Massive Shifts on Wall St.

Global stocks have experienced wild fluctuations this week in the wake of the U.S. government's seizure of insurance giant American International Group, the failure of Lehman Brothers, the disappearance of Merrill Lynch as an independent company and reports the U.S. government will set up a government entity to take on bad debts from financial institutions.
By Heather Landy and Neil Irwin
Washington Post Staff Writers
Monday, September 15, 2008; 12:05 PM

NEW YORK, Sept. 15 -- Lehman Brothers filed for bankruptcy early Monday morning, becoming the largest financial firm to fail in the global credit crisis, after federal officials refused to help other companies buy the venerable investment bank by putting up taxpayer money as a guarantee.

The failure of the nation's fourth-largest investment firm offers a profound test of the global financial system, and government and private officials had been bracing Sunday night for an upheaval in a range of financial markets that have never before experienced the bankruptcy of such a large player. To keep cash flowing normally through these markets, the Federal Reserve announced new lending procedures, while 10 major banks combined to create a new $70 billion fund.

The aftershocks were already being felt. Major European and U.S. stock indexes dropped sharply in morning trading. Major Asian exchanges were closed for a holiday, but markets in India, Taiwan, Singapore and Australia all dropped sharply. Financial regulators in South Korea, where institutions hold over $700 million in investments in Lehman brothers, had called an emergency meeting for Tuesday, when markets reopen.

Central banks around the world issued statements to try to calm an uncertain situation, with the Bank of England saying it stood ready to "stabilize those markets" that need help, and the Bank of Australia freeing extra cash to bolster local banks.

U.S. stock futures pointed to initial losses of as much as 300 points, or nearly 3 percent, for the Dow Jones industrial average.

The filing by Lehman Brothers Holdings, Inc., also touched off a scramble to determine who might be on the losing end of the company's meltdown. On the Paris exchange, shares of insurer Axa SA plummeted after the company was listed as a major Lehman shareholder, Bloomberg news service reported. The company later clarified that the shares were held by clients of an investment subsidiary, not the company itself, Bloomberg reported.

After a marathon series of negotiations over the weekend, Federal Reserve and the Treasury stepped aside to allow a wrenching transformation of Wall Street to proceed. Having galloped to the rescue of other major financial institutions in recent months, the federal government drew the line with Lehman Brothers, ignoring pleas from would-be buyers of the company who insisted on receiving federal backing for its troubled assets.

The grim sense of urgency was underscored this weekend by news that two other major financial firms were seeking lifelines. Venerable investment banker Merrill Lynch will be purchased by Bank of America, and insurance giant American International Group was scrambling to come up with a sweeping restructuring plan.

In refusing to offer federal backing for Lehman, leaders of the Federal Reserve and Treasury Department decided that the firm was unlike the investment bank Bear Stearns, whose sudden collapse in March threatened the world financial system, or Fannie Mae and Freddie Mac, whose potential insolvency did the same.

By betting that Lehman could be allowed to fail without catastrophic consequences, New York Federal Reserve President Timothy F. Geithner, Fed Chairman Ben S. Bernanke, and Treasury Secretary Henry M. Paulson Jr. were making it clear that struggling financial firms cannot count on a bailout.

The decision not to intervene carries the risk that the ripples of Lehman's failure will prove impossible to contain. What worries regulators and Wall Street is a massive, multitrillion-dollar lattice of interlocking financial instruments known as derivatives. The most worrisome to bankers are "credit default swaps," in essence a form of insurance against corporate failures. If the financial firms themselves fail, the value of the insurance they have written will be tested as never before.

So would the market for "triparty repo" -- a form of debt that funds all sorts of financial firms and is held in the money market mutual funds of ordinary Americans -- which is also looking at potential losses from the Lehman bankruptcy.

CONTINUED     1           >

© 2008 The Washington Post Company