Financial Sector Check-Up: Was The July Rally a Farce?

The S&P rallied just over 9.4% from the July 15 low on 1200.95 to the high made August 11 on 1313.13. The market may now be asking itself whether it was ever a sustainable rally. Putting two articles together, one from the Wall Street Journal and one from the Financial Times, that question may now have an answer; it may be hard to rally the financial sector when the bell-weathers of the industry are fighting their own valuations.

The Wall Street Journal is reporting in Thursday's edition that the Federal Reserve called Credit Suisse Group (CS) to see if a rumor regarding the pulling of a credit line to Lehman Brothers (LEH) was true. Rumors of the same kind had been circulating about Bear Sterns in the weeks before its collapse. The Fed had made similar calls to at least two major banks who were rumored to have stopped trading with Bear and was told at the time those rumors were not true. Credit Suisse denied the rumor regarding its Lehman credit line.

While the exact timing of the Fed's call to Credit Suisse is unclear, the rumor had been spreading in early July and the S.E.C. subpoenaed "dozens of hedge funds and financial firms about four Lehman-related rumors," according to the WSJ. This may have been done by the S.E.C. in part because "it had been criticized by Lehman and other Wall Street firms for not responding aggressively to the rumors regarding Bear that essentially caused a run on the bank." Rumors regarding Lehman died down, and the S&P made its 9.4% run.

Meanwhile, the Financial Times is reporting that Lehman tried to sell as much as a 50% stake to the Korea Development Bank and China's Citic Securities, but was rebuffed when the firms decided Lehman's asking price was too high. Lehman was down 3.6% in overnight trading. The parties involved have so-far declined to comment on the article. Lehman may post a third-quarter loss of $3.25 a share, Citigroup analyst Prashant Bhatia wrote yesterday, after previously estimating the firm would have a  41-cent loss, adding that Lehman's may take write downs totaling $2.9 billion on mortgage-backed securities.

The S&P had been in a sharp decline from May 19, falling 16.6% to the July 15th low; the timing of this casts a question as to whether the brief rebound was indeed a farce engineered in part by the S.E.C.'s subpoenas and rules against so-called naked short selling. As for the immediate future, it now seems obvious that Lehman is desperate for cash and that it may be having a tough time finding new sources of liquidity. If the judgment of the Koreans and Chinese are to be believed, after what was probably a close examination of Lehman's books, the firm may be worth a lot less than its current valuation. It looks as though the financial sector FICO and Credit score just took a hit.