Banking & Finance

Lehman (LEH), WaMu (WM), And Merrill Lynch (MER): What Next?

ClownIn the next day or two, the financial markets could hit their tipping point. It is certainly not beyond the realm of the possible that Lehman (LEH) and Washington Mutual (WM) could fail. Merrill Lynch (MER) is also trading off sharply.

Looking into what is now a nearly bottomless well, a failure of several firms could cut the implied value of mortgage-back securities and other consumer debt instruments by 20% or 30% more than their nominal value a few weeks ago.This is not a measured failure of inherent value. It is an annihilation. Value of existing derivatives, which have not been valued by trading in the open market could face a catastrophic failure.

The Fed and Treasury would have little choice other than to step in with tens of billions of dollars, or watch the banking system dissolve.

If the government has to put up this level of capital, it will have effects not unlike those at Fannie Mae (FNM) and Freddie Mac (FRE).The Treasury, and, by extension, the taxpayers end up owning some of the nation’s largest financial institutions. Common shareholders and subordinated debt holders are wiped out.

This is what the markets feared in March and April. This month, it may come to pass.

Douglas A. McIntyre