Bad Bank? Bad Idea.
The latest victim of the global credit crisis, Lehman Brothers Holdings Inc., faces daunting figures for the third quarter of this year: according to U.S. News & World Report, the investment bank will post losses of $3.93 billion dollars for Q3 alone.
You don't have to work on Wall Street to know that that's bad news.
But the bank's plan for addressing the problem seems... well, a little transparent. Before we get into the details, let's take a look at how Lehman got into this predicament to begin with. According to the New York Times, Lehman Brothers finds itself in such dire circumstances because (surprise) it invested heavily in risky mortgage debt.
The bank's problem is on the other side of the spectrum from families facing foreclosure because they can't afford their adjusted mortgage payments or didn't understand the terms of their mortgage agreements. Lehman, like many investment banks on Wall Street, basically bet money on families' ability to stay current with their mortgages.
Now that homeowners from coast to coast are falling behind and defaulting on mortgage payments, those who invested in their ability to repay are losing out.
Good Bank, Bad Bank
Some critics of subprime lending have suggested that creative "innovations" in the mortgage market are the main reason that so many borrowers managed to get into so much debt. And more "innovation," it seems, is the only road out for large-scale investors like Lehman.
The bank's plan to escape the enormous losses, reports the Times, is to separate itself into two banks, a "good bank" and a "bad bank." Keep in mind that these labels weren't leaked from a top-secret office document - they appeared in the headline of a mainstream newspaper.
Sources indicate that Lehman plans to shovel between $25 and $30 billion in struggling real estate debt into a new "bad bank" called Real Estate Investments Global. The "bad bank" should be open for public trading as early as the first quarter of 2009 - and who wouldn't want to invest in a company openly labeled by its creators as a "bad bank" for "struggling" investments?!
Apparently, Lehman executives believe they'll have an easier time convincing investors to pour money into the remaining "good bank" part of Lehman, which will consist of sturdier, better-performing loans.
The logic goes that, once the money starts rolling in from these investors, Lehman will be able to funnel some over to the "bad bank" to help keep it afloat. Oh, and they'll probably also sell off a sub-section of the company for a few billion to get things started. Just in case.
Last Ditch Effort
In a Reuters article, one analyst described Lehman's plan as a "last ditch" effort, since selling off part of the company eliminates any chance of future earnings from that sector. The proposed venture shows a certain level of desperation to appease shareholders, who reportedly lost $5.92 per share in the third quarter, more than even Wall Street economists had predicted.
To those of us unfamiliar with creative accounting and financial manipulation, Lehman's desperate strategy evokes the image of a sick man sawing off his ailing body to save his healthy leg.