15 Sep Lehman Tells the Truth and Has To File Bankruptcy
The market for mortgages was hit hard last week by Lehman Brothers. Lehman may be in bankruptcy today because it was too honest for its own good.
Last week Lehman devalued its mortgage-based assets dramatically. Lehman reportedly marked its Alt-A mortgage assets down to an astonishing 39% of face value — from 63% — and its subprime and junior lien loans to 34% of face — from 55% of face. A “mark” is simply the value the company gives to a given asset on its balance sheet and theoretically ought to represent how much it could be sold for.
For most of us, having to “mark down” our personal assets by a few percent wouldn’t mean very much. For a company (or a family) that relies heavily on borrowing to make ends meet, it’s a staggering problem. Lehman and most of the other Wall Street investment banks have relied heavily on borrowing against their portfolios to operate. By admitting their investment in your mortgage is a bigger risk because it is less likely to be repaid than first expected, the owners of these investments (like Lehman) have less room to maneuver.
The Wall Street Journal estimated that other holders of mortgage securities may take hits because of Lehman’s markdown. The large insurer American International Group (AIG) could have to take an extra $15 billion in asset reductions while Citigroup could face $7 billion in reductions for its Alt-A portfolio alone. It’s not like the Alt-A market has been an island of stability anyway.
As I have discussed before, large Wall Street firms have been trying for a long time to avoid having to truly mark-to-market the value of their mortgage portfolios. The only thing worse than actually reducing the value of these asset on your books would be actually selling them. After all, if I sold an Alt-A bond at 40% of face value that is just like one Citi is currently valuing at 80% of face value — establishing the going rate for that commodity in an open market — would force Citi to do some nasty things on their books. Things that you and I typically have to do every day.
Lehman Brothers was more highly-leveraged than some of the other banks. But it is hard to escape the feeling that they were punished and forced into bankruptcy because they (or at least their accountants) broke ranks with the rest of Wall Street and admitted these assets are less valuable than everyone — possibly including the Federal Reserve and Treasury Department — wants to pretend.
And for their sin of honesty, they did not get bailed out. Whether that’s a good thing for the rest of us in the long run waits to be seen.
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