When Lehman Was a Lemon

Includes: BAC, LEHMQ, MS
by: Cheep Talk

The Times has a great excerpt from “Too Big to Fail: How Wall Street and Washington Fought to Save the Financial System — And Themselves” by Andrew Ross Sorkin. It recounts Lehman’s efforts to sell itself to Morgan Stanley (NYSE:MS) and Bank of America (NYSE:BAC). The Morgan Stanley deal failed as Lehman was not clear about what it wanted – a merger, selling a part of itself etc. But there was also an issue of what Lehman was really worth and Morgan Stanley tried to find that out in tense questioning:

“The Morgan team began to throw out a barrage of questions: How are things marked? they asked, Wall Street jargon for how the assets were valued. Were you able to sell them inside your marks? How much business has left the firm?”

In other words, there was asymmetric information: Lehman knew the value of its assets but Morgan Stanley did not.

The next attempt was Bank of America. They called their main deal maker at BoA, Greg Curl, on a Saturday night and

“Mr. Curl, though intrigued to be getting a call on a Saturday night, was noncommittal; he could tell they must be desperate. “Hmm … let me talk to the boss,” he said. “I’ll call you right back.” The boss was Ken Lewis, the silver-haired chief executive of Bank of America.)”

There is a potential lemons problem triggered by asymmetric information – you do not want to pay more that the value of Lehman Bros to acquire it. The fact they are trying to sell it signals it may not be worth that much. It is combined with incentives to misrepresent information to strike a good deal:

“Mr. Fuld [Chair of Lehman] explained that he would want at least $25 a share from Bank of America to buy Lehman; Lehman’s shares had closed that day at $18.32. Mr. Lewis thought the number was far too high and couldn’t see the strategic rationale. Unless he could buy the firm for next to nothing, the deal wasn’t worth it.”

The deal fell through. A question remains: was there a trade that could have made both parties happy? This would rely on a synergy between the potential buyer’s assets and the assets of Lehman. The bluffing and lemons problem makes it hard to see gains from trade. I’m going to buy the book but this excerpt makes it seem that Fuld did not do a good job selling Lehman and tried to get too much for it. For example, opening up the books might have saved it. This is a bad option in the sense that it puts you in a terrible bargaining position. But it is better than what happened