Thursday, September 11, 2008

What Price For A Lehman Takeover?

After weeks of speculation surrounding Lehman's fate, a period of time during which analysts were frantically upgrading and downgrading the stock, we are near the final chapter for the storied investment bank.  Despite all of the pundits who continued to insist that Lehman was no Bear Stearns, the final chapter of this story seems suspiciously similar.  Here we are near the end of a week filled with rumors of a liquidity crisis, during which the company posted wrenching losses and apparently drove away any potential investors with unrealistic valuation expectations, and a stock that has fallen off the precipice.  Apparently, Lehman must find a partner in a very short period of time or risk having its credit downgraded which may lead to a real liquidity crisis.  Bank of America is among the potential buyers, according to the Wall Street Journal.  If it is indeed the case that an acquirer can cobble together a bid for an investment bank with over $600 billion in assets, many of them difficult to price, in a 48 hour period, what will it be willing to pay?  It seems incomprehensible that an acquirer would offer to pay anything for Lehman's equity at all.  This is a distressed sale, into a market that is already suffering from significant capital constraints.  As I've stated many times before, very few financial institutions are in a position to digest a firm of Lehman's size.  Clearly, nobody wanted to buy Lehman at full price, so if a sale happens at all, it will be at a discount.  But as with the JP/Bear deal, shareholder approval is required.  If the acquirer offers nothing for the equity, then the shareholders can threaten to vote it down and the market will once again face the prospect of a counterparty's failure.  The Treasury and the Fed are involved in orchestrating this shot-gun marriage as this time the Fed is also a counterparty to Lehman.  Although Lehman has yet to borrow from the discount window, it has more than likely borrowed through the TSLF, and the TAF, the Fed's other loan facilities that it offers to dealers.  These loans are collateralized with assets that are difficult to finance.  If Lehman fails, the Fed is stuck with assets it has to liquidate at uncertain prices.  Rather than face the distasteful prospect of having to testify to congress and explain why the Fed owns even more illiquid mortgage assets, Bernanke and Paulson would much rather stuff someone else with all of Lehman's risk.  Why the market rallied so powerfully into the close remains a mystery to me.  How the now inevitable demise of what used to be the fourth largest US investment bank is rabidly bullish news is really beyond my comprehension.  Post-close financials are sharply lower, particularly Lehman, which is down another 25%.  I suspect the rally won't last.  But, as always, the market is full of surprises.

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