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We’re all here. Technically we have jobs till midnight tonight. But it’s kind of weird because there’s nothing to do.”
The date: Monday, Sept. 15. The time: 9:15 in the morning. An investment banker, until very recently safely employed with the financial institutions group at Lehman Bros. in New York, was describing the scene around him. “People are coming into work,” he said. “Some of the junior people are polishing their resumes; senior people are calling their counterparts at other banks to negotiate the sale of their entire division. The mood is a mix of gallows humour, anger at upper management — and panic.”
The night before, negotiations to keep Lehman alive collapsed. According to reports from The New York Times and The Wall Street Journal, the two possible suitors, Barclays Group (LSE: BARC) and Bank of America (NYSE: BAC) had realized that their bids, which relied on infusions of cash from the U.S. Treasury, weren’t going to get the backstop they needed. Both banks dropped the effort.
Since then, it’s been insanity on Wall Street. On Sept. 15, Lehman went into Chapter 11. Merrill Lynch (NYSE: MER) announced an agreement to be bought out by Bank of America for US$50 billion (an all-stock deal). The interest rate on federal funds — the price banks put on lending to one another — spiked to 6%, well above the 2% level targeted by the Federal Reserve.
The resulting liquidity crunch helped spark a week-long roller coaster ride on Wall Street, as short sellers piled into stock after stock and equity investors retreated into gold and Treasuries in a wholesale flight from risk.
After absorbing the shock news from Lehman and Merrill on Monday morning, the market rapidly switched its attention to American International Group Inc. (NYSE: AIG), whose stock lost more than half its value. Investors feared that Lehman’s bankruptcy would create a knock-on liquidity crunch at AIG, given that the giant insurer was reported to hold vast quantities of credit default swaps, or CDS, a form of guarantee, or insurance, on sub-prime mortgage debt and other sub-prime-backed assets.
With Lehman declaring bankruptcy, holders of Lehman assets would be petitioning AIG in large numbers to cash in those swaps. But because the market in CDS is unregulated, no one knew the extent to which AIG was exposed — stoking a sense of panic that the company would fail. That AIG retained a trillion dollars in assets on the books, or that in the past 12 months its stock had enjoyed a high of US$70.13 on the New York Stock Exchange, seemed not to matter one jot.
By Monday night, Standard & Poor’s had cut AIG’s credit rating to A-. The downgrade meant that AIG’s counterparties could demand that it post an additional US$14 billion in collateral, according to a filing AIG made with the Securities and Exchange Commission in August. That meant the cost of borrowing for AIG just went through the roof — at precisely the wrong time for the capital-strapped giant.
Tuesday saw AIG teetering toward collapse: the stock opened at US$1.85 a share. It was saved at the very last minute by a cash infusion from the Treasury of US$85 billion, in exchange for a 79.9% equity stake — in effect, nationalizing one of the world’s largest companies.
By Wednesday, Standard & Poor’s had eased AIG’s credit rating to “creditwatch developing” from “creditwatch negative” on news of the bailout. The stock hovered at US$3. Meanwhile, all eyes were on Morgan Stanley (NYSE: MS). The investment bank had decided to report early — and reported better-than-expected earnings for the quarter ended Aug. 31. No matter. In a repeat performance of AIG’s swoon, Morgan Stanley’s share price also dove — going from a US$37.23 close the Friday before to a close of US$21.75 that evening.
Thursday opened with news that the Fed and other central banks would attempt to ease the credit crunch by pumping new liquidity into global markets. The Fed announced it would make dollar credit swaps of US$180 billion available globally through Jan. 30, 2009, to ease pressure on liquidity. By end of day, the total amount of new liquidity had spiked to US$300 billion worldwide, according to The Wall Street Journal. The moves reversed a steep downward slide in Asian markets, bid up markets in Europe, and gave U.S. markets a 100-point bounce.
Later in the morning, Morgan Stanley stock hit a low of US$11.70. The investment bank was reported to be engaged in merger talks with Wachovia (NYSE: WB) and Citigroup (NYSE: C) — while also considering cash infusions from the China Investment Corp., which had invested US$5.6 billion in Morgan Stanley last December. The stock stabilized by end of day, spiking up to US$22.55.
Not even Goldman Sachs (NYSE: GS), Treasury secretary Henry Paulson’s old firm, escaped unscathed. The week saw its stock drop from a high of US$161.77 on Sept. 12 to a low of US$86.31 midday Sept. 18.
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