As Wall Street ponders the effects of the Lehman Brothers Holdings Inc.’s bankruptcy and Bank of America Corp.’s acquisition of Merrill Lynch & Co. investors are wondering whether today’s developments will tarnish the U.S.’s image as a leader among world financial markets. Before the end of the trade today, the announcements made by the two storied banks, helped cause the New York Stock Exchange to plummet more than 500 points, and caused European markets to tumble. Markets in Asia were closed for holidays.
In an early-morning announcement, Lehman Brothers said it was filing for Chapter 11 bankruptcy protection after attempts to rescue the 158-year-old firm, which was struggling under $60 billion in bad real-estate holdings, failed. Lehman said that none of its broker-dealer subsidiaries or other units would be included in the bankruptcy filing and all of its broker-dealers will continue to operate. Bank of American also said in a statement early Monday that it would acquire Merrill Lynch in an all-stock transaction valued at $50 billion.
“The major investors including mutual funds, pension funds, and private-equity investors are moving money from the stock market to the Treasuries and Bond markets,” says Samuel D. Melvin, a mortgage planning agent at Desert State Mortgage, LLC. “This increases the value of the treasury and market bonds, which in turns takes pressure off of mortgage interest rates, driving them lower.”
Last week Lehman shares lost 45% after the financial company announced a third quarter loss of $3.9 billion. Standard & Poor’s Ratings Services said today that it removed Lehman from CreditWatch and lowered its long-term counterparty credit rating to ‘SD’ (selective default, meaning payments may not be made on some financial obligations), from ‘A’.
“I think it serves to cause all banks to look at transactions a little bit more conservatively,” says Bob Nesbitt, president of the Alabama division of Atlanta-based Citizens Trust Bank (No. 6 on the B.E. 100s Banks list with $338 million in assets). “The investment firms are traditionally firms that buy securities including mortgaged backed securities. As they have more problems it will cause their underwriting to be a little bit more stringent, which will in turn cause commercial banks to be a little more careful in their lending practices.”
Meanwhile, Bank of America’s acquisition of Merrill Lynch will create a company that will rival Citigroup Inc., the biggest U.S. bank, in terms of assets. By adding Merrill Lynch’s more than 16,000 financial advisers, Bank of America would have the largest brokerage in the world with more than 20,000 advisers and $2.5 trillion in client assets, Bank of America said. The combined company would have strong positions in retail brokerage and wealth management.
“Acquiring one of the premier wealth management, capital markets, and advisory companies is a great opportunity for our shareholders,” Bank of America Chairman and Chief Executive Officer Ken Lewis said in a press release. “Together, our companies are more valuable because of the synergies in our businesses.”
“I think it is a consolidation which most people in the business thought needed to happen to get out of the malaise that we are in,” says Dave Jones, president and CEO of Castle Oaks Securities (No. 9 on the B.E. 100s Investment Banking list with $66 Billion in Co-Managed Issues.) He called the forced consolidation a good thing. “With three players out of the market place (Lehman, Merrill Lynch and Bear Stearns) that means increased business for us. Their models might be different but we’re talking to the same client.”
The deal comes as many banks have had difficulties amid the sub-prime credit meltdown. Just last week the Treasury Department took control of mortgage giants Freddie Mac and Fannie Mae in an attempt to shore up the nation’s weakened housing market.
Who Is to Blame?
Benn Steil, a senior fellow and director of international economics at the Council on Foreign Relations, suggests that many of the problems
“Lehman Brothers’ central position in the OTC credit derivatives market emphasizes the critical importance of improving risk management in large OTC markets,” he said. He suggests that a well-capitalized central party, called a Clearinghouse, would protect markets and also renew the emergence of derivatives on exchanges.
However, not all economists agree with that point of view.
“The idea that the lack of regulation is to blame for what’s gone wrong is suspect,” said Sebastian Mallaby, director of the Maurice R. Greenberg Center for Geoeconomics and senior fellow for international economics at CFR. “On the one hand Fannie and Freddie were highly regulated and they still needed a bailout. Regulated banks such as Citigroup lost huge amounts of money. Meanwhile, rather lightly regulated hedge funds have had some trouble but less than the more regulated parts of the financial system.”
Last October, Lehman brothers entered into a groundbreaking corporate-academic partnership with Spelman College to establish and develop the Lehman Brothers Center for Global Finance and Economic Development. Lehman Brothers committed $10 million which would go towards the development of an interdisciplinary curriculum and courses, the creation of a new scholarship program, and the recruitment of new faculty. Neither Spelman College or Lehman Brothers will comment as to whether this partnership will continue or if the money still needs to be distributed.
Adding to the uncertainty in the markets, American International Group Inc., the world’s largest insurance provider, received special permission to transfer some assets to access about $20 billion in cash for short-term liquidity, a move that was approved by the New York Insurance Department. Additionally, Gov. David Paterson sent Insurance Superintendent Eric Dinallo to work with the Federal Reserve on a plan to help AIG.
“Wall Street’s continuing problems should serve as a stark reminder that this recession is far from over. New York State has taken the first step towards helping to stabilize AIG, which is otherwise a very healthy company,” said Paterson. “On a state level, we were able to reach a market-based solution that will stabilize AIG at no cost to New York taxpayers. Policyholders should also know that they are safe, and their insurance policies are still good. AIG’S insurance companies are financially strong, and the Insurance Department will continue to ensure that they remain strong.”
AIG has $1 trillion in assets, and more than 100,000 employees.AIG dropped $7.38 to close at $4.76 in New York Stock Exchange composite trading. The shares traded for $65.96 a year ago.