So maybe trouble at Lehman Brothers isn't just short-sellers spinning a web of financial panic after all. Standard & Poor's cut the ratings of Lehman Brothers, as well as Merrill Lynch and Morgan Stanley today. Counterparty credit ratings, which have been getting a lot of attention lately, were one prong of the S&P credit analyst Tanya Azarchs critique of the banks. The weakness of investment banking business--IPOs off 70% and M&A down 40%, according to some estimates--and the potential for more write-offs didn't help either.

Azarchs is also criticizing the brokerages' much vaunted capital raising. A good portion of the money raised by the firms has been in so-called hybrid securities that combine equity and debt aspects. The ratings agencies are wary of these because certain debt-like covenants and payment obligations can impose increased cash flow stress on banks.

The stock prices have taking a beating and the credit-default swap spreads are getting wider.

The larger commercial banks also didn't escape S&P's negativity on the financial sector.

The ratings outlook on Bank of America and JPMorgan moved to negative from stable. Wachovia was placed on watch for possible downgrades.

Citigroup, however, seems to have fared Well. S&P affirmed its ratings, removed its warnings of possible further downgrades. The insomniac bank still got a negative outlook. Citi may "never sleep" but they aren't quite fully awake either.

Morgan Stanley, Merrill, Lehman Ratings Cut by S&P [Bloomberg]