Lehman Not Far From Insolvency

With mounting losses (first quarter loss of $2.8 billion), management turmoil and a falling stock price (70% down this year and no sign of reversing), it seems likely that Lehman, the fourth-largest U.S. securities firm, will follow the footsteps of Bear Stearns and be sold at rock-bottom prices.

Recently, Lehman announced cash saving measures by increasing the stock portion of its employees’ pay from 50% to as much as 65%. Employees will also pocket a mid-year advance equal to one-fifth of their stock award.

Last year, Lehman allocated $3 billion in company shares to employees, which means they could possibly save up to $4 billion in cash if they increased stock options and do not buy back shares.

Chief executive Dick Fuld is “helping out” by foregoing his bonus. Investors expect nothing less after he built half a billion of fortune as a Lehman lifer and did not discharge his duties effectively in preventing this mess.

The 1999 repeal of the Glass-Steagall Act was a major reason for the sub-prime crisis we are facing today. Reckless banks’ involvement in the stock market ignited the Great Depression of 1929. Back then, banks were in a speculative orgy, not only investing their assets but also gobbling up new shares for resale. The public were encouraged to invest in unsound companies which the banks had taken a vested interest and issued loans.

Banks were greedy for bigger rewards and took on huge risks. In 1933, the Glass-Steagall Act was enacted specifically to “to protect the banks against themselves.” Investment and commercial banking activities were thus separated.

However, with the act repealed, a financial race was once again set in motion. Lehman threw caution to the wind and aggressively pursued their ambitions during the recent housing boom.

At the end of 2003, they had $11.9 billion of equity and $308.5 billion of tangible assets on its balance sheet. As of the first quarter this year, it showed $782 billion of tangible assets and $20 billion of equity. This skewed ratio of 39 to 1 meant little buffer in a market downturn. Amid astronomical losses from bad debts and depreciation, it is now forced to shed assets and raise capital.

There’s no doubt that Lehman is not far from insolvency and rumors of the company being sold could be true. Lehman will not collapse as the Federal Reserve is keen to avoid a confidence crisis in the financial sector. Throughout Lehman’s history, they have shown a knack of surviving challenges – the collapse of the Long Term Capital Management hedge fund in 1998 and the 9/11 terrorist attacks endangered their headquarters.

But this time, Lehman cannot escape the fate of falling into the hands of larger institutions under pressures from capital markets and regulators.

As Eveillard said, “Bankers are sheep. They don’t mind going over the cliff if everyone else goes over the cliff.” So I expect more casualties to be claimed before this financial storm is over.

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8 Comments

Filed under Banking, Stocks

8 Responses to Lehman Not Far From Insolvency

  1. Good article. I agree that the mess is not over. I’m staying away from financials!

    Thanks

  2. Jeflin: This is an excellent article. One should just be on the alert for capitulation selling in the financial sector as that might be a sign that the bottom is in sight. The convalescence period for banks, however, may take quite a while.

  3. Lehman is going down for sure, but government regulations are not the answer here. Check out some of Murray Rothbard’s writings to see what the Great Depression was really about- out of control government regulations rather than a free market problem.

  4. @ kevin -

    Thanks for your comment. And yes, stay away from financials for the time being, still a lot of toxic assets to be cleared.

  5. @ Prieur -

    Thanks for the compliment.

    You are right about keeping a lookout for capitulation selling as we should be able to bottom-fish for cheap financial stocks. However, it is still some distance away, probably towards the end of the year.

    And yes, convalescence period for banks may take months, and hopefully, they learned their lessons.

  6. Its time to stay away from financials.

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  8. @ Kuvashan -

    Thanks for your kind comments. I always try to write readable material, if my readers find the articles top-quality and professionally written, it is a bonus for me.

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