Markets quake as Lehman falls

SOURCE : THE NATIONAL

Wall Street - USA - SEP 16: The demise of two of Wall Street’s most powerful investment banks opens a new and perilous chapter in the global credit crisis.

Lehman Brothers, the 158-year-old firm, filed for bankruptcy protection after a desperate weekend push by the US government to find it a buyer failed.

The world’s largest brokerage, Merrill Lynch, fell into the arms of Bank of America, selling itself for US$50 billion (Dh183.6bn) in stock.

Financial markets worldwide reeled as the US Federal Reserve shovelled more credit at the ailing financial sector, and American International Group, one of the world’s largest property and casualty insurers, asked the Fed for a $40bn loan.

The fallout from billions of dollars in new losses and institutions going under is likely to spread through the global economy, economists and bankers say, stifling growth and costing many people far from the financial industry their jobs as the money machine that drives global commerce sputters.

“The first thing that happens is that people become even less trustful of banks, and banks find it more difficult to deal with each other,” said Jeremy Parrish, chief executive of Standard Chartered Bank’s operations in Abu Dhabi. “It clogs up the system. The grease of the system is taken up.”

One major concern is how well the fragile US economy, the world’s largest, would shoulder the blow. Unemployment was rising and consumers were already in retreat before headlines and broadcasts about Wall Street’s woes began yesterday morning. Any further pullback by consumers would reverberate around the globe, dampening US demand for the Gulf’s oil, Chinese manufacturing exports and European luxury goods.

Markets shuddered yesterday as fears of a renewed global credit crunch spread from Asia across the Middle East to Europe. While major Asian markets were largely closed for a holiday, Mumbai’s benchmark stock index dropped 3.7 per cent. London’s FTSE 100 fell as much as 3.92 per cent and France’s CAC 40 dropped 3.78 per cent.

Oil prices plummeted below $95 a barrel. The price of gold jumped 2.6 per cent as investors sought the perceived safety of precious metal. Another favourite of investors seeking safety amid times of turmoil, US Treasuries, soared by the most since the September 11 terrorist attack.

Although US markets were a modest one per cent to two per cent lower in early trading, Sept 15 2008 is nonetheless a day that will go down in Wall Street lore. Lehman’s Chapter 11 bankruptcy filing could turn out to be the largest in US history, surpassing the collapse of Drexel Burnham Lambert in 1990 and WorldCom’s failure in 2002.

To stave off a collapse of the financial system, the Fed announced that for the first time in its 95-year existence it would accept shares as collateral for loans, even as reeling markets made it a near certainty that most shares would decline in value.

Some hold Lehman responsible for much of the subprime crisis. It was the fourth-largest US investment bank but the largest underwriter of subprime debt. Some blame Lehman for failing to raise more capital earlier to offset its $613bn in debt, an amount more than double the size of the UAE’s entire economy.

Lehman’s collapse followed three days of intense bargaining between its Wall Street rivals, the Fed and the US Treasury Department. Determined not to use taxpayer funds to bail out Lehman, government officials were hoping a deal could be brokered to crack Lehman apart and sell it in pieces. But with no federal money to sweeten the deal, the prospective buyers, Barclays of Britain and the Bank of America, baulked.

Instead, Bank of America ended up in talks with Lehman’s rival Merrill Lynch. Merrill also became a victim of the subprime rot and speculation that it was sitting on too many losses to survive. As Lehman’s fate was sealed at the Federal Reserve Bank of New York on Sunday, the CEO of Merrill, John Thain, turned to a suitor he had once spurned, Bank of America, the nation’s largest retail bank. The back room deal ensures Merrill’s survival, but ends its history as an independent firm, one that started in 1914 when Charles Merrill opened his office on Wall Street declaring: “I have no fear of failure, provided I use my heart and head, hands and feet — and work like hell.”

Concerns have now shifted to AIG, whose share price fell 46 per cent last week amid concerns that it might also succumb. Yesterday Robert Willumstad, AIG’s chief executive, reportedly approached the Fed asking for a $40 billion bridge loan.

Bankers and economists say the latest crisis on Wall Street raises new questions about the future of the financial industry and how to regulate it.

“There’s a lack of belief in the system that is going to take a long, long time to build back,” said Mohamed Ramady, a former banker and a visiting associate professor at King Fahd University of Petroleum and Minerals in Dhahran, Saudi Arabia.

Central banks such as the Fed, which once oversaw only banks, are now being compelled to exercise oversight over the entire securities industry. Many question whether efforts to prop up the banks with easy credit and, in the case of Bear Stearns, taxpayers’ money, are rewarding wealthy bankers for making bad investments.

Such unprecedented intervention, they say, will inevitably result in greater regulation of financial firms and the markets in which they operate, raising questions about the very future of free markets and capitalism.

Most immediately, Lehman’s failure will remove one of the largest players in global financial markets, making it more difficult for investors to trade stocks, bonds and other securities.

Moreover, the prospect that Lehman’s most damaged assets may suddenly flood on to the markets as part of its bankruptcy proceedings may prompt investors and banks to curb their risk by reeling in credit. That would raise borrowing costs for companies, reducing profit margins and crimping growth in a difficult economic environment.

“There could be an impact on the availability of credit and funds to other risk assets, including in emerging markets,” said Hung Tran, director of the emerging markets policy department at Institute for International Finance in Washington DC.

Even if they manage to obtain adequate credit, Mr Tran said, emerging market companies stand to be hurt by tightening credit in the US and Europe.

“And any curtailment of credit growth to businesses and consumer borrowers in the US and Europe would reinforce the slowing of the economies in these areas.

“And if that translates into a general slowing of the global economy that would impact emerging markets in terms of demand for their trade and commodity exports, including oil.”

Some economists warn that the Fed is running out of options. It has already depleted its reserve of short-term Treasury bills, the securities it uses to inject liquidity into the market, from $277 billion last June to $21 billion, according to ANZ Bank.

The US government could eventually need to finance its bailout by printing dollars. On Monday, the dollar posted its biggest drop against the Japanese yen in a decade, partly on those concerns.

A weaker dollar hurts economies that depend on exports to the US because it reduces Americans’ purchasing power. For countries such as those in the Gulf that peg their currencies to the dollar it also stokes inflation.