Lehman Death Watch: Will Paulson Let Lehman Fail?

The short answer is yes, but we need to define fail And BTW, it’s very frustrating to be stuck on a plane waiting for the weather on the eastern seaboard to clear while the markets were having such an exciting day. As readers no doubt know, Lehman broke down after word got out that talks wtih Korean Development Bankhadfialed to produce an investment agreement.

After Freddie and Fannie, Paulson cannot be perceived to be rescuing another firm, particularly a private company that plays no special role (as far as most people are concerned) in things they care about, like housing. Unlike Bear, Lehman is not a big credit default swaps protection writer. That was the exposure that led the powers that be to worry about a systemic failure. Even though Bear and Lehman are similar in size, their business mix differs in ways that make Lehman dispensable. In fact, Paulson almost needs to let a financial player fail to prove that he is not a toady of the industry.

Mind you, that does not mean Lahman will go under. But they look like a fish on the dock, flailing and gasping for air. If they don’t secure some help soon, they are history.

From Reuters:

Several financial experts said Paulson, a former Goldman Sachs chairman, was likely calling friends on Wall Street asking what people know, who is exposed and how much loss they are willing to take…

The Fed already has a borrowing facility open to Lehman, a measure offered to investment banks after the Bear Stearns failure. But it is meant to ensure short-term liquidity and not prop up an insolvent firm.

Yves here. Did you catch that? Reuters has in effect said that Lehman is insolvent. YIkes. That may reflect hasty editing, but is still pretty remarkable. Another noteworthy tidibt:

Lehman shares rose 8 cents to $7.87 in after-hours trading after Citigroup Inc, Goldman Sachs Group and Morgan Stanley all said they were still trading with Lehman.

These are remarkably weak endorsements. The fact that solvency is now a matter of speculation says how far gone the firm is.

From the New York Times:

On Wall Street, there is a growing sense that Lehman may have to solve its problems on its own, without drastic help from the government, which in March brokered the rescue of another Wall Street bank, Bear Stearns.

“Some may worry that Treasury has taken on so much taxpayer burden they don’t have any remaining capacity more to take on the burdens of Lehman,” said David Trone, an analyst at Fox-Pitt Kelton.

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  1. Anonymous

    LEH better get its house in order asap as regardless of the elections it is unlikely that either administration will be sympathetic as even a McCain-Palin administration will definitely not be your father’s GOP.

    After BSC and FNM, I’d wager that GM or F has a much better chance of being on the DC dole than LEH, a firm that Joe/Jane Sixpack has never heard of.

    It would seem that short LEH would be the “obvious” trade. Any takers?

  2. DaddieMac

    If Lehman were to fail what would happen to the financial instruments that are tied to Lehman bros indexes? Thanks

  3. doc holiday

    The question which hangs upon the balance at this juncture, is whether or not Paulson is too big too fail. Mayhaps one should refocus the economic microscope and remove the question of moral hazard and thus look beyond the scope of deeds which have brought us all to this systemic collapse, and begin a process to remove the cancer associated with this biopsy.

  4. Invictus

    Lehman Brothers Holdings Inc. is rated A by Standard & Poor’s, A2 by Moody’s and A+ by Fitch.

    LEH very well could be made the face of how "unfettered wild west laissez faire jungle capitalism" is still gasping and flailing even if on the chopping dock.

  5. Anonymous

    December 20 2007 06:16 AM

    Dodging tough questions about the student loan company’s fiscal well-being and strategy in the midst of the credit crunch, not to mention his recent sale of 97% of his company stock, Sallie Mae’s CEO ended a conference call yesterday with investors by cursing, reports WSJ:In an apparent reference to investors’ anger, he said: “I can assure you, you will be going through a metal detector.” He ended the conference call by saying “Let’s go. There’s no questions. Let’s get the [FUCK] out of here.”

    Sallie Mae spokesman Tom Joyce called the metal-detector remark “an attempt at humor” and the expletive “an unfortunate slip of the tongue.” Mr. Joyce said the call had been intended for Mr. Lord, in his new role, to give investors a “broad overview” of the company’s situation.Afterwards, shares of Sallie Mae fell 21%.

    Will LEH take this approach?

  6. Anonymous

    The KDB report has been denied (again) but is still being reported everywhere. We are now entering the Twilight Zone.

  7. Cash Mundy

    Reuters is also saying:

    The 45 percent slide in the shares of Lehman Brothers Holdings Inc on Tuesday reduced the investment bank’s market value to just $5.4 billion

    and is reporting that KDB is and is not buying Lehman for $6 billion (seems $600 million high). Warring factions in KDB, or good-cop/bad-cop keeping hope barely alive and ready to buy when the market value is as close to zero as it can get before LEH gets delisted?

  8. a

    “If Lehman were to fail what would happen to the financial instruments that are tied to Lehman bros indexes? Thanks”

    My guess, either:
    1/ Someone else will become calculating agent for the indices, in which case there will be no change to the financial instruments, or
    2/ The financial instruments will become based on a different though similar index, with the performance being set on the last day (or one of the last days) the Lehman index is calculated. (So e.g. if the Lehman index was worth 40 when you bought the financial instrument and on the last day d it’s worth 50, and at d the new index is worth 100, then the financial instrument will be based on the new index, pretending that you had bought it when it was worth 80.)

    If Lehman is also the counterpart for the financial instrument (and not just the calculating agent for the index), and Lehman fails, then you may well have lost your money.

  9. Anonymous

    from “wsj”


    “Lehman’s declines came after the Korea Development Bank, which has been in talks with Lehman about a capital infusion, said Tuesday it had closed the door on a possible deal. Discussions between Lehman and KDB ended in early August, according to a person familiar with the talks. But persistent rumors that a deal was still possible continued to bolster the firm’s stock.”

    Ended in early August!!! This rumor is akin to the 2002 bankruptcy filing report by UAL– old news but let’s just recirculate it to screw up shareholders for the fun of it…

    In any event, one has to wonder.

    Look at Freddie Mac. Freddie Mac’s management kept telling us that they had capital cushions and were chugging along, even after the reportings moratorium that was meant to ensure all t’s were crossed, i’s dotted and thousands comma denotations were in the right place, but then along comes Morgan Stanley who deems them insolvent and the Feds seize.

    Lehmans, like the Freddie management, makes the similar capital assurances. Despite not being like Freddie where we had the MS diagnosis, we do have a PARADE of iBanks/SWFs/PEs come along to bid for the firm, only to walk away. What does this tell you, people?!

    One has to wonder.

  10. ruetheday

    Reuters: “Several financial experts said Paulson, a former Goldman Sachs chairman, was likely calling friends on Wall Street asking what people know, who is exposed and how much loss they are willing to take…”

    Industry toady indeed.

  11. Anonymous

    And Paulson is speculated to be asking his Wall Street cronies how much in losses from Lb going under they are willing to take? And what, if they want to take a lower loss, they get a couple of floors of Lemon headquarters to gross them up? Really tragic, if this is the case; is six months’ warning not enough for these guys to get their houses in order?

  12. S

    LEH reports loss of 5.92
    spin CMBC into entity 25 equity infusion and 75% financed by LEH
    Cut Div save 450M
    marks $5.6B net (includes 1.4B of gains on debt spread deterioration!)
    Underlying results in equity business down 60% (capital markets)
    AUM devlined sequentially

    DB, HSBC, RBC, KDB all come out with statements denyuing interest in acquiring an investment bank.

  13. Matt Dubuque

    It must be pointed out that Lehman is a PRIMARY DEALER in Treasuries, which means that it has a critical relationship with the Federal Reserve as a primary market maker in the repurchase agreements (and reverse RPs) that the Fed uses to conduct open market operations.

    As such, it plays a critical role in the distribution of Treasury securities, not a trivial consideration.

    That said, my best judgment is that it is the consensus among attorneys at the Federal Reserve that the authority the Fed used to assist Bear Stearns (another primary dealer) was ONLY an emergency authority.

    This is why they asked for broader statutory authority from Congress to help save the financial system from ruin.

    This was denied. That bill has gotten nowhere. As it stands now the SEC (NOT the Fed) has primary jurisdiction over the affairs of Lehman.

    Therefore the consensus seems to be that, all things considered, the market may well be the arbiter of Lehman’s fate. The Fed’s role would therefore be reduced to ensuring that any substantial repricing of risk that would follow (including a crash) should be as orderly as possible, but that the “end result” would not be managed, just the speed and orderliness of the transition.

    That’s my best judgment. Readers may recall that I expressed this view, that the Fed is actively considering allowing Lehman to fail, last week.

    I know of no other commentator at that time who took such an extreme view. Last week EVERYONE was saying Lehman was too big to fail.

    Remember where you heard it. It’s not a sure thing, but this seems to be a growing consensus (from what I can tell) at the Federal Reserve.

    Matt Dubuque

  14. Anonymous

    Why shouldn’t paulson use LEH’s troubles as an excuse to steal the company from its shareholders, same as he did with FRE and FNM. Stealing by government is good for taxpayers. Nationalize enough companies and he can wipe out the country’s debt.

  15. Matt Dubuque

    The reason why is because at heart, coming from Goldman, Paulson is a free market jihadi who believes that the sacred “invisible hand” of the market will provide miracles to us all.

    To a very large extent, he has been forced, kicking and screaming, to many of his recent actions by the saner heads at the Federal Reserve who know that a hard landing is FAR preferable to a crash landing.

    Matt Dubuque

  16. Matt Dubuque


    Korea has huge economic problems of its own and political ones also.

    What seems more likely is the following:

    1. Yesterday Emperor Bush signed off on a plan to provide a multi-billion dollar missile defense shield (I think it was 7 billion) to one of the Gulf Emirates. Of course this is not really needed, because the Gulf States are VERY low on Iran’s retaliatory response list because of their very high Shia population.

    2. The graft in such a large enterprise in a Gulf state would seem to be sufficient to fork over a bit to Lehman in exchange.

    Perhaps the Emirates are running a little late today? But it is Ramadan after all….

    Perhaps after Ramadan is over Lehman will get a few bread crumbs from the Emirates on very unfavorable terms, a deal which would be celebrated by the chattering classes of the corporate media.

    Matt Dubuque

  17. S

    Matt Dubuque

    Treasuries are a commodity product. MS and GS could ramp the sales force and handle it by themselves. Toss in emerging electronic platforms and the Primary Dealer system looks fairly antiquated.
    Fed Website – it only takes a click

    “The primary dealer system was established by the New York Fed in 1960 and began with 18 primary dealers. In 1988, the number of dealers grew to a peak of 46. From the mid 1990s to 2007, it declined to 20. The most important reason for the decreasing number of dealers is consolidation, as Government securities trading firms have merged or refocused their core lines of business. A current list of primary dealers can be found at the Bank’s website.”

  18. Anonymous

    Regarding the post-Ramadan donation…read Jeffrey Goldberg yesterday; more intervention from the Middle East is the LAST thing that this country needs right now.

    And if we don’t like Df…hard to imagine that the Swfs would.

  19. Matt Dubuque


    The trend you describe is correct and clear. But it is by no means complete, finalized and correct.

    It’s a process that you describe.

    The biggest change of course came when primary dealers no longer had exclusive real-time pricing of Treasuries.

    That changed everything, as you probably know.

    But keep the following in mind as you consider my rebuttal.

    The Federal Reserve is a brilliant market maker in Treasuries that has access to inside information as well because most major macro data (capacity utilization, PPI, CPI, unemployment data, etc.) is supplied to them 24 hours ahead of release.

    And each primary dealer still participates in conference calls every morning with the open market desk of the Fed and each call explores fully the RP and reverse RP markets for that day, week, etc.

    So the primary dealers give the Fed a sense of what they can move and the Fed reciprocally gives the primary dealers a sense each morning what swaps are likely to be in store. And that information has value for the primary dealers.

    So in THAT very important sense, the primary dealers still have a decided advantage over other dealers.

    The trend you describe is clear and accurate and correct.

    But it is by no means complete or dispositive.

    Matt Dubuque

  20. Matt Dubuque

    I’m not saying this country needs more donations and charity from radical Gulf State jihadis bent on destroying the modern world. I am not saying I WANT this injection of funds to happen.

    I’m simply saying it seems to be the most likely scenario given deep French kissing that Bush engages in with his Sunni masters.

    Also, with the recent strengthening of the dollar that give the Emirates more flexibility because of their dollar pegs. Less domestic dissent complaining of inflation, etc.

    Matt Dubuque

  21. Anonymous

    Friday, the day we find out which bank goes under this week, is almost upon us. It would be the perfect time to announce an I-Bank failure and give the weekend to assess the potential damages and look for some solution if possible. If they don’t go under now, they will when the lawsuits start rolling in. I know one very conservative financial firm that bought $6.5 billion of FanFred securities all on Lehman’s advice. It was sold as a very safe investment.

    The unintended consequences of the governments actions will only be realized when small banks, large pension funds, state agencies and other “little people” go broke beacuse of the takeover of FanFred creating a “negative feedback loop”. The government is really attempting to delay until it can dump all this on a new administration. Paulson and company will retire and will hardly be heard from again. Alan Greenspan knew what was coming “We are now in a state of fear”, and stepped out of the limelight before the fecal matter hit the rotating blades. Paulson and Bush will do the same.

  22. S

    Lets also recall that LEH did a lot of the GSE fundraising. That is highly ironic, no!

    When does the emergency rate cut come? Next meeting 16th

  23. Matt Dubuque

    I understand all of your reasoned points and they are all grounded in fact.

    I do not completely agree with all of them, but that’s fine.

    I DO ASK that you keep one empirical fact in mind, if you ever have a chance of understanding what the Federal Reserve is really up to.

    They generally believe, (except for outliers in St. Louis) as do I that a HARD LANDING is infinitely preferable to a CRASH LANDING.

    Matt Dubuque

  24. Matt Dubuque

    Very unlikely rate cut on 16th. The Fed would prefer to FOLLOW the markets as yields crash and bond prices soar (inverse relationship), retaining their credibility and keeping inflation expectations anchored.

    Matt Dubuque

  25. S


    Agree with all said. Still think the shrinking of the Primary dealer community is totally consistent with the call to shrink the IB universe. look at LEh results. The capital markets business was a disaster. All that said, the problem as you correctly point out is the logjam that has been occuring in the repo/financing markets and the fact that the Treasury is loading down the curve with record supply. The advent of CDS that is wo widely toughted sort of reminds me of the saying Im all for it if it happens to you. The note on CDS blowing out on US Gov’t debt is pretty itneresting. The US is currently banking on being the best of the worst and hence attracting capital. Short termism afflicts the entire US psyche and complex. It is this short termism that will eventually come home to roost, just like the short termism (debt) typically does in EM.

  26. S

    chian cpi down japan wholesale inflation down us PPI flat to sequentially down. Inflation is not the issue yet. Inflation will be the issue when they start to monotize

  27. STS

    anon@12:41 AM:

    What makes you think McCain/Palin wouldn’t be “your father’s GOP”? They haven’t got two economic thoughts to put together between them, so they’ll just pull in the usual crowd of Wall Street experts and right-leaning academics and lobbyists that Bush/Cheney have relied upon.

    Nothing could be more “same old, same old” as McCain/Palin. Lipstick on a pig, indeed ;)

  28. Matt Dubuque


    A few points.

    1. When you say: “the Treasury is loading down the curve with record supply.” please keep in mind that now the markets are chowing down all the Treasuries they can in a panic to quality, consistent with deflation. Therefore, because of enormous current appetite, Treasury oversupply is clearly not causing the logjam.

    2. The Federal Reserve is a brilliant market maker in Treasuries that acts in its self-interest. It is partially privately owned.

    They will not tolerate a massive decline in the value of their Treasury portfolio. They will HAPPILY raise interest rates to protect the dollar if the markets demand it through a selloff.

    They will do ANYTHING to protect their portfolio. That includes jacking up interest rates so high it will make your head spin. THEY didn’t create these deficits and they are NOT going to pay for them.

    Trust me on that. I know of what I speak.

    We will have a depression before the Fed EVER tolerates monetizing the debt.

    Matt Dubuque

  29. Anonymous

    He shouldn’t but he will . I won’t stop . This goes on and on until the crash at the end of the road . We are getting there fast .

  30. Matt Dubuque

    My best estimate is before the end of February, for a confluence of factors.

    If we make it past that point, the descent could be more gradual.

    Matt Dubuque

  31. Red Pill

    We will have a depression before the Fed EVER tolerates monetizing the debt.

    Matt Dubuque


    I really appreciate your commentary. You realize many would passionately disagree with the above statement? This is a key (maybe THE) question for the current crisis. If I believed this more confidently it would make decisions going forward much easier.

    Could you elaborate on why you so strongly hold this view?

  32. Anonymous

    Matt D said

    They will not tolerate a massive decline in the value of their Treasury portfolio. They will HAPPILY raise interest rates to protect the dollar if the markets demand it through a selloff.

    Good point Matt. However, what if the rest of the central banks around the world feel the same way and collectively , yet quietly, decide to support the dollar at the same time (perhaps by selling GOLD)?

    I use this hypothetical example because of the obvious role of the reserve currency of the world a.k.a. the USD (US dollar)…

    Wouldn’t that be inflationary? and if so wouldn’t a stagflationary environment be possible if not probable before a deflationary scenario takes hold?

    – RM

  33. S


    As for monotizing debt, we are half way there with the TAFs, TOF, PDLF etc. Now the hope is of course that you can cram down rates, recover the losses on NIM (or debt deterioriation as was the case with LEH today to the tune of $1.4B) and work through the bad debt. But the market is not coorperating on the organic business front. Perhaps that is why people are ducking under the cover of the Fed in the money centers. Will that be safe.

    Now, as for being brilliant, I would only say someone so brilliant would have recognized the problem a long time ago and acted in their capacity to correct the situation. Now since the banks are part of the system, they should have in theory being of course so atune to the conditions self corrected. Instead their enabler lowered rates to keep the party going. Perhaps I am missing something. The profitability of MER for the better part of 7 years plus has been erased. Sure the bankers still got paid but the shareholders got fleeced. And if I am a banker or running a company and I am taking 60% of my pay in stock is it in my self interest to run my firm into the ground? And if these firms and their patriarch in the Fed are so brilliant why is it that they ran themselves into the ground? bubble dynamics notwithstanding, please explain the historically prescedent that supports your contention that the Fed is brilliant. The Fed is an unnatural act bordering on criminality. I bet you think nationalizing the GSE was a brilliant manuever by the Fed to capitalize on spread economics.

    This whole line of reasoning is a bit like calling dick Fuld brilliant for navigating the company into a ditch and then organizing a salvage operation that leaves it breathing but limbless.

    You are correct the Treas is loading down the curve and force feeding the rest of the world toilet paper. They buy I buy we all buy. Why not “risk free” for 3%is a bargain. gthen again maybe not. And yes they like the front end to save “the people” money.

    A quick look at the TIC data demands a military analogy, as in flanked. The only thing left holding the US together is hope, faith and goodwill. There is absolutely nothing brilliant about the Treasury. Zero. The statement is ludicrous. tactics without strategy.

    Take a look at the budget of the uS and explain to me how the $10T of debt gets paid back? Now I assume you would agree GDP is overstated by the rampant overcapacity in the US economy. So as wages fall and business disappears, that receipts line will look overstuffed. Exactly how is he US going to pay back its debt? I suspect every CEO of a company pre bankruptcy made the same claims as you regarding the “I” would never on their debt. Didn’t PAulson make some claimn about the GSE a few weeks back.

    While I come out in the same cul de sac of deflation that you do, whether it is flat out printing first and then intogarble the tank or just straight into the tank, we’ll just have to wait and see. But ther is nothing brilliant about the Federal Reserve. It is an inflationary vehicle in the employ of the banking complex. Period. Any doubts just read Bernanke’s writings. Your meme is just a dressed up Fed pitch fronting for Keynesian garble and central planning. ISn;t that what got us here.

    This whole things sounds a lot like the day after circa 1986.

  34. Cash Mundy

    One time-honored response to difficult economic times is a war of choice. Broad emergency powers, unlimited deficit spending, semi-mandatory contributions from allied countries, what’s not to like?

    H. Con. Res 362 seems like just the thing. Rather than clutter up this thread with the details, I posted about it at length

  35. Matt Dubuque

    In terms of a war, bombing Iran has very broad appeal among the Cheney crowd. The idea is that if Israel attacks in October (assisting McCain and the neocons) and Iran so much as lifts a finger in response a substantial NUCLEAR retaliation would send a signal that, despite being overstretched militarily, the USA is perfectly willing to engage in its own version of “asymmetrical” warfare.

    This of course would be insane. But this is the scenario being floated, but has been thwarted to a substantial extent by Russia’s incursion into Georgia for several reasons.

    In terms of the Fed “force feeding” Treasuries to an unwilling market that comment has no relationship to the facts.

    Have you ever participated in a Treasury auction? It does not seem like it.

    These Treasuries are being BID UP THROUGH THE ROOF in the Auction process.

    Not even CLOSE to being “force fed”.

    But it is a metaphysical impossibility to convince broad swaths of Americans that the Federal Reserve is anything but an inflationary machine, so I won’t frustrate myself in such a quixotic task.

    Again, perhaps a spanking global depression lasting several years will disabuse some of those harbouring that illusion.

    But I doubt it. It’s kind of a religious thing, with Milton Friedman and his primitive mathematics from the 1960s being the deity that cannot be questioned.

    Matt Dubuque

  36. Cash Mundy


    Have you ever participated in a Treasury auction? It does not seem like it.

    Nor would I pretend to any such expertise; far from it. While I did manage 60% return on investment over the last month or so (puts on FNM FRE LEH AIG mostly) and so have some very modest combination of luck and skill in such matters, I am a financial neophyte compared to the level of discussion here and in Alphaville, and a very small-time micro-investor who not so long ago took inflatable rafts, “river pigs” in the technical jargon, down rivers for quite modest remuneration.

    A shiny new war, even a transparently ill-advised and ill-omened one, would be expected to not dampen the ongoing flight to quality. However, it should be remembered that a recent post here or in Alphaville suggested that the flight to quality could turn into a flight from the dollar with little warning.

    Allow me to speculate that such a war would probably not happen until after the election if McPalin is well ahead in the polls, and also would be less likely until hurricane season is over. If Obama is ahead, an October Surprise is always possible, and if he wins, the pre-inauguration period will be dangerous.

    As for a nuclear attack on Iran, that is a degree of apocalyptic madness I had not considered, yet it is apparently being considered. I would like to look into it if you can provide a pointer. If things are that far gone, it is conceivable that Russia’s recent assertiveness may have been eliberately designed to forestall such an immeasurably destabilising event.

  37. S

    MD pedantic musings.

    rising inflation is core to support greater and greater debt loads in the context of “growth”

    You seem to have the anwser which is a depression is coming. But you have yyet to offer a solution. what exactly is the solution. How do you sove a solvency crisis? Where does the money come from when there isn’t any left? You either default and tank GDP or you print your way out. Really, all the academic mumbo jumbo and fancy words doesn’t change a binary outcome. Nor does creative solutions.

    What is your solution. More regulation. More intervention. MWhat is it. If you think it is avoidable, what is the colution. how do you “fix” a bond whose collateral is worth 30% of notional without writing it down? and what if the capital cushion supporting the exectuion is shrinking becasue the complex supporting the overpriced collateral is collapsing on itself? The short answer is there is no solution other than taking the losses and carting off the roadkill. perhaps depression is just wahat the dr. ordered. Guns and Butter

    I guess we will see if the Fed doesn;t jump on a lower PPI number as ammunition to take down rates. ZIRP ZIRP ZIRP is the sound coming out of the Fed.

    By the way, you appear to be an expert in a lot of areas and well connected. Do you have a blog withg a bio

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