Lehman Bros. Earnings Ease Market Fears

The stock market rebounds after news that Lehman Brothers posted better-than-expected earnings, dispelling rumors of huge subprime losses. But longer term concerns about the credit crunch and a weak economy remain.

Copyright © 2008 NPR. For personal, noncommercial use only. See Terms of Use. For other uses, prior permission required.

MICHELE NORRIS, host:

NORRIS: Even before the Fed's big rate cut, shares of financial firms started bouncing back today on Wall Street. The most dramatic was Lehman Brothers, the investment banking firm was rumored to be the next possible victim after the implosion of Bear Stearns. But after releasing better than expected earnings today, Lehman's stock rose 46 percent.

NPR's Chris Arnold has that story.

CHRIS ARNOLD: Lehman Brothers has been aggressively trying to fight rumors that it was falling apart. Today, the company's chief financial officer, Erin Callan offered a lot of details about the company's financial picture during a conference call. She was basically saying that company is still turning a profit and it's a pool of billions of dollars worth of assets and it's not about to go bust.

Ms. ERIN CALLAN (Chief Financial Officer, Lehman Brothers): We can tap into this pool to get additional cash at any time.

ARNOLD: Still, Callan wasn't too rosy about the economy and the financial markets.

Ms. CALLAN: We don't expect that this extremely challenging period is going to end (unintelligible). However, we do believe, we have the leadership, the experience, the risk management discipline, the capital strength and certainly the liquidity to ride out the cycle.

ARNOLD: So things may not be so bad that we're going to see the failure of another major investment bank inside of a week. Most economists think the Fed helps by offering to loan investment banks money directly if they needed. But, beyond that immediate crisis, it's still pretty scary out there to some people on Wall Street trading floors.

Mr. WILL ASTON-REESE(ph): (Vice President, Money Market Sales, Tradition Asiel Securities): I'm very scared. Yeah.

ARNOLD: Will Aston-Reese is the vice president of money market sales at the broker dealer Tradition Asiel Securities.

Mr. ASTON-REESE: I'm not a naysayer or anything but I just think that we could be on that - just on the precipice looking down into the abyss right here. I really do.

ARNOLD: Aston-Reese put together large institutional investment and CD's issued by all kinds of banks.

Mr. ASTON-REESE: Were talking, you know, hundred million, 500 million, a billion in one issuance. And so to have the sources of funding this type of funding dry up is really puts a crimp on, you know, their day-to-day operations.

ARNOLD: And it is drying up, Aston-Reese says despite all the efforts by the Fed, this part of the market hasn't been functioning right since the credit squeeze hit last summer. Investors who use to (unintelligible) a yearlong CDs won't touch anything longer than a few months. The worry is that tightness of credit will ripple to the whole economy and mean less hiring, more layoffs, bigger recession.

Mr. ASTON-REESE: People are unwilling to lend long. They're waiting for another shoe to drop. What's the next shoe that's going to drop? Is going to be bank A this time? Is it going to be bank B? You know, that is it going to be dealer A, dealer B? They don't know. That's the same thing that we've seen since this has hit last August. And this is why I'm saying that nothing has really changed.

ARNOLD: In other words, nobody knows which bank or hedge fund or company will be the next to announce crushing loses from subprime loans, so the Fed's actions have limits.

Bill Cheney is chief economist at John Hancock.

Mr. WILLIAM CHENEY (Chief Economist, John Hancock): I think the Fed is totally on the ball in terms of what it can do.

ARNOLD: A growing number of economists think more drastic action is called for. One idea that's getting a lot of attention right now is a government bailout similar to the one in the savings and loan debacle. The idea is the government would basically buy up the millions of problematic loans to slow foreclosures and get the bad investments off of everybody's books.

Mr. CHENEY: I think I would still argue against it right now.

ARNOLD: Cheney says he thinks it would be healthier for the companies that made bad debts on some subprime loans to pay the price for it. But he admits the government can't take too long to make up its mind about doing more.

Mr. CHENEY: I think it makes excellent sense for the folks in Washington to be working out contingency plans and negotiating what would go into it, if they have to take action.

ARNOLD: Cheney says the longer the credit markets stay fouled up, the worst the damage to the already stumbling economy.

Chris Arnold, NPR News.

Copyright © 2008 NPR. All rights reserved. No quotes from the materials contained herein may be used in any media without attribution to NPR. This transcript is provided for personal, noncommercial use only, pursuant to our Terms of Use. Any other use requires NPR's prior permission. Visit our permissions page for further information.

NPR transcripts are created on a rush deadline by a contractor for NPR, and accuracy and availability may vary. This text may not be in its final form and may be updated or revised in the future. Please be aware that the authoritative record of NPR's programming is the audio.

Fed's Moves Highlight Fragile State of Markets

Stock traders negotiate in Sao Paolo Monday morning i i

hide captionStock traders negotiate in Sao Paolo Monday morning. Brazil's stock market dropped amid fears the global credit crisis that sank Bear Stearns would spread.

Stock traders negotiate in Sao Paolo Monday morning

Stock traders negotiate in Sao Paolo Monday morning. Brazil's stock market dropped amid fears the global credit crisis that sank Bear Stearns would spread.

Listener Q&A

It's no easy task to keep up with all the intricacies of the housing crisis, the credit crunch and the rest of the economy's doldrums. NPR's Adam Davidson and former Federal Reserve governor Laurence Meyer answer listeners' questions.

The Federal Reserve took dramatic measures over the weekend to reassure the increasingly anxious investment community, including negotiating the bargain-basement sale of Bear Stearns, one of Wall Street's biggest and most storied banks. The Fed's moves raise questions about just how deep the financial industry's woes go — and what other banks might be at risk.

Here, a look at what happened and what it means for the markets:

What was the Fed's role in the sale of Bear Stearns to JP Morgan?

The Fed extended JPMorgan Chase a $30 billion credit line to help it buy rival Bear Stearns, a firm with an 85-year history on Wall Street that was on the verge of collapsing due to losses in the mortgage market. JPMorgan is getting Bear Stearns for the rock-bottom price of about $2 a share — or about $236 million. That's a stunningly low price when one considers that Bear Stearns' shares were trading at $30 each on Friday, and that its company headquarters building in New York is valued at $1 billion by itself.

Why did Bear Stearns agree to be purchased for such a fire-sale price?

Bear Stearns really had no choice. The bank is facing an onslaught of rumors about its losses in the mortgage industry, and on Friday it reported some major liquidity problems — investors were pulling their money out and the bank was short on cash. The only way for Bear Stearns to keep doing business was to let itself be bought by another firm like JPMorgan. But the deal effectively wipes out most of Bear Stearns' shareholder wealth, and it's not clear whether it will win shareholders' approval.

What about customers of Bear Stearns? Will their investments be affected?

Bear Stearns customers will become customers of JPMorgan Chase. Their accounts will transfer automatically; they don't have to do anything, says Laurence Meyer, a former Federal Reserve governor.

What would have happened if the government had not stepped in and instead allowed Bear Stearns to go bankrupt?

Bear Stearns doesn't just have its own assets — it serves as what's called a "counterparty," meaning it works as the middleman for billions of dollars in transactions. So, working people have retirement funds there, for example, and smaller banks and hedge funds can trade stocks or securities through Bear Stearns.

If the bank did go bankrupt, an unbelievably long and complex legal process would begin. Thousands of Bear Stearns customers — from individual retirees to massive hedge funds — would have huge amounts of money just frozen. Imagine how complicated a personal bankruptcy is and multiply that by tens of billions of dollars in assets. The Federal Reserve wanted to avoid that.

What other measures did the Fed take?

Perhaps the Fed's most significant move over the weekend was the creation of a new program to give emergency loans directly to the 20 largest so-called "primary dealers." These are investment banks that do business directly with the Fed and which purchase the majority of Treasury securities.

In addition, the Fed lowered the discount-lending rate — that's the rate which it charges banks for very short-term loans — by a quarter-point, to 3.25, on Sunday. It followed that on Tuesday with a cut of three-quarters of a percentage point to another key interest rate, the federal funds rate.

Why did the Fed feel the need to take such dramatic action?

It's an indication of just how precarious things are in the financial markets. The fear is that if an investment giant like Bear Stearns fails, it could spark a run on other banks with sizable exposure to troubled credit markets, creating a domino effect of defaults.

Investment banks like Bear Stearns are the lifeblood of capital markets, providing the cash flow that keeps economic gears turning. They facilitate short-term loans to businesses, raise money for corporate expansions and IPOs and assist the trading of securities. Without them, financial markets would grind to a halt.

Does the Fed's intervention mean that things might be worse on Wall Street than they appear?

It certainly feeds those suspicions. The current credit crisis is largely being fueled by fear and uncertainty. Because they are not traded on a daily basis, mortgage-backed securities are difficult to value even in the best of times. Now that the mortgage market is in free fall, it's almost impossible to gauge just how much bad debt these banks have been left holding. That has made banks extremely nervous about making even short-term loans to each other.

Are other banks in serious trouble?

Yes, and everyone is asking who's most at risk. Some of the names mentioned most frequently are UBS and Lehman Brothers, both of which have a lot of exposure to subprime and mortgage-related securities.

Why do the markets feel comfortable with the Fed actions to help JPMorgan buy Bear Stearns, but not with government action to provide relief to homeowners who cannot pay their mortgages?

Actually, the Fed's action is quite controversial. "People do worry about moral hazard, although I think that Bear Stearns was significantly punished," says former Fed governor Meyer. The Fed has taken credit risk onto its portfolio that it wasn't really set up to do, but global investment banks are really too big to simply go out of business, he adds.

But when it comes to homeowners, it's important to understand that there are actions the Federal Reserve can take, and actions that the administration and Congress would have to handle. Helping out homeowners is up to the latter. "Again, there's moral hazard issues as to whether you should do that," Meyer says. "But the problem is so significant here ... I think you could reasonably argue that it is a time for [the Treasury Department] and the administration to put some taxpayers' money at risk here, in order to reduce the risks ... and help homeowners."

With reporting by NPR's Jim Zarroli, Chris Arnold, Adam Davidson and Uri Berliner

Comments

 

Please keep your community civil. All comments must follow the NPR.org Community rules and terms of use, and will be moderated prior to posting. NPR reserves the right to use the comments we receive, in whole or in part, and to use the commenter's name and location, in any medium. See also the Terms of Use, Privacy Policy and Community FAQ.

Support comes from: