The U.S. Treasury: Out of Bullets?
This weekend finds Lehman Bros. twisting in the wind. Guys who remember 8th grade dance class remember the feeling, as the Teutonic teacher loudly and suddenly announces the Sadie Hawkins dance, where girls get to pick boys, and there you are, still sitting along the wall. (Of course, for girls, every dance offered this delightful experience.)
Welcome to the world of Lehman.
People are fond of reciting the phrase: The darkest hour is often just before the dawn. It seems to me, on local as well as global stages, that the opposite is just as often true: the moment of greatest peril is when you think the challenge is over.
So it is for the U.S., and therefore global, financial system. And I don’t say this with any intended hubris. I doubt that any reader would argue long over the posit that a failed U.S. financial system would cast the world into complete economic chaos. In this particular and key universe, the U.S. is still in the World Series hunt, and China is a farm team.
With the rescue of Fannie and Freddie (may we make that assumption? on paper, at least), my prediction to my British friends and co-bloggers has come to pass: there was no way Secretary Paulson was going to let them fail, and he didn’t. It was never about moral hazard, it was about the complete collapse of the U.S. lending system.
But now what? Paulson has, just as wisely, met with Lehman and the leading global banks last night. While I haven’t seen any transcript of the meeting, my guess is that he has told them he will not be bailing out Lehman, that he will be glad to help with the meetings part, but the money and risk assumption will be theirs. Support, but no money.
This, too, is exactly the right move, in my opinion, but it brings up a difficult question. What if, in this game of chicken, no one blinks?
I have little doubt that Lehman is a basket case, based solely on their losses announced to date. But I have the same feeling about Merrill Lynch, one of the supposed saviors in last night’s meeting. Other than Goldman Sachs, there are a lot of “walking wounded” out there right now, who, despite all the triage and medical care, will take a couple more years to heal their balance sheets.
The Congress, and the Treasury, are probably on the same page regarding additional bank failures: let them happen. But what will be the result, if they do?
The chances of another bank failure, starting with Lehman, are, I believe, very high. When these failures occur, they will probably be like Palin’s self description: pigs with lipstick on. In this case, that probably means, for example, a sale to someone like Bank of America on such draconian terms that all equity value is effectively wiped out, the managers are fired, and huge headcount reductions follow.
Was it a sale, a fire sale, or just a fire, with B of A sweeping up the ashes?
And if it turns out to be the latter, as I expect, will the ensuing damage to the markets be manageable? Once? Twice?
I think the Treasury is essentially out of bullets in this war to save the U.S. financial system, and if so, the next few weeks and months will be those of greatest peril, even as many on the Street are heaving sighs of relief and writing about how the danger has already passed.