The Upside of a Lehman Crash

Is "Lehman Crashing Again", in the words of Alea's headline? The Lehman (LEH) stock price reminds me of Zeno's arrow: First it falls by half, and then by half again, and then by half again -- and each time it's "crashing". Quite impressive, really: A company can easily crash two or three times a week, at this rate.

Looking to the CDS rather than the increasingly-meaningless equity, John Jansen reports that "Lehman Brothers are wide but real at 750/800". I think that's a more useful datapoint. The equity is already at zero (plus a little something for option value); if it falls further that makes little difference to the debt. And if you believe Michael Lewis, the moral hazard trade is still going strong:

This is one of the many unintended little side effects of the government bailout of Bear Stearns....: to greatly reduce the interest of the people who do business with Lehman Brothers in the survival of Lehman Brothers ...

After all, the Federal Reserve will give them their money back, re-insure their credit defaults, take another pile of these distressed assets out of the market.

We'll see: I have a feeling that the NY Fed won't be able to easily find a buyer for Lehman this time around, and that it won't feel any great need to bail out the bank itself. A Lehman default would send shock waves through the financial system, to be sure -- but if it happens slowly and with a lot of advance warning, those shock waves might not be substantially larger than some of the other events which Wall Street has weathered over the past 14 months.

Indeed, in a case of "that which doesn't kill me makes me stronger", a Lehman default could actually be a good thing for the markets as a whole. If Lehman defaulted and the sun still rose the following morning, the single greatest fear of the markets -- systemic meltdown following the collapse of a major intermediary -- would be shown to be overblown. And that could trigger a major relief rally in credit.

Comments

[phdinsuntan...:]

your credit relief is coming, but not in the US/Japan:
as interest rates are starting to go down with falling
prices of all, except the greenback everywhere,
starting in the Uk and China, the next big thing
is better credit. Only Brazil is raising rates now.

2008 Sep 11 01:53 PM

[1worldcurrency:]

The sun will come up, certainly. But that fact does not make investment banks more profitable.

2008 Sep 11 02:25 PM

[JasonC:]

Err no, the sun won't come up.

Lehman has $600 billion in debts, Washington Mutual has another $300 billion. Call those $900 billion.

Ford and GM have $450 billion in debts between them.

Merrill has $1 trillion in debt.

Ignore the regionals and the airlines and such as chicken feed in comparison. We are still looking at more than $1.35 trillion going through bankruptcy and possibly twice that.

Believe me, that will not be a simple workout experience for anyone. On earth.

What is actually happening right now is every leveraged naked short of Fannie and Freddie is doubling up all their winnings selling the crap out of Lehman and Washington Mutual and Merrill. And if you feed them another $10 billion in leveraged gains for nothing, they will just pick another target and blow it away.

This doesn't end until the shorts are routed and lose billions. Just protecting bondholders but sending the common to zero, everywhere any short has a brainstorm, will never end. Until they lose their shirts, they will keep doubling and redoubling.

2008 Sep 11 02:54 PM

[SW Richmond:]

The upside of a Lehman crash will be this: the regulators will step in and pick winners and losers in CDS, forcing CDS claims to be paid at less than par. Even the diehards will then be forced to acknowledge that contracts and private property don't mean anything in the USA anymore if those contracts and private property are deemed to be "not in the public interest" or if the dot gov, having seized said swapholder, is on the unfavorable side of the trade.

Just wait and see. This is the only short-term solution to the mounting CDS crisis. You read it here first. The long-term solution is of course widespread default and collapse.

2008 Sep 11 04:49 PM

[JasonC:]

Actually, I've read it 48 gazillion times before, everywhere under the sun, but it is still utter nonsense.

2008 Sep 11 04:51 PM

[Michael Eis...:]

in the famous S curve, i think Lehman failing would be called capitualtion.

2008 Sep 11 05:18 PM

[Fish Gone Bad:]

The saying, "that which doesn't kill me makes me stronger" has never been true.

Think about it. Jumping off a cliff? Catching a dangerous wave?

It should be, "That which doesn't kill me, can certainly cripple me."

Clark Jenkins
FishGoneBad.com

2008 Sep 11 06:15 PM

[User 256849:]

I guess wall streeters doesn't like the idea of selling apples on street corners....bail, bail, bail. Who's next WAMU, MER, Bank of China? Is it possible for the FED to take on the entire deleveraging world? Or will the tsunami overwhelm them? How many fingers does Bernanke left to hold the ol dike? Why not keep the Treasury and Fed out of this one...no guarantees to anyone and let American capitalism return to its roots.

2008 Sep 11 06:50 PM