In the meantime, what a mess:
Regulators and others were preparing for a hectic Monday. The New York Stock Exchange prepared contingency plans over the weekend to reassign the approximately 200 blue-chip stocks that Lehman's specialist unit trades, according to people familiar with the matter. If Lehman is forced into liquidation, the exchange will likely transfer the stocks to one or more of the remaining specialist firms, most likely using the same technology and staff that currently trade the stocks.
Dozens of Wall Street desks have trades with Lehman. As word spread that the Barclays deal was falling apart, worries that the company could be thrown into bankruptcy mounted, and traders labored to get out of those contracts.
At approximately 2:30 p.m., government officials hosted a call, and a trading session was opened to ease fears. One trader said it was agreed that other brokers would pick up contracts that trading desks have with Lehman. If Lehman does open on Monday, the deals struck on Sunday, often at a worse price, would be void. "It is utter chaos here," the trader said.
At many Wall Street firms, traders of credit-default swaps -- contracts that act as insurance against debt defaults -- were told to come to work immediately. Concerned investors were rushing to buy swaps tied to other brokerages and corporations, sending the cost of protection on investment banks such as Goldman Sachs and others sharply higher.
In a statement Sunday, the International Swaps and Derivatives Association, a trade group whose members include many large dealers, said a "netting trading session" took place between 2 p.m. and 6 p.m. on Sunday. The idea was to allow firms to try to unwind their derivatives transactions with Lehman by finding other parties to step into Lehman's shoes.
"The purpose of this session is to reduce risk associated with a potential Lehman Brothers Holdings Inc. bankruptcy filing," it said. It added that trades conducted during this period "are contingent on a bankruptcy filing on or before 11:59 p.m. New York time" on Sunday. If no filing takes place, the trades will be canceled, ISDA said.
As it happens, I was on a panel about new technology regulation this morning. This crisis can be seen as a failure to adequately regulate new financial products that came out of the revolution in financial theory that took place in the late 20th century. One of the main problems, I think, is that regulators became obsessed with certifying things as safe. The agency was supposed to check them out, make sure they were safe, and then approve or disapprove. Thus we hoped to make life in America as safe as a whiffle ball game.
But it is not possible to make things perfectly safe, not least an enormously complicated financial system like ours. But having declared things safe based on the verdicts of 3 government approved rating agencies, we didn't put much focus on how to wind things up if they failed. The FDIC has a very smooth system for handling the liquidation of commercial banks, and as a result, no one panics. We should have been thinking about something similar for investment banks.
We need to shift our focus on regulation from a fruitless search for 100% safety to accepting risk, and trying to make the markets more robust to withstand it. The government should encourage, rather than discourage, multiple sources of information and analysis. It should pay more attention to outlying risks. And it should have systems in place to wind down the inevitable failures, rather than letting the outcome depend on how Hank Paulson is feeling this morning.
According to The Onion, Fitch and Moodys downgraded Lehman debt to junk status this morning.
Oh, wait, that wasn't in The Onion, but in the WSJ. My bad.
Not as sure as you are that this is a capricious move by Paulson (cf. "how [he's] feeling this morning". That said, the broader point about regulation being more effective as risk management rather than a system of binary permissions/proscriptions is more on the mark, particularly in complex systems.
BTW could you post up some advance notice when you're doing some of these panels? That one could have been quite interesting.
Given that there are only two independent investment banks of any size left, I'm not sure that an system for their orderly liquidation would be on my list of priorities.
Lehman Brothers filed the largest bankruptcy petition ever
I'd just like to say, as someone who has worked for a judge: I'm feeling for the law clerks this morning. What a Grade-A PITA, to be dealt with on a government salary.
We should have been thinking about something similar for investment banks
The danger now is that we have to worry about the insurance companies as well. If counterparty contagion spreads ... Good night Irene.
Thanks for shedding some light on a story that's important and compelling but one that this news junkie doesn't really understand.
Am I right in thinking that part of what's gone on here is that people have developed a series of ways of shielding the financial markets from risk but that in the end someone has to bear that risk and when the music stopped it's Bear Stearns, Lehman, Merrill and others TBA?
"We need to shift our focus on regulation from a fruitless search for 100% safety to accepting risk, and trying to make the markets more robust to withstand it."
Yes, but that would amount to a 180-degree turn in the approach that the public, press, and government take not only toward regulation but just about everything. The first question that gets asked whenever something bad happens is "What can we do to make sure [insert disaster du jour here] never happens again?" And the activist groups...their whole raison d'etre is to press for ever-increasing layers of rules and regulations (written by them, of course) on the grounds of "safety".
In other words, our whole culture is focused on trying to ensure 100% safety. If you know how to turn that around, let's hear it.
Megs, I agree with you, as usual. But it's not only how Hank Paulson feels that day, it's also the fact that Lehman wasn't too big to fail. Their mistake was not blowing up earlier and bigger. Think about it: Cayne's $10/share for BSC is looking pretty good right now. Also, I think the counterparty risk argument is a bluff and it's been called today. If Wall Street wanted a deal, then it would have happened. It didn't happen because they figured any mess would be smaller than the problems of actually owning...whatever the hell Lehman owns.
If anyone needs me, I'll be selling oranges by the freeway.
I'll be with Freddie.
Sarah Palin either a) doesn't know what the FDIC does or b) doesn't share Megan McArdle's enthusiasm for the organization. Last week Sara Palin was quoted as saying:
"I don't want some bureaucrat standing between you and your money," Palin said to the cheering crowd of 5,000. "The liberal elites will tell you they know how to handle your bank accounts better than you do. But where I come from, we think we don't need another big federal agency handling our hard-earned paychecks.
"That's why I've fought earmarks and said 'thanks, but no thanks' to the Bridge to Nowhere. And that's why, as your Vice President, I'll reduce the size of government by drilling in the Federal Deposit Insurance Corporation."
I suspect the correct answer is a) and that Sarah Palin is no more knowledgable about the FDIC than she was about the Bush Doctrine.
Davido,
It looks like musical chairs, but minus the chairs.
Last week Sara Palin was quoted as saying:
In an article that is obviously intended as satire.
Michael Berube was accused of really unimaginative satire in a complaint filed with the the Federal Humor Control Board. However, with Bush's lame duck status, the Senate has refused to fill any of the open seats leaving the board without a quorum. Action on all complaints will be delayed until Obama takes office and appoints Al Franken, Steven Colbert, and Moe.
Michael Berube was accused of really unimaginative satire
I don't know, I kind of liked this line: "Besides," he added, "if there really are deposits of insurance in the FDIC, why shouldn't we drill for them?"
Rob,
Yeah, that line wasn't too bad.
Just like I said in my far too long comment on the other thread. Regulations can't work, because 300 people on government salaries can't imagine in 1 year everything that a few million people world wide on serious finance/law/accounting/consulting salaries will figure out in 5-50 years (some finance regs are REALLY old). Especially when the typical career path for those 300 people is to leverage their inside experience of a few years int a high paid job figuring out how to exploit the rules.
A seriously great exploration of this is "Traders, Guns, & Money". Detailed histories of cases where institutions that were "strictly regulated" managed to legally do things that they were explicitly not allowed to do. 10 guys who can get a Ferrari with the right idea will easily out think any number of lawyers with a $75k starting salary.
I await the usual suspects explaining how the regulations will just work because government bureaucrats and politicians mean well.
It was fascinating watching Merrill and Bank of America's stock prices today. Merrill went from 17 to 22 on this morning's opening, but closed at 17 anyway (with an offer on the table of 29- all stock, however). Bank of America has trended down all day long is down over $7/share.
Well, now we get to see if that creative destruction business is as good in practice as it sounded in theory.
"Michael Berube was accused of really unimaginative satire in a complaint filed with the the Federal Humor Control Board. However, with Bush's lame duck status, the Senate has refused to fill any of the open seats leaving the board without a quorum. Action on all complaints will be delayed until Obama takes office and appoints Al Franken, Steven Colbert, and Moe."
Oh the irony!
Joel,
I am a beneficiary of the Senate's obstructionism.
Sooooo, given that Lehman filed at 12:02am (i.e., over 15 hours before this post), why are you still talking about ISDA trades that don't count?
Oh, they'll count. No court will let you off for something as tiny as that.
I think B of A's bid for Merrill is for a fraction of a share of B of A (like .83 or something, I'm too lazy to look) rather than $29 per share.
I suppose if Lehman sets off a cascade, Paulson and Bernanke can step in then, albeit at a much higher cost.
If this gambit to call the market's bluff works, they'll go down in history as geniuses.
Oh, they'll count. No court will let you off for something as tiny as that.
If Lehman intended to timely file to make the session count, they wouldn't have missed by 3 minutes. They had some reason to miss the deadline--and failure to enforce the rules ISDA itself made up would provide Lehman with leverage that ISDA (and all of the counterparties) would certainly prefer it not have. Can't set the rules of the game and then decide to ignore them without consequences.
I wonder who advised ISDA to set 11:59pm, rather than "prior to trading open in [euro markets]" which would have accomplished the same thing w/o the possibility of Lehman gaming the deadline as they appear to have done.
If Lehman intended to timely file to make the session count, they wouldn't have missed by 3 minutes.
Are you kidding? Their lawyers probably found a typo in the final copy or a paralegal went to the bathroom at a bad time and left the partners standing around wondering how CM/ECF works. There's not a law office in the country that hasn't run red lights trying to make it to the courthouse before 4:30.
Can't set the rules of the game and then decide to ignore them without consequences.
This is substantial compliance with the rules. The difference is too small to matter. Maybe everyone will back out, but given that there was no prejudice to anyone because of the 3-minute delay, I find it unlikely that any court will endorse this kind of flyspecking. Hey, I could be wrong, though, so we'll see.
Ethics Question: If you take a job at a company that you later find is intent on running itself into the ground, what obligation do you have to point that out?
I could see having the obligation to point it out once, maybe twice, maybe even three times, but no more than that.
To Yancey Ward:
You understand that because it's an all stock offer at a fixed exchange ratio, the offer from BofA is no longer worth $29/share, right? The offer is ~0.85 shares of BofA per Merrill share, which at BofA's Friday close of ~$33.50 was worth ~$29. But if BofA's share price drops $7, the value of its offer drops $6.
You also see a higher risk discount to the nominal offer price in an fixed exchange stock deal, because that discount reflects not only uncertainty of close but uncertainty around where BofA's shares will ultimately be trading at close.
TH,
Yes, I understood most of that (but was unsure if the offer was set at a firm $29 worth of BofA stock or a set fraction of a share that would not change), but it was interesting watching the actual market participants value the deal by selling/buying each company.
A lot of the talk last night was wondering why BofA was paying a premium to Friday's close. I guess now we can say that the market will actually set the price over the coming months.
If Lehman winds down in an orderly fashion. We still don't know who will buy what and when. There is the serious issue of Lehman's counterparty risk which are unknown to investors at this point.
However, perhaps the larger story is the wave of writedowns to risked by a fire sale on Lehman assets. Right now no one has said anything to that removes this from the table.
Moreover, Lehman falling makes things seem worse for AIG. If the Fed didn't step in to save Lehman then who wants to be the first to stick out their neck for AIG. This is a Prisoner's Dilemma of the worst kind and isn't that exactly what we have government for.
In the end, this by Paulson is gutsy. If it works then he is a courageous defender of the public trust. If it fails then we may be responsible for deepening the crisis and possibly being the straw that sent the US economy into recession.
The WSJ today points out that of the five independent investment banks only two remain standing, possibly signaling the end of a Wall Street institution. They're either dead or absorbed by consumer banks.
How high are the barriers to entry for a new investment bank? I assume they're very high, since there haven't been any big startups recently and a lot of consolidation over the last 50 years.
Still, could some hedgies boot up a new investment bank in the space left by the victims?
My guess is that we wouldn't be seeing any new investment banks popping up in the new future, not with the sub prime crisis and impending recession.
This is substantial compliance with the rules. The difference is too small to matter.
Not to put too fine a point on it, but that's horseshit, Rob. If it was a mere screw up, then WGM will file (or, more likely, has already filed) a pleading asking for the filing time to be deemed to be 11:59. If not, they did it on purpose.
Basically, unless the cock-up was b/c of the ECF system, WGM did that intentionally, most likely to keep options open. Whether that was warranted or wise, I don't know, but if it were just a mistake (your "LA in the bathroom" scenario--as if they didn't have 12 LAs working all weekend), it would be grounds to fire WGM. There is nothing that excuses missing a deadline in bankruptcy, especially for a firm with the resources of WGM.
There is nothing that excuses missing a deadline in bankruptcy
But there was no "deadline" here. It's not like they were up against a statute of limitations. There were contracts which specified a condition subsequent. That condition was substantially met with a trivial deviation. Unless the contracts were explicit about time being of the essence (and they may have been, I haven't seen the text), then there's no reason to think an actual judge is going to let 3 minutes stand between the markets and an orderly winding up.
I agree there's no excuse for a screw up, but that doesn't mean there can't be a screw up.
Time will tell who is right on this one.
FWIW, I emailed ISDA and they say that traders who wanted to validate their trades despite the late filing were permitted to do so; presumably some did.