Bad Times on Wall Street: Lehman Brothers and Merrill Lynch

Weekly Corporate Growth Report, Sep 22, 2008 by Dolbeck, Andrew

The credit crisis is hitting Wall Street hard. One by one, giant financial corporations are falling victim to the troubled economic times. Over the weekend of September 12-14, two major financial industry giants took desperate steps against an uncertain future - Lehman Brothers declared bankruptcy and Merrill Lynch agreed to sell itself to Bank of America. In response to these recent developments the stock markets dropped more than 500 points, the biggest plunge since the September 11 terrorist attacks.

The bankruptcy and the Bank of America deal were both the result of a series of emergency meetings that took place over the weekend at the Federal Reserve building in Lower Manhattan. The meetings were convened by Federal officials and attendants included Treasury Secretary Henry M. Paulson Jr. and several top bankers.

There was speculation that the government might help bailout Lehman Brothers. But Treasury officials let it be known that they would not be using taxpayer dollars to support the troubled lender. The Treasury and Federal Reserve had already stepped in on several occasions to support the financial services industry, including financing the merger between Bear Sterns and JP Morgan Chase and agreeing to bail out Fannie Mae and Freddie Mac. This time Wall Street would have to fend for itself.

Merrill Lynch and Lehman Brothers both indulged in risky real estate investments during the credit boom and were left severely weakened, burdened with inadequate capital and toxic assets. And both firms are now pursuing desperate measures in order to survive.

Denied government backing, Lehman Brothers began to seek potential buyers, including British bank Barclays and Bank of America. Lehman has previously proposed a plan to split the company, allowing a buyer to purchase the parts of the firm that were performing well while a group of 10 to 15 Wall Street companies would have agreed to absorb losses from the bank's troubled assets. But other Wall Street banks opposed the deal, unwilling to face potential losses while Bank of America or Barclays walked away with the potentially profitable part of Lehman at a discount price. With no rescuer to be found, Lehman Brothers was running out of options.

Lehman Brothers announced that it would file for Chapter 11 bankruptcy protection in New York. The filing listed about $613 billion in debt, making it the biggest bankruptcy case the United States has ever seen. The bankruptcy also marks largest failure of an investment bank since the collapse of Drexel Burnham Lambert 18 years ago.

Bank of America reportedly approached Merrill Lynch unsuccessfully earlier in the year. Seeing the fate of Lehman Brothers may have made Merrill Lynch more willing to deal, as the repercussions of a Lehman bankruptcy could ripple through Wall Street and further cripple Merrill Lynch. On Sunday, September 13, Bank of America and Merrill Lynch cemented their deal.

Investment banking and brokerage firm Merrill Lynch was worth more than $100 billion during the last year, but Bank of America is buying it for roughly half that price. Based on Bank of America's last closing price prior to the deal announcement, the stock-based transaction values Merrill Lynch at $50 billion. But Bank of America shares fell $7.19, or 21 percent, after the deal was announced, bringing the deal value down to less than $40 billion.

Lehman Brothers and Merrill Lynch aren't the first Wall Street giants to take actions that may have been unthinkable before the subprime mortgage market crashed. Bear Sterns Companies agreed in March to sell itself to JP Morgan Chase & Co. at a bargain price. Just last week, the government announced a bailout strategy for troubled mortgage firms Fannie Mae and Freddie Mac. And American International Group seeking support from the Federal Reserve. How far these disturbing trends will ultimately run, and what impact they will have on the US economy, remains to be seen.

Sources: Broadgate Consultants, The Guardian, New York Times, Seattle Times

By Andrew Dolbeck

Editor