Lehman: This time, feds let a big bank fall
As venerable Wall Street firms succumb to the home loan crisis, focus shifts to limiting taxpayer cost.
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Washington Mutual, one the nation's biggest mortgage lenders, has also been pummeled by investors in the past week.Skip to next paragraph
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Merrill Lynch, despite its long emphasis on serving retail brokerage clients nationwide, fell victim to its own load of hard-to-value real estate investments. It was not on the brink of bankruptcy, but a plunging share price pushed it toward a rapid $50 billion deal Sunday to be acquired by Bank of America.
The merger will pair Bank of America's huge depositor base with Merrill's investment brokerage. But in the short term, it also saddles the bank with Merrill's sour real estate portfolio.
Mr. Shin says policymakers, including Treasury Secretary Henry Paulson and Timothy Geithner, president of the Federal Reserve Bank of New York, calculated that financial markets could weather the storm following a Lehman collapse.
"The Lehman problems have been so well [known], the hope was that the web of interlinked obligations and claims was not as serious" as when Bear Stearns collapsed, he says. "Time will tell whether this was the correct move."
Even in the rescue of investment bank Bear Stearns and mortgage giants Fannie and Freddie, the Fed and Treasury imposed a measure of market discipline – showing aversion to any bailout for private-company shareholders.
But the interventions did bail out the financial system. "Now it becomes a matter of who don't you help," finance expert Joseph Mason said in an interview just after the Fannie/Freddie takeover. "Who doesn't get help other than the hurricane victims?"
Lehman Brothers, apparently, is the reply.
Mr. Mason warns that bank failures could leave the Treasury with $100 billion or more costs beyond its current deposit insurance fund. The cost to keep Fannie and Freddie healthy could be as high.
Minimizing taxpayer costs may be a matter of choosing among bad options. Judging by history, a point will come when so-called vultures swoop in to buy distressed assets, forming a bottom in real estate. But many financial firms are highly leveraged, investing with borrowed money. That creates a risk that firms including hedge funds, now rushing to "delever" and rebuild a safety cushion of capital, will create a glut of assets on sale.
Some finance experts say the Treasury may ultimately need to set up a fund to buy bad assets, or liquidate failed institutions, as the Resolution Trust Corp. did in the wake of the 1980s savings-and-loan crisis. Recovery in financial stocks "is likely to be when the government forms an entity specifically designed to facilitate the consolidation of the financial sector," Richard Bernstein, chief strategist at Merrill Lynch, wrote recently.