Lehman set to go into insolvency

“Chapter 11 Bankruptcy looming for Lehman Brothers...”

Preparations are being made for US investment bank Lehman Brothers to file for bankruptcy protection. The firm was pushed to the brink on Sunday after UK bank Barclays pulled out of talks to buy most of Lehman. If no new financing is found before Wall Street opens on Monday, Lehman will have to seek so-called Chapter 11 bankruptcy protection. This could result in a severe shock to the global financial system, as banks unwind their complex deals with Lehman.

It could take weeks or even months to complete and put banks around the world in a state of extreme uncertainty. In the UK, accountancy firm PWC has been lined up to run the British operations of Lehman.

Potential implications
BBC business editor Robert Peston says Barclays' decision to walk away from a Lehman deal was a huge setback for the effort to rescue the fourth-largest investment bank in the United States. A source close to the talks told the BBC that Barclays was unlikely to change its mind.

Barclays terminated the negotiations because it was unable to obtain guarantees in relation to financial commitments faced by Lehman when markets open on Monday. Unless the US government does a U-turn and puts taxpayers' money into Lehman, the bank will have to file for bankruptcy protection.

Bad bank, good bank

The rescue effort for Lehman is being co-ordinated by the US Treasury and the New York Federal Reserve. In the light of the credit crunch and the parlous state of financial markets, Barclays feels it would be running a crazy risk if it took [Lehman's obligations] on without any protection right now

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The US government had hoped to arrange a bailout under which other US investment banks - such as Citigroup, JPMorgan Chase, Morgan Stanley and Goldman Sachs - would finance a "bad bank" that would hold the most "toxic" investments of Lehman in the property and mortgage market.

The "good bank" or rest of the firm, including its investment and wealth management arms, would then be sold to another financial institution, for example Bank of America or the UK's Barclays.

Although such a deal would have cost the other investment banks millions, it might have restored confidence in the sector and avoided a sharp drop in the share price of all banks. However, it appears that this plan is falling apart.

The only thing that can prevent Lehman collapsing would be a huge injection of taxpayers' money," a banker close to the talks told the BBC, but added that US Treasury Secretary "Hank Paulson has made it clear he doesn't want to do that.

Bank of America to buy Merrill?

Our business editor adds that in the light of the credit crunch and the parlous state of financial markets, Barclays feels it would be to risky to take on Lehman's obligations without any protection.

Bank of America, meanwhile, is said to be unconvinced that buying Lehman would be in the interest of its shareholders.

Instead, according to a report in the New York Times, Bank of America is in "advanced talks" to buy investment bank Merrill Lynch for more than $38bn.

Like other US investment banks Merrill has suffered losses of tens of billions of dollars in the subprime crisis, and has seen its share price plummet during recent months.

'Too difficult to value'

"No other large firm should buy Lehman whole - its toxic real estate and securities are too difficult to value," said Peter Morici of the business school of the University of Maryland.

Only a fool would think he could fairly assess their value, unless those are assigned them a value of zero.

Lehman is up for sale after it reported a $3.9bn (£2.2bn) quarterly loss last week amid concerns over its long term financial viability.

The firm's share price has plummeted as fears over its future have mounted.

Unless a bailout deal can be arranged and another large bank steps up to buy the good bits of Lehman, the US firm will have to file for bankruptcy protection.

This would deal a severe blow to the global banking industry, which is based on the expectation that the other party will always honour its commitments.

It could take weeks or months to unwind Lehman's complex deals with and obligations to other banks, both inside and outside the US.

'Difficult decision'

Former Federal Reserve boss Alan Greenspan said the US government faces "very difficult decisions" over Lehman if it cannot secure a rescue deal that does not involve public funds.

"They [will then] have to make a very difficult decision as to whether or not they allow it to liquidate or they support it," he said.

Yet Mr Greenspan said it would be "unsustainable" for the government to bail out every US bank that got itself into difficulty. Predicting that Lehman would not be the last to require rescuing, Mr Greenspan added that this would not necessarily pose a problem. "The ordinary course of financial change has winners and losers," he said.

Source: BBC News