Sunday, September 13, 2009

One Year Ago - September 14th, 2008

This time last year I was an equity analyst at Lehman Brothers. As the firm collapsed, I sent a series of notes to my friends and family with my take on the situation. To coincide with the anniversary, I am publishing them here over the next few days. [Photo: Newstruck in fron of Lehman HQ]
More Lehman
Originally written Sunday September 14th, 2008, 2am (Saturday night)

This is going to be extremely interesting as every player is at this point waiting for someone to blink and the Wall Streeters, I'm guessing, are thinking the one most likely to blink will be the Feds. Btw, the brother of the Treasury Secretary Hank Paulson is a senior Lehman employee so there are all kinds of angles to be richly explored.I'm pleased to see the Equities Division, where I work, referred to yet again as one of Lehman's good businesses worth keeping intact. No Deal Reached Yet to Decide Lehman's FateFrom the Wall Street Journal on the web. By CARRICK MOLLENKAMP, DEBORAH SOLOMON, AARON LUCCHETTI, SERENA NG and SUSANNE CRAIGSeptember 14, 2008 1:27 a.m. The outlines of plans to determine the fate of Lehman Brothers Holdings Inc. emerged today even as it became increasingly clear that a clean sale of the entire firm to a big bank would be too difficult to execute. A sense of optimism that a rescue could be arranged today dimmed as a growing sense of gloom descended on Wall Street. Executives from top banks in the U.S. and Europe huddled with federal regulators in an attempt to come up with plans to either buy pieces of Lehman or prepare for an orderly winding down of the firm in a manner that would minimize the collateral damage for the ailing global financial system. After 6 p.m., the formal meeting ended for the day with no resolution, though some participants stayed behind to continue talking. "Senior representatives of major financial institutions reconvened on Saturday with U.S. officials at the New York Fed. Discussions are expected to continue tomorrow," said a spokeswoman for the Federal Reserve. At about 8 p.m., New York Fed President Timothy Geithner was still at the bank's headquarters. Officials from the New York Fed and various banks were expected to continue working through the night. Under one plan, either Barclays PLC or Bank of America Corp. would buy Lehman's "good assets", such as its equities business, people familiar with the matter say. Lehman's more toxic, real-estate assets would be ring-fenced into a "bad" bank that would contain about $85 billion in souring assets. Other Wall Street firms would try to inject some capital into the bad bank to keep it afloat for a period of time so that a flood of bad assets don't deluge the market, damaging the value of similar assets held by other banks and insurers. The banks are also looking for the government to somehow financially backstop the bad bank.The problem, though, is getting enough banks to back that plan. While teams of bankers are working through structures, it's clear that only a handful of banks are in a position to provide enough funding. Many banks are inclined to preserve capital ahead of third-quarter and year-end cash preservation moves. Also, banks aren't keen to see a big rival such as Barclays or Bank of America walk away with valuable assets by only paying a pittance. As of Saturday afternoon, Barclays, the U.K.'s third-largest bank in terms of market value, appeared to have more interest in pulling off a deal for Lehman's good assets. At about 3 p.m. on Saturday, Barclays President Robert E. Diamond Jr. was seen entering the New York Fed's employee entrance on Maiden Lane, carrying a briefcase. Bank of America, an obvious buyer, appeared to be cooling toward a deal, people familiar with the matter. Of course, some of this could be the posturing that happens in any auction. Neither Barclays nor Bank of America wants to buy all of Lehman without some government assistance, and so far the government has been reluctant to do so. Both Bank of America and Barclays remain fixated on the disposal of the bad real estate assets, and are less focused on evaluating Lehman's investment bank, said one person involved in the due diligence process. Things were moving so quickly Saturday that there was little time to do extensive employee interviewing that typically happens in company auctions. "It's all triage," said this person.The real fear in the discussions, this person added, was that the fire-sale prices, or "marks" of Lehman's real estate book could set off a cascade of problems for other Wall Street firms. If those marks were made against other banks' portfolios, it could eventually force those firms to raise more capital, too. For firms' considering funding the bad bank, the calculation has thus become the price of that contribution against the price of a widescale markdown. There could be further effects to such an event, with the banks calling in loans from hedge funds and other clients, in turn setting off more forced selling that further depresses asset and securities prices. "Unless something is settled, it's going to be a bloodbath Monday," said this person. In a meeting at the Federal Reserve Bank of New York in lower Manhattan, some participants also were discussing insurer American International Group Inc. and thrift-holding company Washington Mutual Inc. While those two financial firms aren't the focus of the emergency meeting, participants also are weighing the potential implications of their problems. One person leaving the building said at least 100 people were gathered inside trying to settle the fate of Lehman, which has been staggered by its exposure to soured real-estate-related assets. By 5:15 pm, some Wall Street executives started to leave the New York Fed one at a time, getting in their cars inside a garage so they can't have their photos snapped. Outside the Fed's downtown headquarters, a fleet of black towncars waited for bankers who were inside. At one point, the towncars blocked the narrow streets around the building, causing a traffic jam that had to be broken up by the Fed's uniformed guards. Meanwhile, bankers and Fed staffers milled around outside, smoking cigarettes and talking on their cell phones about subjects like counterparty risk. "Everybody is hoping there will be a Wall Street solution to deal with Lehman's toxic assets," said one senior executive at a major bank. "It is a cheaper alternative than having everything unravel." With it unclear whether the gap between the federal government and potential buyers can be bridged, a second group at the New York Fed is focusing on the possibility that there might be no alternative to liquidating Lehman and winding down its operations in an orderly fashion. On Saturday afternoon, the credit-trading heads of major investment banks gathered at the meeting to discuss how to deal with their exposures to Lehman in the intertwined credit-default-swap market. The lack of a central clearinghouse in this market means that dealers, hedge funds and others are directly facing each other in insurance-like contracts that are tied to trillions of dollars in debt instruments. Credit derivative traders at some firms were asked to come to work over the weekend to help quantify their exposures to Lehman and compile lists of outstanding contracts they have with the investment bank. One person familiar with the matter said large dealers contemplated showing each other all of their credit default swap trades with Lehman. Disclosing their positions may enable dealers to find ways to offset their positions with each other wherever possible. Later in the day, some traders were told that Lehman -- with the help of Federal Reserve officials -- will try to figure out which of its counterparties have CDS trades that can be offset. Those counterparties would be informed of the offsetting positions, following which they can unwind their respective swaps with Lehman and concurrently enter into new swap contracts with each other. For example, if one dealer has bought a swap from Lehman and Lehman sold a similar swap to another bank, the two banks could agree to face each other directly. Such moves could help prevent individual firms from scrambling to find new counterparties to rehedge their positions with when the markets reopen on Monday, potentially unleashing turmoil across the credit markets. They could also help facilitate an orderly wind-down of Lehman's derivative positions, if that becomes necessary. Still, sorting out the firm's CDS positions promises to be a difficult and time-consuming task, because many of the contracts have different terms and maturity dates. It is not known how much in CDS contracts Lehman has. In a survey last year by Fitch Ratings, Lehman was listed among the 10 largest CDS counterparties by number of trades and the amount of debt to which the contracts were tied.Wall Street traders poured into their offices Saturday for emergency meetings to consider the actions they would take if Lehman is forced into liquidation. They broke into teams to evaluate their positions and exposure to Lehman in everything from energy trades to equity derivatives to credit, One trader said conditions in the credit default swap market and the short-term repo markets are more stable today than they were in March, when Bear Stearns nearly collapsed, but still, "if they go into liquidation," it is going to be a bad situation on Monday. A disorderly unwind of Lehman's derivatives trades is only one worry. Another worry is that if Lehman collapses, its distressed assets -- such as commercial real estate -- could suddenly hit Wall Street for sale, forcing prices even lower and potentially forcing other dealers to mark down once again the value of their own holdings. Lehman has hired law firm Weil, Gotshal & Manges LLP to prepare a potential bankruptcy filing, according to a person familiar with the situation. The New York-based Weil has a leading bankruptcy practice and advised Drexel Burnham Lambert on its 1990 bankruptcy filing. In a Lehman bankruptcy, the firm's brokerage units would have to enter a Chapter 7 liquidation, in which a court-appointed trustee would take over, liquidate the firm's assets and get Lehman customers back their money. In general, securities that a customer holds at a brokerage firm are legally the investor's property and aren't exposed to the claims of the firm's creditors. In trying to hold firm to their no-bailout stance even while pressing for a deal, federal officials could try to pit Bank of America and Barclays against each other. But that leverage can work only if both banks stay in the discussions. Bank of America and Barclays know each other very well, having considered a merger several years ago. More recently, Bank of America agreed to pay $21 billion for ABN Amro Holding NV's LaSalle Bank of Chicago in 2007. That deal came at a time when Barclays was trying to buy ABN and fend off a European consortium bid. Bank of America's purchase was seen at the time as helping that Barclays bid, which ultimately failed. At Barclays, a big question will be whether CEO John Varley and his No. 2, Mr. Diamond, both agree on buying all or part of Lehman. Mr. Diamond is eager to expand Barclays's U.S. investment bank operations. But the unit, called Barclays Capital, is also responsible for write-downs the bank has recorded. After 5 p.m., bank executives began leaving the meeting, some getting into cars inside a garage where they couldn't be photographed. Those seen leaving included Merrill Lynch & Co. Chairman and Executive John Thain and Citigroup Inc. CEO Vikram Pandit. Bank of New York Mellon Corp. Chairman and CEO Robert Kelly declined to comment. While some executives had left the Fed meeting, those of other firms, including three carfuls of Barclays executives, remained at the Fed office past 6 p.m.At least 20 New York Fed staffers left from another exit. They refused to say if they were done for the night.

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