It's Lehman's turn in the woodshed
The North American stock markets are not open for another 90 minutes, but that hasn’t stopped investors from dumping their shares in Lehman Brothers (LEH:NYSE). By 7 am EDT, the stock was down about 18% in premarket trading, to US$32.25. The loss grew to 28% before 8am, to US$28.20.
There’s one thing you need to understand about many of the complex risk models at the various banks across North America: one of the key inputs is public company share price performance. Within the RAROC model (Risk Adjusted Return On Capital), for example, an important driver of the risk rating of a business is the action of its stock. The theory is that the stock market is a better predictor of default risk than credit agency ratings. JP Morgan (see prior post “JP Morgan inks the deal of the year” March 16-08) is one of the key disciples of RAROC.
When credit officers turn on their computers this morning, the risk rating on Lehman Brothers will have jumped sky-high, given the performance of the stock on Friday and early this morning. Nothing will have changed at Lehman, but it doesn’t matter. Institutions will have no choice but to reduce their funding relationships or demand more collateral for the same trades — the risk models will require it.
South Asia’s largest bank, DBS Group Holdings, pulled their relationship with Lehman earlier this morning according to the WSJ, although once word got out an internal communication was issued, reversing the prior direction:
Lehman’s stock was battered overnight, tumbling 27% in premarket trading to $28.49 after the developments around Bear Stearns and amid word that DBS Group Holdings Ltd., Southeast Asia’s biggest bank by market capitalization, had asked several traders not to make new transactions with Lehman. An email later reversed those instructions, said a person familiar with the matter.
Earlier Monday, DBS sent an email to several traders instructing them not to conduct any new dealings with Lehman Brothers or Bear Stearns Cos., two people familiar with the situation said.
DBS didn’t deny the existence of the first email. “There are still transactions with Lehman that went through today,” a spokeswoman said. “Given the current market conditions, we are merely exercising more vigilance and reviewing all new transactions on a case-by-case basis.”
Moodys has stepped in to support Lehman, affirming its A1 credit rating.
We’ll see if equity investors find that to be sufficient to end the rout on Lehman prior to the market opening…but I doubt it.
My hypothetical question for everyone is… what would the world look like if all debts were called tomorrow?
AT – I see one of two scenarios:
1. a post-nuclear apocalyptic nightmare where mass poverty engulfs the G7 nations as loan defaults trigger systemic losses and bankruptcies, and all i-bankers, securities law firms, accountants and rating agencies are thrown into the oceans, or
2. a land of sugarplums and fairies where everyone is happy that there’s no more economic reliance on fractional reserve monetary systems and everyone can get back to the business of generating wealth by manufacturing tangible assets—oh, and all i-bankers, securities law firms, accountants and rating agencies are thrown into the oceans.
“It’s Lehman’s turn in the woodshed” oh gosh i am still on the floor laughing my ass off. if all debts were called in tomorrow i guarantee somebody already thought about it and is trading puts or bets and shorting and longing them. if it does happen that trader or firm would be the new “fractional reserve monetary system” since he, she or it would have all the capital and liquidity. i doubt this would happen since the fed would have an epiphany and flood the market with currency as it is doing right now. so the answer to your first question under normal market conditions with the removal of the circuit breaker in the stock market some type of crash would have plunged the financial markets into hell. not to mention the fed playing match maker and giving our tax dollars to certain financial players to artificially hold or stabilize a very delicate financial system on the verge of collapse. so no i really do not think the banking or financial system will collapse but rather transfer to one entity. the key is to know which entity and to place shorts and longs on it. and no the fed is not that entity it just will control it behind the scenes 🙂