Friday, September 12, 2008

Who will blink?

Wanted: Dead or Alive?
The Fed does not want Lehman dead and its ashes scattered all over Wall Street. I know this because there is no 'Wanted Dead or Alive' poster with a picture Lehman Bros. in the lobby for the FRBNY (Federal Reserve Bank of New York).

Avoiding the confetti effect
The Fed does not want the portfolio of Lehman sold across Wall Street like so much strewn confetti, driving down prices for other like securities. That would force other banks to use new price lows to mark their portfolios costing them precious capital that the banking system can't afford.

I want what he got: wah!
But the argument is being made that BofA may want concessions to absorb Lehman. The Fed gave concessions to JP Morgan Chase when it took the stinking carcass of Brear Bear Stearns off the market's hands instead of throwing it in the Briar patch.

Lehman is solvent while Bear was not...but Bear still had value too!
But this may not really be about what BofA wants after all. Bear Stearns was sold, not seized but that transaction was done under extreme duress. Today, Lehman's counter-parties have stuck by it giving it more time than Bear had. Plus there is the dealer lending facility that is a new wrinkle of support. Lehman is believed to have value and to be teetering due to instability and losses but not to be threatened by bankruptcy per se.

Does B of A really want a concession? Did JPMorgan Chase really benefit?
So if B of A wants a concession- it should get it from Lehman in terms of a lower offering price. I was never quite sure why Bear Stearns was sold for a such a price when that price could have been cut, diminishing the need for a Fed concession (which was taking nearly $30bln off JP Morgan/Chase's books with a guarantee). As I see it, that concession did not benefit JP Morgan Chase as much as it benefited Brear Bear that was able to cling to a still low but higher share price that it would have gotten had there been no guarantee. And of course there was the protection to Bear's bondholders...It wasn't just the $10 or so per share. There was still lots of value in Bear when the Fed stepped up and paid a handsome price for a smooth transition and no fight from Bear. The Fed BOUGHT stability and speed.

My view of this blink thing and concession-seeking is that it is LEHMAN that is bargaining for a concession (not BofA) just as it was Bear before.

Who is threatening whom and for WHAT?
Think about it. The takeover target is a wounded beast, a bit like a terrorist holding a grenade with the pin pulled out in a crowded room. You can't deal with him harshly, he has bargaining power. But only until he gives in. So he must get what he can now. In the real markets case at hand, the question is what are you going to give Lehman? You gave something to Bear Stearns to go away nicely and not make a markets mess. Bof A is not threatening a markets mess. Bear Stearns got a higher price than it should have from JP Morgan Chase and in return JP Morgan Chase got a Fed guarantee. In return Brear Bear went quietly (sort of).

Who does the concession help? What's the leverage?
To me if any guarantee is given it helps the acquired firm since if the acquiror needed more juice it could have lowered the asking price. As long as the stock price is some positive number I will have this view. It's the acquisition target that will not accept the deal without outside help. And if so that reflects it holding up the Fed with the threat of a disorderly liquidation, like our terrorist threatening to let go of his grenade. That is where the leverage is for Lehman over the Fed. But can Lehman effectively make such a threat with its counter-parties standing behind it?

Always wanting more...
Who is the troublemaker here? Its Lehman Bros. Lehman is the firm that at every turn wanted more than it was worth to sell a unit or give up a stake or to sell the firm. Lehman wanted more, failing to complete transaction after transaction. Successive deals walked away from it. The only way for Lehman to get more than it is worth now is to have BofA pay it and then have the Fed compensate BofA for doing so. To accomplish this Lehman needs leverage over the Fed of the sort we have discussed: Threatening to make a markets mess. DO NOT assume that the firm that directly benefits from the concession is the one that is the true beneficiary.

I fought the law and the law won?
This not about Bof A's bargaining prowess. It is about the Fed and if it will stick to its guns and face down Lehman. BofA can always walk away. There could aways be other suitors. Would Lehman really blow itself up and set the market for real estate-backed securities on its ear? We may find out.

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