Monday, September 15, 2008

Lehman, Merrill Lynch and AIG - the Morning After

The 'Helicopter Economics Investing Guide' is meant to help educate people on how to make profitable investing choices in the current economic environment. In addition to the term helicopter economics, we have also coined the term, helicopternomics, to describe the current monetary and fiscal policies of the U.S. government and to update the old-fashioned term wheelbarrow economics.

Monday, September 15th was a bloody day on Wall Street. The Dow dropped 504 points, in its biggest point loss since 911. The financial stocks led the way down. Lehman went to 21 cents. Merrill Lynch, the success story of the day gained an entire penny. Its acquirer, Bank of America, fell over 20%. The market made it abundantly clear what it thought of the Merrill acquisition. AIG, the latest and the most serious of the financial blow ups, lost almost 60% of its value.

The day's trading tone was set when Lehman declared bankruptcy in the morning claiming in its filing that it had $639 billion in assets and $613 billion in liabilities. A three day marathon session at the Fed's New York offices failed to piece together a rescue package. All the possible acquirers wanted federal government guarantees for Lehman's bad loans and the government refused to grant them. The real reason for this refusal has yet to come to light. It is highly unlikely that Paulson or Bernanke suddenly realized fiscal responsibility was a good thing. More plausible explanations are that the money is simply no longer available; Lehman has already borrowed some astronomical sum through the Feds PDCF and the Fed was unwilling to throw more good money after bad; or the authorities realize there is going to be a need for funds for a much more serious bailout in the near future.

The deal that was pieced together at the weekend session was Bank of America (BAC) acquiring Merrill Lynch in an all stock deal. The acquisition price was based on the price of 0.8595 shares of BAC and rises and falls with BAC's price. Initially estimated to be worth $29 a share to Merrill, the takeover price had fallen to just under $23 by the market close on Monday. According to news reports, the takeover was 'encouraged' by the Fed and the Treasury department.

Also resulting from the meeting was the creation of a pool of $70 to $100 billion put together by a consortium of big banks to lend to financial institutions in trouble. This purpose was to prevent the dumping of close to worthless bond holdings on the market, driving their prices down even lower - and forcing banks to record the actual prices on their books, instead of the inflated ones currently being used. The Fed said that for its part it would be more generous with how it handled its credit facilities to help support this effort.

AIG, the biggest insurance company in the world has literally imploded since the end of last week. Its problem is somewhat different from the those being experienced by Lehman, Merrill and Bear Stearns before them. Exposure to CDOs (credit default swaps) is AIG's undoing and this seems to be the first derivative meltdown of the credit crisis. AIG was saved, at least temporarily, from oblivion when New York State agreed to let it tap $20 billion as a 'loan' from its subsidiaries. JP Morgan and Goldman Sachs were exploring putting together a credit facility of between $70 and $75 billion for AIG with the 'full support' of the Fed. AIG had first tried to get a $40 billion precedence setting loan directly from the Fed itself. Considering that the market cap of AIG was just under $13 billion at the market close on Monday, any loan even close to to that amount, let alone way above it couldn't be justified as being financially sound.

Next on the list of possible insolvencies, Washington Mutual and Wachovia did not fare well either in Monday's action. Washington Mutual was downgraded to junk status by S&P (Moody's had cut it to junk last week) and fell 27% to 2.00. It is already perilously close to the less than one dollar price that indicates an imminent bankruptcy. Wachovia fell 25% on the day closing at a much safer, at least for now, 10.71.

NEXT: The People's Republic of the U.S. - the AIG bailout

Daryl Montgomery
Organizer, New York Investing

This posting is editorial opinion. Like all other postings for this blog, there is no intention to endorse the purchase or sale of any security.

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