Lehman Fails-Merrill Lynch Is Acquired
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.