Dead Firm Walking

Lehman is a sad tale, a classic story of hubris and greed. The chances were there to fight another day, but Trader Fuld forgot the key tenet of trading in fast markets: LIQUIDITY CREATES OPTIONALITY. He gambled the liquidity card, and lost. In the absence of liquidity, there are no options. But wait, how about that Fed window? Well, not exactly the unlimited safety net perhaps anticipated by Lehman management. The Fed’s liquidity creates optionality for whom? Lehman shareholders. Suffice it to say, the Fed is in no mood to hand out any more subsidies to any more shareholders, at least not during this Administration. And the Fed isn’t going to be left holding the bag once again, not if it can help it, ergo, their role in getting Lehman sold – and fast. Had the Fed been willing to silently wait on the sidelines, implicitly backstopping Lehman’s centi-billion dollar balance sheet, it is possible that Lehman shareholders could have witnessed a V-turn in the stock price once liquidity re-entered the MBS and CMBS markets and values started to trade up. But this is not a waiting game either the Fed or Lehman’s counterparties were willing to play.

So what now? Lehman and BofA? HSBC? Santander? Barclays? Come on. Lehman has a brand. It has some good groups. But it has a balance sheet hole that simply raises too much uncertainty for a buyer in today’s fragile markets. Further, no big acquisition of an investment bank ever works. It always has been and always will be about the people; the Lehman brand, in a vacuum, isn’t worth anything. There is no goodwill. It inevitably gets written off years later, when acquirer managements are finally willing to face into their failures. Which speaks to letting Lehman fail and picking up the pieces, e.g., the best people and teams, after the fact. Why deal with the milk when you can skim the cream? This is fine if you are a buyer of post-failure Lehman assets, but it doesn’t really help Lehman shareholders or the Fed (or the U.S. taxpayer, for that matter).

My Good Bank/Bad Bank suggestion will happen – it just won’t be done privately; it will be done publicly. If the KDB or other potential investors aren’t going to step up (because of Fuld’s mind-boggling, shareholder value-destroying stubbornness), the Fed will perceive that it has to. It will be 1989 all over again. The Fed will partially capitalize the Bad Bank after selling off the Good Bank assets (for whatever can be gotten; the realizable value is dropping every day), and a group of investors (read: hedge funds) will walk away with a sweetheart as they did in the 1980’s FSLIC bailout (Richard Rainwater, Apollo, etc.). I view this as being a high-probability outcome, unless one of the potential acquirers hits the bid in a drunken stupor and buys this pig before it is slaughtered. But if they do this after witnessing all the failed attempts at integrating an investment bank into an existing commercial banking business, I’d short the stock and laugh all the way to the bank.

At least moral hazard is moving up the capital structure: first there was protection for equity holders, now there is air cover for unsecured debt-holders. We’re going in the right direction, but we still seem to be a ways away from the time when the Fed and the Treasury will do what is right and fair in the marketplace: LET THEM FAIL.

 Sad Songs Say So Much