Sunday, September 14, 2008

Lehman goes bust

Lehman Brothers hurtles towards bankruptcy, see here. The Treasury and the Federal Reserve have clearly chosen to draw the line on bailouts. Whether this stems the tide remains to be seen, but the thinking seems to be that the market had time to adjust to Lehman's problems, so that the chance of a systemic crisis is lessened.

Lehman's troubles arise from a familiar source. As this article in the Washington Post notes,
Lehman, the number one underwriter of mortgage-backed bonds last year, amassed a giant portfolio of properties and mortgage-related securities. But the value of the assets began to sink last year amid a spike in mortgage defaults by homeowners with subprime credit.
One thing to look for now is what happens to the market for credit default swaps. Traders have suggested that even solid firms are finding it hard to buy such insurance now. This could be an interesting weak (note also Bank of America purchasing Merrill Lynch and the problems AIG seems to be facing).


Eric Wilhelm said...

I own a car, so when I get into an accident my insurance policy will be able to help cover some of the costs. This kind of insurance works great for spreading risk because in exchange for that policy the "insured" must own an asset or suffer a loss. However, in the case of a credit default swap, although it does hedge risk, there is no requirement to hold an asset or suffer a loss. In my opinion these types of deals are purely speculative and could be seen as plaque in the American financial system (not unlike bad cholesterol). The government has already played doctor, giving a double by-pass surgery with Bear Sterns and Fannie and Freddie. Does the American financial system need a triple by-pass?

dkh141 said...

I saw a commentary on MSNBC where the person being interviewed was saying in effect that this will all pan out because the wealth will eventually disperse through the market. Is there any truth to that statement? Won't there be significant wealth lost in the failure of Lehman? And will investors be at all willing to continue to invest with such financial giants and cornerstones going belly up?

Barry W. Ickes said...

I waited too long to answer. So it is now obvious that the problems were very serious. Triple bypass has come and gone. The credit market seized up. So the worries expressed here by both comments were well thought out.