Will the US Government allow another big bank to fail? Kohler

Would Hank Paulson and Ben Bernanke let investment bank Lehman Brothers go bust, if it came to that? Yes, they probably would, but not without a lot of trepidation.

Would Hank Paulson and Ben Bernanke let investment bank Lehman Brothers go bust, if it came to that? Yes, they probably would, but not without a lot of trepidation.

Bernanke put the Fed’s balance sheet behind the takeover of Bear Stearns by JP Morgan, and according to Bryan Burrough’s account of the last days of Bear in Vanity Fair, although Paulson set the price of the takeover, and made sure it hurt, he also signed a document confirming that, in the event Bear defaulted on its securities, the American taxpayer would pay the tab.

And it was Paulson who put together the bailout of Fannie Mae and Freddie Mac, with a government cheque for $US1 billion in new equity, plus further unquantified equity and debt.

But Lehman? The view on the street is that this venerable 157 year old would be left to sink, alone.

It’s all about counter-party risk. Reuters has a story quoting financiers to the effect that Paulson is likely calling friends on Wall Street asking what their exposure to Lehman is, and how much loss they are willing/able to take.

A New York University economics professor, Lawrence White, is quoted as saying: “It’s a close call. I don’t think there would be a big effect on the stock market … if (the counter-party risk is) relatively small, the Fed turns its back and says tough luck.”

David Trone, an analyst with Fox-Pitt Kelton, no doubt expressed the fears of many with this quote in the New York Times: “Some may worry that Treasury has taken on so much taxpayer burden they don’t have any remaining capacity … to take on the burdens of Lehman.”

The real problem facing the US financial system now is that the strong are not strong enough to help the weak.

In 1907 John Pierpont Morgan bullied and cajoled other financiers to take over the failing Knickerbocker Trust Company, and in 1998 Alan Greenspan organised a Wall Street bailout of the hedge fund Long Term Capital Management (which by the way, Bear Stearns, alone, stood aside from).

This year JP Morgan bought Bear Stearns, but only after the Federal Reserve guaranteed $US30 billion of its worst assets.

But there will be no appetite for doing the same with Lehman. Its investment management business is saleable, and that is now on the market.

But now Lehman Brothers is on death-watch. The story of how Bear Stearns was brought down by rumours and short selling, as told by Burroughs in Vanity Fair, is truly horrifying; now it’s Lehman’s blood in the water.

It will be saved only by the damage that would be caused by its death.

This article first appeared on Business Spectator