The Economy Guy

Lehman Bros is about to go bankrupt – and I’m writing this before it happens.  If it doesn’t happen, then the pain continues as it has in the past weeks for the financial sector of stocks and the stock market as a whole.  If Lehman declares bankruptcy, watch out!!!!!!  The FED appears to have chosen to NOT back any purchaser of Lehman – as it guaranteed loans for Bear Stearns sale to JP Morgan.

This will be unprecedented. On Monday, the stock market will go crazy, and won’t know whether to cheer or cry!!!!  I can’t predict which way it will go, but it will go BIG.

BUT, stocks are not the market to watch.  Watch all the others – watch bonds, and watch futures.  

The CDS market where “re-insurance” goes on (and is a $150TRILLION market) is the one that will get shaken.  This market opened for 2 hours on SUNDAY – something it never does – it’s like having your local bank open on a Sunday because it wants to help you (personally) through some problem – it just doesn’t happen.  However, that market did open for 2 hours on Sunday so its members (lots of self interest) could trade “Lehman” debt problems before it declares bankruptcy later on Sunday.  You see – after Lehman declares bankruptcy, all trading MUST STOP.  So, the pre-bankruptcy trading gives these trading firms time to buy/sell their obligations before the “s… hits the fan!”

How did Lehman get in this mess??  The CEO (known as the Gorilla – I guess this means he intimidates people) is the wrong person in charge of a company going down the toilet.  He may be wonderful in a growth environment, but he can’t find the toilet paper in the bathroom during an emergency.  Just chalk this one up to a single personality creating history.  He’s about the only CEO of the big investment banks not replaced during the last 24 months.

BUT, that is NOT the really BIG NEWS in my opinion.  Bank of America has agreed to buy Merrill Lynch for $50B (about half price from the good old days).  This is a permanent change in the landscape of investment banking – one of the big boys is going to be run by a “real” bank.  This is great news for you, me and the FED – who must be worried sick about Lehman going under.  Having real “bank” management at one of Wall St investment banks will bring order to at least one of the big boys, and maybe cause all the remaining boards to consider how they are being managed – i.e. What policies do they have in place that REALLY would prevent risky investments from happening in the future?

Merrill Lynch cut this deal with BofA in 48 hours of negotiation.  Think about that for a second.  Merrill could see the Lehman handwriting on the wall, and got out of their problems before the Lehman toilet flushed, and dragged them down the drain too.

Merrill had previously known it was in a very bad position, and had fired its CEO, and tried to repair its balance sheet.  As part of that repair, it sold $30B in mortgage back securities at 22 cents on the dollar.  How would you like to buy a house at that steep a discount???  However, that wasn’t enough of a fix for Merrill.

Bank of America had been in negotiations with Lehman, and dropped Lehman when it saw a much better deal at Merrill Lynch.  Bank of America was in a perfect position to make this deal happen – it knew what was going on more than probably the FED knew.

By the way, in both the Lehman Bros and Merrill Lynch cases, the writedowns are not done yet.  They are so bad in Lehman’s case, they are declaring bankruptcy.  Maybe in Merrill’s case too – who knows besides Bank of America?  The drip, drip, drip of Balance Sheet writedowns is continuing as the housing price meltdown continues, and won’t stop until the housing prices stabilize.  Bank of America is taking on a risk by buying Merrill, and could be threatening its own future if housing prices fall much, much more.  Bank of America clearly thinks that we are near (sometime in 2009??) the bottom of the housing problem – and they are willing to take this risk.