Nouriel Roubini | Sep 13, 2008
It is now clear that we are again – as we were in mid- March at the time of the Bear Stearns collapse – an epsilon away from a generalized run on most of the shadow banking system, especially the other major independent broker dealers (Lehman, Merrill Lynch, Morgan Stanley, Goldman Sachs). If Lehman does not find a buyer over the weekend and the counterparties of Lehman withdraw their credit lines on Monday (as they all will in the absence of a deal) you will have not only a collapse of Lehman but also the beginning of a run on the other independent broker dealers (Merrill Lynch first but also in sequence Goldman Sachs and Morgan Stanley and possibly even those broker dealers that are part of a larger commercial bank, I.e. JP Morgan and Citigroup). Then this run would lead to a massive systemic meltdown of the financial system. That is the reason why the Fed has convened in emergency meetings the heads of all major Wall Street firms on Friday and again today to convince them not to pull the plug on Lehman and maintain their exposure to this distressed broker dealer.
The Fed doesn’t want to simply bail out Lehman Brothers, as they did Bear Stearns, for a bunch of reasons — including, it appears, that it doesn’t set a good precedent to keep failing out banks that take crazy risks and then fail. Also because Lehman is in worse shape than Bear — insolvent, not just illiquid.
So will anyone step in and save Lehman? Signs point to no.
Unable to find a savior, the troubled investment bank Lehman Brothers appeared headed toward liquidation on Sunday, in what would be one of the biggest failures in Wall Street history.
Should we be surprised to learn that many of Lehman’s problems stem from worthless mortgage-related assets, known colorfully as “toxic waste”? Probably not.
Lehman put itself on the block earlier last week. Bad bets on real-estate holdings — which have factored into bank failures and caused other financial companies to founder — have thrust the firm in peril. It has been dogged by growing doubts about whether other financial institutions would continue to do business with it.
Everything is connected, which is why we can’t just let bad banks fail and to hell with them. My cartoon-based knowledge of the economy doesn’t accurately predict what will happen if banks start falling like dominoes, but it can’t be good, right?