Lehman as it might have been … The following is part of a special feature package marking the fifth anniversary of the collapse of the Wall Street securities firm. Breakingviews writers imagine what might have happened if post-crisis reformers had acted pre-crisis. Herewith a column from that alternative archive.
London – Monday Sept. 15, 2008
The unprecedented operation taken by U.S. regulators yesterday to prevent a bankruptcy of Lehman Brothers is triggering ructions across global stock, bond, currency, and money markets. The pain will be universal, but longer term, the slide in equity markets is likely to eclipse the turmoil in other asset classes.
Bank shares are already being pummelled worldwide. The innovative use of a “bail-in” mechanism by regulators led by the Federal Reserve may have averted a messy collapse of the Wall Street firm, but it is fuelling fear that similar measures may be taken to save other troubled banks. Further losses look likely.
At the very least, investors need to re-evaluate the risks of holding shares in the financial sector. Though the funding costs of banks rose after the June passage of the SOB Act, bank bonds are sliding and the cost of insuring against defaults has surged. Against this backdrop, Wall Street’s fear gauge, the VIX, is likely to test or exceed all-time records.
Lehman’s recapitalisation is reverberating well beyond the equity markets. Money market tensions are rife and the scramble for dollar funding is driving frantic trade over the foreign exchanges. The greenback, now finding favour as a safe haven, is likely to continue strengthening. The rally in the highest grade sovereign bonds may persist as falling share prices trigger flight into U.S. Treasuries, German Bunds and British gilts.
Still, these trends should prove less scary than if Lehman had gone bankrupt. With a potentially global systemic crisis averted, financial institutions should gradually become more willing to lend to each other in the interbank market. Dollar funding is likely to become less difficult to access as the money markets heal. A sharp jump in implied volatility in the currency options market should also prove temporary.
Avoiding a chaotic unwinding of Lehman through a bankruptcy filing means that money markets, the plumbing of the financial system, are unlikely to freeze up. Nor will the popularity of dollars turn into a desperate dash. But the rescue comes at a cost. Investors in equities and bank bonds look like they will pay the heaviest price.