Lehman Brothers Holdings (LEH) Could Suffer a Bear-like Liquidity Crisis

Jun.26, 2008 in Market Outlook

Paulson, in other words, raised the specter of “moral hazard,” or the
government’s inadvertent promotion of reckless lending, trading and other risky
behavior by guaranteeing that banks won’t be allowed to fail. And he risked
bringing up his own Wall Street lineage to bring home the point.

When the Treasury and its central bank opened the Primary Dealer Credit Facility
to Goldman, Lehman Brothers Holdings (LEH), Morgan Stanley (MS) and Merrill Lynch
(MER) in mid-March, they were hoping to pump confidence into a fragile financial
system. Bear Stearns Cos. was near collapse, and shares of Lehman were being
pummeled out of concerns that it, too, could suffer a Bear-like liquidity crisis.

The emergency facility, which allows banks to borrow overnight loans in exchange
for collateral such as mortgage-backed securities that investors have been
shunning, opened on March 16. Investment banks immediately embraced the action.

The new facility “takes the liquidity issue for the entire industry off the
table,” Lehman Chairman and Chief Executive Richard S. Fuld Jr. said in March
during an attempt to halt a Bear Stearns-induced slide in his company’s stock.

The government said it would let investment banks use its lending “window” for at
least six months, with extensions if conditions warranted.

Paulson’s words last week do suggest, however, a strong government reluctance to
continue the facility, and raise questions about investor confidence in other
investment banks still burdened by balance sheets loaded with real estate and
other dicey assets.

“The future of the Federal Reserve’s Primary Dealer Credit Facility will
increasingly be a matter of interest and concern for investors and creditors as
the mid-September shutoff date for the facility approaches,” Sanford Bernstein
analyst Brad Hintz told clients in a recent note.

To be sure, some bankers think the Fed will maintain the facilities, given
continuing lack of liquidity in the credit markets and mounting problems in the
consumer economy. “I don’t think the Fed will back away until it is sure the
environment is stable,” said Everett Schenk, chief executive of BNP Paribas for
North America “The facilities are very important psychologically for the banks
and for their counterparties in the debt markets.”

Did you like this? If so, please bookmark it,