Lehman heading for Chapter 11 as Barclays pulls out of rescue deal

Published on Sunday 14 September 2008 21:44

IN THE most dramatic development yet in the global credit crisis, stricken US investment bank Lehman Brothers was preparing last night to file for bankruptcy protection after both Barclays and Bank of America pulled out of takeover talks at the last minute.

Traders in major financial centres now fear a severe shock to the global financial system as banks scramble to unwind their complex deals with Lehman if no new financing is found overnight. Failing last-minute financing appearing, the 158-year-old bank is likely to file for Chapter 11 bankruptcy protection.

Lehman, America's fourth- largest investment bank, has substantial operations in the UK including an extensive commercial property portfolio and residential mortgage book. Accountancy giant Pricewaterhouse Coopers is said to be on standby to put these operations into administration.

At the end of August, Lehman was reported to be poised to axe 1,200 jobs, its fourth round of cuts in the past year, bring total redundancies to about 6,400 since June last year.

In a separate developing drama last night, Bank of America (BoA) and broking giant Merrill Lynch were said to be in talks about a possible merger.

According to a Wall Street Journal report, BoA pulled out of the Lehman talks as it considered Merrill Lynch to be a better fit. Senior officials from the US Treasury and the New York Federal Reserve have been closely involved in negotiations, which have been running since Friday.

Both BoA and Barclays had hoped that the US government would offer some help to facilitate a rescue of Lehman and avoid a crisis of confidence across the world's financial markets when trading opened today. But the US Treasury Secretary, Hank Paulson, remained adamant there would be no US taxpayer bail-out for Lehman.

It could take weeks or even months to sort out Lehman's affairs and the failure to reach a rescue deal will put banks around the world in a state of extreme uncertainty.

Barclays is thought to have broken off the negotiations because it was unable to obtain guarantees relating to financial commitments faced by Lehman when markets open today.

In addition, the UK bank said it would need shareholder approval before a deal could be fully completed. Senior US administration officials said that presented a huge obstacle to putting together a credible package in time.

As word that a Barclays deal was off filtered across Wall Street, credit derivative traders scrambled to unwind their outstanding contracts with Lehman and shift their positions to other banks. Traders at many Wall Street firms were told to come to work immediately as an emergency trading session began. Wall Street's deepest fear is of a disorderly panic spreading through markets today.

Global markets will pay high price to defend Paulson's principles

IT IS the moment in the global credit crunch that markets, central banks and governments have dreaded: the collapse of a major bank with implications for financial institutions worldwide. Stock markets are now set for a stormy ride, the bank sector especially, as traders, Lehman Brothers executives, accountants and regulators scramble to prevent a disorderly rout.

How did it come to this? The US government has been adamant that taxpayers' money would not be used in any bail-out of Lehman. Yet the ink is barely dry on the effective nationalisation of mortgage giants Fannie Mae and Freddie – but here millions of mortgage borrowers across America were directly involved. Lehman, say many, was the author of its own misfortunes. The government should not bail it out.

For that, Treasury secretary Hank Paulson will surely be applauded. For the greater danger is moral hazard: banks continuing to devise and trade in risky products, safe in the knowledge if their concoctions blow up, Uncle Sam will ride to the rescue. No more.

Once one investment bank is effectively rescued by the injection of billions of taxpayer dollars, it would be impossible to draw a line: other stricken banks would have a claim.

But defending this principle comes at a cost. The first is the likelihood of chaotic trading today, then other banks being destabilised and confidence fleeing the system. Traders have rushed to buy credit default swaps tied to other brokerages and corporations, sending sharply higher the cost of protection on investment banks such as Goldman Sachs.

The key obstacle to a deal to rescue Lehman was reluctance by US regulators to back an acquisition or the creation of a so-called "bad bank" to wind down Lehman's assets. And Bank of America, the other leading bidder alongside Barclays, indicated yesterday that it wasn't interested in a transaction without some form of government support.

But a disorderly unwind of Lehman's derivatives trades is only one worry. Another is that its distressed assets – such as commercial property – could suddenly flood the market, forcing prices even lower and potentially forcing other dealers to further mark down the value of their own holdings.

Whether this marks the height of the credit storm no-one dares to say – previous such pronouncements having proved all too wrong.