Another bank with its chin in the dust Lehman Brothers
Their bank losses shake financial markets WORLDWIDE

By Andre Damon
12 June 2008

Lehman Brothers announced a projected $2.8 billion second-quarter loss on Monday, its first since going public in 1994. The Wall Street firm concurrently announced its intentions to raise $6 billion of capital and reduce its reliance on borrowed funds.
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Both Moody’s and Fitch Ratings downgraded Lehman’s creditworthiness in response to the announcements. The investment bank’s stock has fallen sharply since last Friday.

The losses at Lehman’s were coupled with Monday’s announcement by Standard
& Poor’s that it had cut the AAA credit
ratings of bond insurers MBIA and Ambac Financial Group, effectively
lowering the credit ratings of some $100 billion in debt.
Analysts, meanwhile, announced that they expect Washington Mutual, the
United States’ largest savings and loan association,
to suffer mortgage losses of some $21 billion over the next three years.
The firm’s stock has tumbled by 34 percent over the
past two weeks.

Erin Callan, Lehman Brothers’ chief financial officer, played down the
current risks to the bank’s balance sheet, but said that
the capital-raising was engineered to “end the chatter about Lehman
Brothers.” The “chatter” is persistent speculation that the
firm is teetering on the brink of insolvency.

At the time of the March 14 bailout of Bear Stearns by the Federal Reserve
Board, it was widely believed in US financial
markets that Lehman Brothers would soon follow Bear Stearns into
bankruptcy. The Fed’s decision to extend direct loans to
investment banks—something unprecedented since the Depression of the
1930s—was in part prompted by fears that a
Lehman failure would trigger a wave of Wall Street collapses and a general
financial meltdown.

Lehman, the smallest and most vulnerable of the major US investment banks,
was among the major beneficiaries of the new
Fed policy, and used the loans to temporarily stabilize its positions.

Lehman Brothers is attempting to trim its leverage—the ratio of its assets
to borrowings—from 32 to one to 25 to one. The
firm had previously been able to provide high returns to its shareholders
by using the easy credit conditions that then prevailed
to make very large investments with borrowed money.

This approach has become unviable as credit has dried up, leaving Lehman
with what appears to be a crisis of both short-term
and long-term profitability. Within financial circles there is talk that a
further deterioration of credit conditions could result in
more bank failures along the line of Bear Stearns, and Lehman Brothers is
generally considered to be the most endangered.

Of the big Wall Street investment banks, Lehman remains the most closely
tied to mortgage-backed securities and speculation
in leveraged corporate buy-outs—two markets that have imploded since last
summer. The firm’s announcement served as a
rude awakening to markets that the banking crisis is by no means over, and
that more Federal Reserve bailouts may be in the
offing.

The Federal Reserve has made clear its intention to prevent the failure of
major Wall Street firms, ultimately with public funds.
There are those within the financial establishment who see large-scale
bailouts as detrimental to financial stability in the long run.

A criticism along these lines was put forward June 5 by Jeffrey Lacker,
president of the Federal Reserve Bank of Richmond,
who observed: “The danger is that the effect of recent credit extension on
the incentives of financial market participants might
induce greater risk-taking, which in turn could give rise to more frequent
crises, in which case it might be difficult to resist further
expanding the scope of central bank lending.”

Lacker’s public dissent, coming on the same day as a major speech by Fed
Chairman Ben Bernanke, is highly unusual, and
underscores the internal tensions and divisions fueled by the ongoing
financial crisis.

The cheap and abundant credit injected into the financial system by the
Fed’s policies has contributed to an inflationary upsurge
in the United States and internationally and accelerated the fall of the
dollar relative to the euro, the yen and other major
currencies. This depreciation has in turn fueled the eruption of oil prices
and rampant speculation in commodities prices.

In a speech delivered June 3, Bernanke said that the Federal Reserve would
take measures to fight inflation and prop up the
dollar. This led to a temporary strengthening of the US currency, but by
Friday markets panicked in response to the release of
higher-than-expected US unemployment figures. Investors dumped dollars and
poured into commodities futures, driving the
price of oil up $10 in a single day.

Bernanke again attempted to take an anti-inflationary stand on Monday
evening, telling a conference in Massachusetts that the
Fed will “strongly resist an erosion of longer-term inflation expectations,
as an unanchoring of those expectations would be
destabilizing for growth as well as for inflation.”

Asian markets tumbled at the announcement on Tuesday, with China’s stock
index falling 8 percent. China’s currency is
unofficially pegged to the dollar, and is especially responsive to US
policy. The country is also experiencing significantly higher
inflation, which has reached an annual rate of 8 percent and has resulted
in negative real interest rates.

The European Central Bank (ECB) showed no signs that it would cooperate
with the Fed’s new exchange rate policy. Last
week, ECB President Jean-Claude Trichet indicated that the central bank
would raise its interest rate by 0.25 percent,
undercutting a short-lived rally of the US dollar on currency markets.

The conflict between the Federal Reserve and the European Central Bank is
in many ways unprecedented. As Wolfgang
Münchau of the Financial Times noted, “In the past, European central
bankers tended to follow the US Federal Reserve,
often with delay, never perfectly, but generally in the same direction.”

A major and common aim of both the Fed and the ECB is to soften the labor
market through job-cutting, in order to prevent
the development of a wages movement by workers seeking to offset soaring
fuel and food costs. The US unemployment rate
has increased for five straight months, culminating in last week’s
announcement that the official jobless rate jumped from 5 to
5.5 percent during the month of May.

Long-term layoffs have increased significantly over recent months,
spearheaded by job cut announcements at major airlines,
which have eliminated 22,000 jobs this year alone. The trend is by all
indications accelerating, as indicated by recent figures
showing that planned layoffs increased by 15 percent in May over April.
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