In the wake of the sale of Bear Stearns (BSC) to JPMorgan Chase (JPM) for the investment-banking equivalent of pocket change, the worry now on Wall Street is that the high-stakes game of dice the big firms were playing with asset-backed securities of dubious quality may force more players to exit the table.
Fear that the crisis of confidence that hit Bear Stearns last week, causing the fifth-largest U.S. investment bank to be sold for 2% of its former value on Mar. 16, could quickly spread to other big firms was only partly relieved by expansion of the Federal Reserve's discount window to other kinds of players, broader collateral, and longer lending terms.
Treasury Secretary Henry Paulson's assurances Mar. 17 that the Fed and the Treasury could be counted on as lenders of last resort if any other banks face liquidity shortages rekindled investor confidence in the broader equities market but offered scant comfort to investors in financial stocks.
And that has market players asking: Who may be next?
More Subprime Fallout
Some figure Lehman Brothers (LEH) may be vulnerable to a liquidity seize-up. Shares of Lehman took a beating Mar. 17 because of the similarity of its business model to that of Bear Stearns. Lehman shares lost as much as 48.4% of their value before bouncing back to finish 19% lower, at $31.75.
Other big names got caught up in the selling as well. Morgan Stanley (MS) shares fell 8%, to close at $36.38. Citigroup (C) shed 5.9%, to end at $18.62, and Merrill Lynch (MER) lost 5.4%, to trade at $41.18.
The pounding Lehman shares took was understandable given concerns that its relatively heavy exposure to the subprime mortgage market puts its capital balance at risk.
"At Lehman, fixed income is very big. They were leaders in securitization of mortgages. Bear was No. 2," says Christopher Whalen, managing director at Torrance (Calif.)-based Institutional Risk Analytics, which builds customized risk-management tools for audit firms and others. "That's why everybody is looking at Lehman now."
And though Lehman has a stronger investment banking business than Bear did, its merger-and-acquisition advisory services are effectively worthless in view of the credit freeze, making Lehman next on the target list for a liquidity crisis, Whalen says.
The "Pro" Lehman Position
Deutsche Bank Securities disagrees, upholding its buy rating on the stock and declaring in a Mar. 17 research note that Lehman is not Bear. As that note got some play in the financial media on Monday, it may have helped prompt investors to rethink their gloomy outlook for Lehman, leading to the bounce in its share price as the market closed.
Deutsche Bank (DB) analyst Michael Mayo cited Lehman's $2 billion working capital line with 40 banks as proof that counterparties haven't lost confidence in the broker-dealer and pointed to the fact that nearly half of Lehman's franchise is outside the U.S. and that its asset-management business is more than twice as large relative to its size as evidence of its diversified business model.
Mayo predicted that Lehman will weather the credit storm and reaffirmed his estimate of a price-to-adjusted-book-value ratio of 83%. At the close of 2007, Lehman had $35 billion in excess liquidity, combined with $63 billion of free collateral, implying $98 billion available for liquidity, or $70 billion more than needed for $28 billion of unsecured short-term debt, including the current portion of long-term debt, Mayo wrote in his note.