the clock and buy more time for fraud, or is there a reason that we have weekend panic attacks from our government, which now runs predictably low on adrenaline injections and thus seems to be incapable of sustainable planning for the future. This looks more like attention deficit disease, along with drug addiction, and at the very least, this looks like pathetic gambling addiction and misappropriation of funds and malfeasance (for starters). Is it any wonder that all future value from this mess decreases every time these bafoons make another move?

    The most sickening aspect of this destruction is the corporate denial and oblivious nature as to why this is happening or why they are involved in this catastrophe which is based entirely on their greed. This is like watching a bunch of drug addicts pick through the garbage for used needles, while the police drive by and ignore the depravity-like cancer that is beyond their control and so obvious as to be beyond salvation. These meth addicts, called corporate bankers are as self-serving as any drug lord that uses power to abuse law, power to make the next bigger deals — these financial meth dealers have nothing in mind besides the next round of option grants and bonuses which they will kill to get!

    This is not a rescue in any realistic form, it is armageddon in motion!

  2. Jojo

    It does not matter what we, the people, think anymore. Our representative form of government is giving us the representation we deserve.

  3. bg

    “If you stay in Galveston you face certain death’.

    “If they do nothing its Armageddon”

    I don’t know what to think, and increasingly I don’t think ‘they’ know either.

  4. bg

    I know I am over my post limit (1 per 10) but I couldn’t sleep trying to think through this thing.

    $3B/bank. In LTCM the amounts were not equal. So I would assume GS would be $5B, and Merrill would have to put in a little for show (for example). What then with AIG, WM and Merrill. Is that another $5B x 3? What if the net value of the industry is negative? Won’t each see this as simply accelerating their demise?

    For these banks I think it is heads you lose and tails you lose. They should call Treasuries bluff and find out if the political cost of a bailout is really as high as the political cost of accelerated asset depreciation.

    Maybe I can sleep now.

  5. Matt Dubuque

    I’m under my limit. 1 in 10.

    These negotiations are a textbook case of The Prisoner’s Dilemma from Morgenstern’s game theory, kind of an arcane branch of mathematics. Fortunately Axelrod (from Harvard as I recall) managed to solve it a while back. It had been perplexing mathematicans for decades.

    In 1985 Gerald Corrigan, then head of the Federal Reserve Branch of New York, published a speech that shocked me to the core.

    That speech explored in considerable detail the scenario where SEVERAL major international banks would become BANKRUPT ON THE SAME DAY, due to settlement risk.

    In March of this year, I filmed a short video discussing how this critical paper from 1985 is directly applicable to our current crisis.

    My video discussion of this topic begins at 5:55 of the following video:

    http://tinyurl.com/6zrc9p

    NOTE: The video and audio quality is INTENTIONALLY substandard in order to insert very short excerpts into one of my films as time-worn archival “Forrest Gump” type footage.

    Several money center banks insolvent on the same day.

    This is the risk that these negotiations are trying to manage.

    Matt Dubuque

  6. Walker

    “If you stay in Galveston you face certain death’.

    “If they do nothing its Armageddon”

    I don’t know what to think, and increasingly I don’t think ‘they’ know either.

    This is the problem with doing anything preventive in this country. The majority is so mathematically illiterate that they have no understanding of the concept of risk. Everything is either 100% right or 100% wrong.

    The odds of the surge overcoming the sea wall were very, very good. Only a last minute shift and some weaking kept the surge down (and at another 4 feet it would have gone over). But luck is treated by the American people as “experts are completely wrong and the models are useless”.

    This is why nothing will ever be done until it is too late.

  7. Walker

    “If you stay in Galveston you face certain death’.

    “If they do nothing its Armageddon”

    I don’t know what to think, and increasingly I don’t think ‘they’ know either.

    This is the problem with doing anything preventive in this country. The majority is so mathematically illiterate that they have no understanding of the concept of risk. Everything is either 100% right or 100% wrong.

    The odds of the surge overcoming the sea wall were very, very good. Only a last minute shift and some weaking kept the surge down (and at another 4 feet it would have gone over). But luck is treated by the American people as “experts are completely wrong and the models are useless”.

    This is why nothing will ever be done until it is too late.

  8. ruetheday

    What incentive is there for the 10 firms to pony up billions for the “bad bank”? Where’s the upside? These assets aren’t going to be in the black anytime soon. As for staving off Armageddon, it’s not like LEH is the last firm with a problem and once they’re fixed the danger disappears.

  9. RangerTurtle

    rue has it right:
    “As for staving off Armageddon, it’s not like LEH is the last firm with a problem and once they’re fixed the danger disappears.”

    The toxic derivatives are not wholly contained in banks/ibanks. AIG, for example, can take the whole system down through not being able to cover CDS. Foreign entities that our government CAN’T bailout (thankfully) can also contain toxic derivatives.

    Again, bailing out LEH won’t/can’t be the end of it, so why should these banks pony up any of their precious $?

  10. Anonymous

    You would think that they would have been creative enough to use a number other than $30 billion (the same amount of toxic waste shifted to taxpayers by BS).

    Apparently, they are still using that same EXCEL spreadsheet.

  11. Blissex

    «These negotiations are a textbook case of The Prisoner’s Dilemma from Morgenstern’s game theory, kind of an arcane branch of mathematics. Fortunately Axelrod (from Harvacrd as I recall) managed to solve it a while back. It had been perplexing mathematicans for decades.»

    The “iterated prisoner’s dilemma” problem has been been solved thousands of years ago by politicians/businessmen/gangsters, using political/business/gangland logic.

    The best strategy is elegantly simple:

    Give some strong incentive for the other guy to choose “cooperate” by threatening him or promising him something (like “salvation in the afterlife”), and then always choose “defect/betray”.

    The current Republican leadership and electoral strategists have elevated this to an art form.

  12. Blissex

    «What incentive is there for the 10 firms to pony up billions for the “bad bank”?»

    But “firms” don’t have any incentive, they don’t exist. The question really i

    “what incentive is there for the beneficiaries of the bonus pools of the 10 firms to waste their shareholders’s money?”

    Now such an incentive exists, and it is very strong: that in order to maximize their personal income, all these guys want to avoid reporting huge losses, which would happen if they marked to market the values of their derivatives following price discovery ensuing a Lehman collapse.

    Then using your shareholders’ money to prevent price discovery and collecting a few more months/years of compensation looks like a good deal.

  13. DownSouth

    If the taxpayers don’t bail out Lehman this weekend and its $80 billion in toxic waste (real estate loans) are marked to market at some small percentage of that $80 billion figure, what does that say about the value of the $6 trillion in real estate loans (toxic waste?) that were transfered to the taxpayers last weekend?

    It looks to me like it is the American taxpayer (as of last weekend) who has the most skin in this ponzi scheme.

  14. Blissex

    «If the taxpayers don’t bail out Lehman this weekend and its $80 billion in toxic waste (real estate loans) are marked to market at some small percentage of that $80 billion figure, what does that say about the value of the $6 trillion in real estate loans (toxic waste?) that were transfered to the taxpayers last weekend?»

    But they are very different types of real estate loans, as the Gses were relatively conservative until recently, and most of those loans are old.

    The really big deal with Lehman and the others is that until the cost of money was made negative by Greenspan and the rating agency CEOs discovered that they could become wildly wealthy by selling investment banks AAA ratings, investment banks were not in the mortgage business because it was boring and unprofitable.

    So the percentage of toxic in the Gse portfolio is much smaller than that in the investment bank ones, because the latter’s is much more recent.

    «It looks to me like it is the American taxpayer (as of last weekend) who has the most skin in this ponzi scheme.»

    70% of voters are home owners, and they have been delighted to participate in the scheme.

  15. Mara

    downsouth said “If the taxpayers don’t bail out Lehman this weekend and its $80 billion in toxic waste (real estate loans) are marked to market at some small percentage of that $80 billion figure, what does that say about the value of the $6 trillion in real estate loans (toxic waste?) that were transfered to the taxpayers last weekend?”
    I agree with downsouth that this is already way too much, in that estimates of the ‘toxicity’ of the $6bln is around $1.2bln (about 15x the current LEH toxicity).
    I would counter blissex’s comment: “«It looks to me like it is the American taxpayer (as of last weekend) who has the most skin in this ponzi scheme.»

    70% of voters are home owners, and they have been delighted to participate in the scheme.”

    Well, half-right. Those homeowners were also sold a bill of goods that wasn’t honestly represented. And some were greedy, some were stupid, no doubt. As a former insurance underwriter, I have to wonder about the sanity of the mortgage underwriters (or, more likely, their managers). We were taught to think ahead as to the ramifications of taking on the risk presented before us. Ignoring long-proven rules was taboo.

    This was our economic line of defense that was breeched.

    What to do now? The largest fraud will require the largest bright ideas and actions to overcome it. In all good conscience I can’t see leaving it to the same short-sighted reptiles that got us into this mess. Nor do I trust Paulson or Bernanke. Look at Mr B, he is in fear. If I was at a card table with him, I’d smile every time, knowing I would be leaving with his money. He’s the schmuck who’s behind on his payments, hasn’t found the productive solution to his predicament, and decides to go down with his last few bucks and win big. But desperation rarely makes a mistress of luck.

    I would request of our dear Yves to pose this question: What would your Bright Ideas be for this economic situation? Doesn’t matter if you think they will actually get used, just go for it. I think our lot here can come up with better answers than we’ve seen thusfar.

  16. Mara

    On a side note: when I finally establish my island nation, I want to have doc holiday be my sec. of state and richard kline as my treas. secretary…

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