naked capitalism

The Financial Times tells us that a consortium, Bank of America, bank investor JC Flowers, and Chinese Investment Company are pursuing a joint bid for Lehman.

At least on paper, this makes far more sense than a solo BofA bid. The bank already has a garbage barge on its hands in the form of Countrywide, (yes, this is allegedly a zero cost deal due to the tax losses, but paying zero for something with negative net present value overall, admittedly held in a bankruptcy-remote sub, is still not a great deal. The management distraction s likely to offset whatever value they might extract from it). Sharing the risks, and getting a second set of eyes (Flowers is a savvy deal-doer) is of considerable benefit to BofA.

But the gorilla is still in the room: if this deals does have negative net worth, any buyer is going to want support from the government for preventing damage to the financial system. However, the article alludes to a new angle: making the creditors take a haircut instead. How such a resturcturing could be effected in absence of a bankruptcy filing is unclear (recall that the trigger for the Bear deal was the desire to avoid a bankruptcy filing, which was seen at the time as having nasty consequences). But the view, according to the FT, is that mechanisms are now in place to prevent a “disorderly liquidation”. The article states a prepackaged bankruptcy is a possible, but hopefully unlikely, outcome.

From the Financial Times (hat tip reader Saboor):

Bank of America, JC Flowers & Co, the financial investor, and China Investment Co., the Chinese sovereign wealth fund, are considering a possible joint bid for Lehman Brothers…

A forced sale of Lehman Brothers at a fire sale price appears to be the most likely option in the wake of the massive drop in Lehman’s share price over the last few days, people familiar with the matter add. “The only question now is what price,” says one person who has been in discussions with Lehman over possible asset sales as well as with regulators.

While the details of any proposal haven’t yet been fully worked out, a bid from the BofA-led group may involve losses for holders of the debt as well as shareholders….

Regulators will most probably remain on the sidelines….

“Bear Stearns happened so quickly,” says one former Fed official. “At the time, there was no infrastructure to keep Bear alive. Now, there is an infrastructure to prevent a disorderly liquidation with the Fed willing to lend against good collateral.”

Moreover, while Bear Stearns was a big player in the credit default swap market, ran an important prime brokerage business and had a big role in the clearing system, Lehman poses less of a threat to financial stability, many of these people believe. ”Lehman may be the poster child for enough is enough,” says a senior executive at one major private equity firm that has been in talks with Lehman regarding possible asset sales….

Mr Flowers, a former Goldman Sachs partner who is close to BofA, currently manages about $3.2 bn of CIC’s money in a fund dedicated to taking stakes in financial institutions…

The CIC fund complements a $7bn fund that Mr Flowers has just raised from a wider group of investors. Mr Flowers has structured that fund so that he can exercise control rather than take minority stakes as private equity firms have done in the past. CIC may invest additional sums in Lehman alongside Mr Flowers and Bank of America…

There remains a slight chance that Lehman might be forced into a pre-packaged bankruptcy, some of these people believe….

Lehman’s plight is sure to raise questions both about regulatory oversight and the consequences of mark to market accounting. Some bankers and private equity tycoons including David Bonderman, co-founder of TPG and a minority investor in troubled Washington Mutual, believe that in times of stress, such accounting treatment can lead to a death spiral. That’s because the sale of a small portion of assets at distressed prices can force a firm to mark down the value of all its holdings, leading to rising funding costs—the lifeblood of a securities firm —and plunging share prices.

Even before Lehman’s fate has been sealed, there has been quiet finger pointing, with the Securities & Exchange Commission likely to come under increasing criticism. That is because the SEC is supposed to monitor broker-dealers to ensure that they hold enough capital to support illiquid holdings such as Lehman’s real estate investments. But Lehman held these investments outside that entity, and thus avoided heavy capital charges to which regulators seemingly turned a blind eye.

If the regulators refuse to offer a sweetheart deal to a potential buyer, it will change the trading dynamic around troubled financial institutions, creating uncertainty about what was becoming a safe one-way bet. So far, shareholders have been almost completely wiped out while debt holders have been protected.