The Fed's 'Suez Crisis'

Something that struck me about Lehman’s (LEH) demise is how little power the Federal Reserve really has. Don’t get me wrong, the Fed is darn powerful, but it’s not all-knowing and all-seeing, despite what some folks think. The Fed is powerful because people think it’s powerful.

Analysts hang on every word in a statement or testimony, but in the case of Lehman Brothers, the Fed really couldn’t do much. Wall Street basically stood up to the Fed and the central bank was exposed. Since Bear Stearns (BSC) was the first, the Fed can open its mouth and get its way. But the Fed can’t make the weaker argument the stronger, and that’s what was needed with Lehman.

I’d say the Lehman story was a combination of too much debt—at one time the company was leveraged 40-to-1, it didn’t know what it owned, and it refused to listen to any criticism. To top it off, the company had horrible luck too. That’s not a good combination.

With Level 3 assets (these are basically assets that can’t be priced easily so we have to trust Lehman for the price), Lehman once claimed that its Level 3 stuff was up 9%, even though the market was down by 10%. When people called the company on it, Lehman got mad and blamed the shorts. That’s just arrogance. Then it spent something like $22 billion on Archstone? I mean, what the hell? Talk about the wrong price, the wrong industry at the wrong time. Aside from that, it was a great deal!

Einhorn and other shorts said they didn’t know what their stuff was worth and they were undercapitalized. Fuld & Co. just refused to listen. I don’t think they’re crooks at all, they sincerely believed in what they were doing. Until the end, the company was offering assurance to investors.

With Bear and Lehman we often heard about counterparty risk. Well, that theory got shot down with Lehman. I’m going to go on the idea that the reason there wasn’t a deal for Lehman is that no one wanted one. If someone wanted, it would have happened. Novel thinking I know. But it tells us that the Street is hardly concerned about counterparty risk. JP Morgan (JPM) was concerned about Bear because it was mostly its risk.

I heard Hank Paulson talk about bringing stability to the markets. Yeah, right. That’s basically like the flea giving orders to the dog. The Fed and the Treasury do not have this thing contained. If the housing market recovers, then the problem goes away. It’s as simple as that.

Comments

[TraderGreg:]

What happened to the second half recovery?

2008 Sep 16 02:24 AM

[carey_jim:]

Most people think that the Fed should play the role of referee in a game whose rules are fixed and based on experience, intelligence and do I dare say wisdom?

Without the ability to call fouls and make real punishments for too many fouls, (five fouls and you are out of the game) referees are of no use.

Your metaphor of fleas giving orders to the dog fits our present financial situation, unfortunately.

Woof, woof.

2008 Sep 16 11:02 AM