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Fallout: The Financial Crisis

Big firms’ failures aren’t the last of it

Bob Moon Sep 15, 2008
Fallout: The Financial Crisis

Big firms’ failures aren’t the last of it

Bob Moon Sep 15, 2008


KAI RYSSDAL: Like anybody who does a lot of public speaking, Henry Paulson knows it’s best to start things off with a joke. So the Treasury secretary gave it his best shot today when he stepped to the podium at the White House.

HENRY PAULSON: Good afternoon, everyone. And I hope you all had an enjoyable weekend. [Laughs] Yeah, yeah, well …

Yeah, would have been fine except for that nervous laugh there at the end, don’t you think? But really, who can blame the guy for a little bit of stress. Arguably, it was his decision last week not to bail out Lehman Brothers that set off the scramble yesterday — a last minute search for a handout or a buyout.

Among Lehman’s employees outside the company’s headquarters in mid-town Manhattan this morning sentiment was mixed.

EMPLOYEE 1: Well it felt like they were using Lehman as an example. That’s just my opinion.

EMPLOYEE 2: I don’t think the government made a mistake at all. I think they have to draw a line and they drew a line. We had six months to fix this problems and we didn’t do it. I think it’s the fault of our senior management.

EMPLOYEE 3: While I’m biased, I think it’s kind of crappy that when it came time to saving Lehman the government really kind of backed down and I think we’ll see the ripple effects as a result of it.

And now there there are two: Goldman Sachs and Morgan Stanley are last of the big Wall Street investment banks standing. Bear Stearns, you remember, was dispatched back in March. Lehman said in the middle of the night last night it is set to file Chapter 11 bankruptcy. Merrill Lynch, as you know, has been snapped up by Bank of America. Marketplace’s Bob Moon is here to walk us through things.

Hi, Bob.

BOB MOON: [Sigh] Hi, Kai.

RYSSDAL: But, really, I mean, you sigh but it could have been, could’ve been worse.

MOON: Yeah, it was not Black Monday. It could have been a lot worse. May sound strange to say when the Dow was ONLY down close to 500 points and ONLY sank around 4.5 percent. But it really could have been worse.

RYSSDAL: Why wasn’t it, though?

MOON: Well, the markets hate uncertainty, you remember. And there’s a lot less unknown out there today. Experts have been saying for many, many months now that we needed clarity in the markets. And we finally got some today. Investors finally ran out of patience with Lehman. The firm took too long to get its balance sheet in order. It still had $50 billion in risky mortgage-related investments on the books. Then it reported the worst loss in its history last week. And, with the bankruptcy filing today and the surprise sale yesterday of Merrill Lynch, we got some clarity over the weekend about where things stand now. So that helped put kind of a floor under the market.

RYSSDAL: Clarity’s great and all, but here’s something that’s still a little murky. Why is it that Bear Stearns back in March was considered too big to fail — the chairman of the Fed said basically that — but Lehman Brothers is not.

MOON: Well, you remember how surprising the Bear Stearns move was. There’s a school of thought here now that there was plenty of warning and there was plenty of time for investors to get their ducks in a row, their act together about Lehman’s problems.

You have long-time market-watchers out there who argue that this is going to shake things up at first, but then we’re going to see an eventual adjustment process as these losses distribute themselves across the market. And you can also read between the lines here that the Treasury and the Fed decided the markets have adjusted since Bear Stearns. In fact, some supporters of that view say that there’s no better evidence of that than the surprise sale of Merrill Lynch to Bank of America. Merrill effectively cleaned up its books and, essentially, it took care of the situation itself.

RYSSDAL: You’re not really telling me that all the bad stuff’s behind us, are you?

MOON: Not at all. The fallout’s going to be really profound here. Will the bank profits take a hit? Absolutely. Is this going to take a lot more time to play out? No question about that. This is the result of bad decisions, Kai, that were made back as far as the ’80s, and it’s still going to take a long time to unwind all that. The trick is doing it gradually without shocking the system, but not so slow that you really create this water-torture effect.

RYSSDAL: The Fed meets tomorrow. They’re going to talk about interest rates and, obviously, everybody’s going to be looking at that very closely. I wanted to ask you, though, about the companies that are still left. The ones that are getting bigger — the Bank of Americas, the Goldman Sachses. Aren’t we now setting ourselves up for another round of “too big to fail?”

MOON: There is concern about that. You know, Bank of America gobbles up Merrill Lynch and it becomes even bigger. And don’t forget that Lehman Brothers had a very big closet and there are still some very big shoes in there to drop.

Let me give you a case in point there: Today’s bankruptcy filing lists the biggest single creditor as a Tokyo-based bank, Aozora Bank. It’s on the hook for a $463 million bank loan. Well, it turns out that Aozora may be based in Tokyo, but it’s actually controlled by Cerberus Capital Management, the big U.S. private-investment firm. Now, Cerberus issued a statement today that its exposure is really “significantly less” that Lehman’s balance sheet might indicate because it’s protected by what it calls “risk-management instruments.” Well, guess what they are? They are essentially these exotic insurance policies that others are going to have to cover now — if they can afford it.

RYSSDAL: Funny you should mention that because that is where we are going next — insurance. Marketplace’s senior business correspondent Bob Moon. Thank you, Bob.

MOON: Thanks, Kai.

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