Hank Paulson is keenly aware that his Goldman Sachs Group (NYSE: GS) and Treasury predecessor, Robert Rubin, helped save the market by encouraging the then-head of the New York Fed to force Wall Street leaders to team up to save Long-Term Capital Management's collapse from taking down the financial markets. Just as George W. Bush needed to recap Iraq, so now does Hank Paulson need to recap that famous meeting in lower Manhattan.
Bloomberg News reports that the meeting -- which took place yesterday afternoon -- involved a rogues gallery of Wall Street executives coupled with Paulson and New York Fed president Tim Geithner. The message these regulators delivered was reportedly a simple one: "You need to solve your own problems, and we're not going to provide any more capital." But Wall Street -- as represented by the likes of "Citigroup, Inc. (NYSE: C)'s Vikram Pandit, JPMorgan Chase (NYSE: JPM) 's Jamie Dimon, Morgan Stanley (NYSE: MS)'s John Mack, Goldman's Lloyd Blankfein, and Merrill Lynch & Co., Inc.'s (NYSE: MER) John Thain" -- are convinced that the Fed will blink when it comes to the 158 year old Lehman Brothers Holdings (NYSE: LEH).
Bank of America (NYSE: BAC) reportedly wants to put in a bid for Lehman contingent on getting government help -- such as the $29 billion JPMorgan got in its Bear Stearns acquisition and its nationalization of Fannie Mae (NYSE: FNM) and Freddie Mac (NYSE: FRE). After these two precedents, Paulson now wants to reverse himself. He says Lehman is different because people have known it was in trouble for a long time and it can access the Fed's discount window. But I think this could just be a little show for the President who is worried about how this will look to history. He may not realize that he has already opened the Pandora's Box of moral hazard and can't shut it now.
There was a bit of good news for Lehman buried in this game of chicken. "Lehman received bids for [its investment management unit] yesterday from private-equity firms including Bain Capital LLC and Clayton Dubilier & Rice Inc., [which value its] Neuberger Berman fund business, private-equity funds and a brokerage firm serving wealthy individuals, at about $5 billion," according to Bloomberg.
If one of these deals goes through this weekend, it could avert the need for an immediate takeover of the entire firm. But as of August, Lehman still held $50 billion worth of mortgages and it holds other mortgage-backed securities. Anyone taking over Lehman would need to take into account the true market value of these securities -- and the related write-downs could dwarf the purchase price of its equity (Lehman's market value stands at a mere $2.5 billion).
Ultimately it all comes down to too many mortgages -- which is derived from the French words for death (mort) and pledge (gage). I am not sure I understand how these words are connected but were it not for all these dead pledges to repay, Fannie, Freddie, Lehman and many other mortgage-holders would be doing just fine.
I think there will be more to come this weekend -- and a TV network that seems to know something will happen then -- asked me to appear at 8pm this Sunday night.
Peter Cohan is President of Peter S. Cohan & Associates. He also teaches management at Babson College and edits The Cohan Letter. He owns Citigroup shares has no financial interest in the other securities mentioned.