Is There A Case For A Lehman Bailout?

Posted by John Carney, Sep 11, 2008, 11:54am

Many on Wall Street still assume that the government might step in to rescue Lehman Brothers, perhaps as early as this weekend. But the case for bailing out Lehman is far less compelling than the case for bailing out Bear Stearns and the risks even greater. This could mean that Lehman would be allowed to fail.

One difference between Bear Stearns and Lehman is that the collapse of Bear had not been anticipated by the equities market. Going into the weekend of its collapse, Bear was trading at around $30 a share. The market had not priced in its failure. Creditors, customers and counter-parties could credibly claim they had been caught unaware by the firm's collapse.

With Lehman's stock suffering day after day of double digit declines, the market signals of a potential failure are all too clear. The market has priced in a potential collaps. Regulators can reasonably conclude that market participants had ample warning from the equity markets that Lehman was in trouble.

To put it another way, the moral hazard risk is even greater if the government steps in to bail out Lehman than with Bear. Where the market was arguably blindsided by the Bear Stearns collapse, with Lehman all the market signals are there. Anyone continuing to keep money in accounts on which Lehman can draw or lever against is accepting a large amount of risk. A bailout would further drain the ability of the market to discipline investment firms.

The pricing also makes Lehman a risky equity investment. Bear's $30 share price became $2 in the initial rescue. Work out that ratio for Lehman and investors should expect to receive less than 30 cents a share. Even at the elevated $12 Bear investors eventually received, Lehman investors could expect just over a dollar based on today's market price.

We're not hoping for a collapse here, and our analysis shouldn't be read as encouraging a panic. We simply call them as we see them and market participants can make up their own mind about what this means. From our point of view, this analysis only makes it clearer that Lehman's leadership needs to make some dramatic moves to pull their company back from the brink. Yesterday Lehman said it was exploring all strategic alternatives. Many investors, including Lehman employees, are now saying: "Faster, please."

[Editorial Note: I know we promised to move on but there's just too much to talk about with Lehman right now. We'll try to do a better job this afternoon.]

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