The “orderly liquidation” of Bear Stearns is certainly dramatic, but I think that it will be the only US investment bank to fall from the current mess. The reason can be found in this press release from the Federal Reserve:
Release Date: March 16, 2008
For immediate release
The Federal Reserve on Sunday announced two initiatives designed to bolster market liquidity and promote orderly market functioning. Liquid, well-functioning markets are essential for the promotion of economic growth.
First, the Federal Reserve Board voted unanimously to authorize the Federal Reserve Bank of New York to create a lending facility to improve the ability of primary dealers to provide financing to participants in securitization markets. This facility will be available for business on Monday, March 17. It will be in place for at least six months and may be extended as conditions warrant. Credit extended to primary dealers under this facility may be collateralized by a broad range of investment-grade debt securities. The interest rate charged on such credit will be the same as the primary credit rate, or discount rate, at the Federal Reserve Bank of New York.
Second, the Federal Reserve Board unanimously approved a request by the Federal Reserve Bank of New York to decrease the primary credit rate from 3-1/2 percent to 3-1/4 percent, effective immediately. This step lowers the spread of the primary credit rate over the Federal Open Market Committee’s target federal funds rate to 1/4 percentage point. The Board also approved an increase in the maximum maturity of primary credit loans to 90 days from 30 days.
The Board also approved the financing arrangement announced by JPMorgan Chase & Co. and The Bear Stearns Companies Inc.
You might argue that this should have been in place a while ago, but now that it’s in place, I doubt that any more US investment banks will fall. You can safely assume a 50bp drop in the base rate in the next week, I think. As with the previous drops, I think that we will see little, if any drop in longer-term paper. That increased gradient in the yield curve, combined with the effectively-intentional inflation (their liabilities are largely nominal and a fair fraction of their assets are real), should be enough to recapitalise the banks over time. The new lending facility from the New York Fed seems designed explicitly to give them that time.
Lehman is Not Bear. 1) It has more liquidity, 2) It has support among its major counterparties, evidenced by an extension on Friday of a $2B working capital line with 40 banks (one issue w/Bear Stearns [BSC] seems to be that counterparties pulled in lines). 3) Its franchise is more diversified given almost half outside the US and an asset management business that is more than twice as large relative to its size (BSC was more plain vanilla). 4) It has a seasoned and experienced CEO (Bear’s CEO was new). We maintain our Buy rating given a belief that LEH will weather this storm and our estimate of a price to adj. book value ratio of 83%.
The industry issue seems more liquidity than solvency, and LEH protected itself more fully after it’s problems similar to BSC in 1998. At year-end, it had $35B of excess liquidity combined with $63B of free collateral, implying $98B available for liquidity, or $70B more than needed for $28B of unsecured short-term debt (which includes the current portion of long-term debt). While it also has $180B of repo lines, we take comfort that 40 banks extended credit on Friday and believe that some of the repos are likely to be termed at least to some degree.