Saturday, September 13, 2008

U.S. demands that Wall Street save Lehman

International Herald Tribune
Saturday, September 13, 2008

NEW YORK: As Lehman Brothers teetered Friday evening, Federal Reserve officials summoned the heads of major Wall Street firms to a meeting in Lower Manhattan and insisted that they rescue the stricken investment bank and develop plans to stabilize the financial markets.

Timothy Geithner, the president of the New York Federal Reserve, called a 6 p.m. meeting so that bank officials could review their financial exposures to Lehman Brothers and work out contingency plans over the possibility that the government would need to orchestrate an orderly liquidation of the firm on Monday, according to people briefed on the meeting.

Flanked by Henry Paulson Jr., secretary of the Treasury, and Christopher Cox, chairman of the Securities and Exchange Commission, he gathered the executives in person to impress on them the need to work together to resolve the current crisis.

Geithner told the participants that an industry solution was needed, no matter what, and that it was not about any individual bank, according to two people briefed on the meeting but who did not attend. They said he told them that if the industry failed to solve the problem their individual banks might be next.

Lehman Brothers was noticeably absent from the talks.

A spokesman for the Federal Reserve Bank of New York confirmed the meeting but declined to provide details on the discussions.

The Wall Street executives included the following chief executives:

Lloyd Blankfein of the Goldman Sachs Group;

James Dimon of JPMorgan Chase;

John Mack of Morgan Stanley;

Vikram Pandit of Citigroup;

John Thain of Merrill Lynch.

Representatives from the Royal Bank of Scotland and the Bank of New York Mellon were also present.

The meeting was reminiscent of the circumstances that preceded the near-collapse 10 years go of Long-Term Capital Management. At that time, William J. McDonough, then the president of the New York Fed, summoned the heads of big Wall Street banks to the Fed to stop the failure of Long-Term Capital Management, a hedge fund firm that had made big bets on esoteric securities using borrowed money and which had already lost $4.5 billion.

The bankers ended up committing $3.65 billion to save the firm, though Bear Stearns, the hedge fund's clearing broker, refused to contribute to the investment. Traders from the banks wound down the fund over time, averting what might have been big losses across the financial system.

The fallout from a failure of Lehman Brothers could be even more severe, given the firm's much larger size and its entanglements with trading partners around the globe.

Policy makers fear that its losses could ripple through the financial industry at a time when banks and securities firms are trying to overcome $500 billion in write-downs.

One observer briefed on the situation described the session as a "game of chicken" between the government and the heads of the major banks.

Bank of America, Barclays, and HSBC have expressed interest in bidding for Lehman Brothers, according to people briefed on the situation. But they have indicated that their bids are contingent upon receiving support from the government, just as it supported the rescues of Bear Stearns and the mortgage giants Fannie Mae and Freddie Mac.

But Paulson and Geithner made it clear to the company, its potential suitors and to the meeting participants on Friday that the government had no plans to put taxpayer money on the line this time. The government is deeply worried that its actions have created what economists call a moral hazard, and the Federal Reserve does not want to reach deeper into its coffers. Instead, Paulson and Geithner insist that Wall Street needs to come up with an industry solution to try to stabilize Lehman Brothers and calm the markets.

Still, some of the other Wall Street banks, facing billions of dollars in losses themselves, have resisted this approach. They argue that Lehman Brothers overreached and brought its current troubles on itself. If there are no bidders for Lehman Brothers, these banks say they can collect their collateral and liquidate the troubled firm's assets. In this high-stakes game, they may also be trying to call the government's bluff, knowing that if push came to shove, it would provide financial support.

Geithner, who led the session, firmly stood his ground. He told the banks that this was about fixing the system and preventing the crisis from worsening.

By the time Lehman's shares went into a spiral this week, officials at the Fed and the Treasury were convinced that Lehman posed far fewer real risks than Bear Stearns had back in March. The confidence by Washington officials stemmed from the fact that, after the Bear Stearns collapse, they obtained stronger regulatory powers that gave them the ability to peer into the activities and risk exposures of institutions on Wall Street.

Fed officials, for example, are now embedded at each of the big Wall Street investment banks and have at least some capacity to gauge the firms' exposure to hedge funds and other big players, as well as their positions in financial derivatives and other opaque markets. Fed and Treasury officials have also been taking the daily pulse of executives and traders on Wall Street for months, and much of that discussion has been about Lehman.

Officials detected a rising number of defections by Lehman's institutional customers to other firms, but nothing near the panic that caused Wall Street executives to bombard Paulson with dire warnings about a Bear Stearns collapse in March.

Edmund L. Andrews reported from Washington.

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