Editor's note: Our "On the Brink" series will provide daily insight into the financial firms facing capital shortfalls and the growing pressure from short sellers in the market.
scrambled to find a buyer, concerns are mounting that a deal may involve government money and place too much of a burden on already strained taxpayers.
Treasury Secretary Henry Paulson reportedly was "adamant" that no government money would be involved in any deal for
, but potential buyers were reported to be looking for a backstop similar to the $29 billion cushion against potential losses the
when it bought
earlier this year.
Lehman last week entered what looked very much like Bear's death spiral, as the firm's shares shed 77% over the course of the week to $3.65 at Friday's close.
The severity of the investment bank's situation was underscored Friday night when the Federal Reserve Bank of New York
held an emergency meeting
with government officials and Wall Street chieftains to discuss Lehman's fate, according to a report in
The Wall Street Journal
. The group, which included Paulson and
Securities and Exchange Commission
Chairman Christopher Cox, is expected to meet throughout the weekend and attempt to come up with a rescue plan for Lehman, according to the report.
Just a week after the U.S. government took over
, taking on trillions more in debt in the process, regulators find themselves faced with another potential bailout candidate.
But many analysts view it as unlikely the government will provide a financial backstop to a Lehman buyer.
Brian Gardner, chief political analyst at investment bank Keefe, Bruyette & Woods, argues Paulson, who is scheduled to testify before the Senate Banking Committee Tuesday to discuss the government takeover of Fannie Mae and Freddie Mac, got a pass in the Bear Stearns situation because it happened so quickly and there was no liquidity facility in place.
"I don't think Congress is going to stand behind him if taxpayers are on the hook again," Gardner says. "The Street is trying to pinch him and call his bluff on whether there will or will not be government intervention."
Such an intervention could pose even larger problems for the economy, however.
"The policy of 'too big to fail' crossed over into 'too big to bail out,' once we allowed the massive housing bubble to occur," says Bill Fleckenstein, president of
, a short-seller who believes the possibility of a full-blown depression cannot be overlooked, as the government takes on more and more debt.
"The possibility is non-trivial that that is the outcome," he says.
Moreover, there is a concern that if regulators bail out another institution, it will encourage even greater risk-taking.
"I think if they did step in again to take out another institution, having already done it with Bear, it really does ring a 'moral hazard' bell that I think a lot of people would be concerned about," says Tim Backshall, chief strategist with Credit Derivatives Research.
The cost of insuring against $10 million worth of U.S. government debt jumped from $18,000 to $22,000 last week, as measured by the credit default swaps market, indicating investors see a greater risk of what was once unthinkable: the U.S. government defaulting on its debt.
By opening its discount window to Lehman Brothers and other investment banks in March, the Federal Reserve already is providing at least an implicit backstop. Lehman had not accessed the discount window as of Friday evening, and it is possible that the firm will be bought without a government backstop.
The Financial Times
on Friday reported that
Bank of America
, private equity firm JC Flowers & Co. and China Investment Co. are weighing a joint bid for Lehman.
have also been cited elsewhere as possible buyers.
Ladenburg Thalmann analyst Richard Bove wrote in a research note Friday that BofA is the most likely buyer for Lehman. If a buyer does not emerge for Lehman, however, the government will have to choose between taking over another failed institution, lending to it indefinitely in the midst of a panic, or letting it fail.
Many fear this last option would send shockwaves throughout the global financial system, as Lehman has untold obligations to institutions around the world, mostly through the credit default swaps market, where parties bet on and insure against debt defaults by large institutional borrowers.
A default by Lehman would create a "huge unknown" according to
contributor and Cavanaugh Capital Management managing director Tom Graff, as many institutions that thought they had insured against various liabilities suddenly had to take those risks back on their books.
"I don't think that's going to be acceptable to the Treasury," Graff says.
But despite the seemingly enormous burden the government has already taken on, assuming the liabilities of failing companies does not mean the U.S. will necessarily lose money in the bargain, notes Wes Marple, professor of finance at Northeastern University.
"I think a lot of the securitized obligations on the books of Lehman will eventually settle close to par
their original value at the time of the loan as they did when the bank crisis of the late 1980s was finally resolved," Marple says. "We just have a panic situation at the present time."