Lehman Free-Fall Continues

Updated from 2:57 p.m. EDT

Lehman Brothers(LEH) shares plummeted as much as 23% Friday, as investor confidence in the investment bank's capital position continued to erode.

It was the second straight day of big losses for the firm, which on Thursday was battered by a rumor -- later discredited - that bond giant Pimco was curtailing trading with the firm. On Friday, however, despite little news, investors continued to make bearish bets against Lehman.

Spreads on credit default swaps on Lehman debt, which insure the debt against default, were widening, while options traders pushed implied volatility, a measure of the expectation of a price change in the underlying stock, to levels 50% above their level when Bear Stearns neared collapse on March 17.

Many investors fear Lehman, now the smallest of the major Wall Street banks after Bear's fire sale to JPMorgan Chase(JPM) with the Federal Reserve's assistance in a March, could suffer the same fate. The firm's heavy mortgage holdings could be hit hard by recent downgrades to mortgage insurers MBIA(MBI) and Ambac Financial(ABK).

Meanwhile, Treasury Secretary Henry Paulson and Fed Chairman Ben Bernanke testified on Capitol Hill Thursday that large financial institutions needed to be allowed to fail, making a Bear-style rescue for Lehman -- should that become necessary -- seem less likely.

While Pimco founder Bill Gross shot down the rumor his firm had stopped trading with Lehman on Thursday, Standard & Poor's on Friday emphasized that the firm's liquidity position remained strong. S&P said it was "concerned ill-founded and persistent pressures on Lehman's stock unnecessarily prolong what is already a very challenging business environment."

Lehman last month reported a $3 billion loss for its second quarter, leading to the dismissal of its CFO and COO. The firm has been the target of short-seller Greenlight Capital's David Einhorn, who has accused it of masking losses.

The firm also was not helped by Fannie and Freddie, both of which were plummeting amid mounting concerns about their viability. Weakness in the mortgage market will continue to weigh on financial firms like Lehman who hold significant structured finance products tied to mortgages that already have declined sharply in value and have proven difficult to trade during the credit crunch.

Lehman shares closed down 16.6% to $14.43.

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