Fed Likely to Save Lehman

| About: Lehman Brothers (LEH)

The Wall Street Journal is reporting (“Fed Acted on Lehman Rumor”), that Federal Reserve officials contacted Credit Suisse (NYSE:CS) in response to a rumor circulating in July that the Swiss bank planned to a pull a line of credit with Lehman Brothers (LEH).

Credit Suisse told the Fed the rumor was false. Both Credit Suisse and Lehman declined to comment for the Journal article. The Journal doesn’t know whether Fed officials contacted Credit Suisse before or after the SEC’s temporary ban on naked shorting (July 21 - August 12) of 19 financial stocks that included Lehman.

In a June 13 post (“The Two Faces of Lehman Brothers”), I wrote that “this is likely to be a long, hot summer of challenges for Lehman and its CEO.” Lehman’s stock hit a closing low of $12.40 on July 14 and an intra low of $12.02 the following day.

The Financial Times reported late Wednesay that Lehman held parallel talks at its New York headquarters during the first week of August with government-owned Korea Development Bank and China’s Citic Securities to sell up to 50% of its shares to raise capital, but neither party was interested. On Thursday morning, Citigroup (NYSE:C) analyst Prashant Bhatia increased his third quarter loss for Lehman to $3.25 a share from 41 cents, expecting larger writedowns.

If the Journal’s information is correct, the big takeaway here is that the Federal Reserve is not going to let Lehman follow the Bear (NYSE:JPM). The Journal said that “Fed officials called at least one major firm rumored to have stopped trading with Bear and were told that wasn’t true.”

But that was before the Fed set up their Primary Dealer Credit Facility [PDCF], allowing investment banks to borrow from the discount window through January 2009. The Fed is already holding enough less than stellar collateral, so it is going to do what it can to ensure Lehman survives.

While the Fed’s actions to some extent remove the question of Lehman’s survival, book value and current shareholder’s equity most likely will be further diluted.

Disclosure: Long C, JPM.

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