Monday, September 15, 2008

Lehman Fails-Merrill Lynch Is Acquired

It is now confirmed that Lehman Brothers will go into bankruptcy. The chicken race between U.S. Treasury Secretary Henry Paulson who refused to offer government support and the potential acquirers who demanded government support to go in ended with neither side yielding, causing Lehman Brothers to crash.


Meanwhile,Bank of America announced
it will acquire Merrill Lynch for $29 a share, a surprisingly high price (70% above the Friday close, although it is still 70% below year ago levels). They would most likely have gotten it cheaper if they had waited longer so it might seem puzzling that they now offer such a high price. Perhaps they want to be sure the deal goes through and also wish to avoid a general run on Merrill Lynch in the wake of Lehman's collapse, which would lower the price but also the underlying value of the company.

It is too early to estimate of this. I will almost certainly have to return to this issue in future posts. However, a few things seem immediately clear:
1) This will not be the last financial institution that collapses. A lot more companies have suffered great losses related to the bursted housing bubble and so a lot more will approach insolvency. And this collapse will in itself cause further losses for those with stakes in Lehman. Moreover, the loss of confidence created by this will create "runs" on many financial institutions, causing them to collapse in a self-fulfilling prophecy. The sell-offs on global stock markets and rally in Treasuries are early indicators of this.
2) There is now simply no way that the Fed will raise interest rates. Indeed, this will likely open up the possibility of future interest rate cuts.
3) This as well as point 1 will likely cause credit to contract which in turn will likely cause monetary contraction, which will lower inflation and deepen the economic downturn in the short term.
4) Because of point 2, and because it will scare away investors from almost all American assets except Treasuries (U.S. government bonds) this will be bearish for the U.S. dollar.

Like I wrote earlier, I will certainly return with more on this issue later, so stay tuned.

3 Comments:

Blogger Wille said...

Regarding point 2, opening for further rate cuts - does the Fed really have anywhere to go on this?

To put it bluntly, it seems to me they blew their load too early - they lowered rates aggressively when lowering the rates was highly counterproductive, and pretty soon when lowered rates might have been useful, they have nowhere to go.

3:42 PM  
Blogger ... said...

It seems obvious to me that the way BOA decided to buy MEH was much like a groom with Paulson's "Big Gun" to his back next to the pregnant bride. I feel way about the Countrywide deal too.

4:30 PM  
Blogger Celal Birader said...

USD/GBP broke 1.80 in the very very last minutes of trading yesterday (does somebody know something we don't?). The USD looks to be on the move downward. How far down i guess depends on what Mr Bernanke utters today : 0, 25 or even 50 bp.

8:17 AM  

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