What if you hold billions of securities that no one wants to buy?

[Guest]

This is what happened to Bear Sterns. In this article, the author shows you how bad the situation is for Lehman Brothers, Bear Stearns, Citi Groups and others.

This article is dated Mar 10, 2008, less than a week before Bear Sterns went under.

"Shouldn’t they be eliminating their dividends to conserve capital? I'm sure that it wouldn't make many of their shareholders happy, but it would certainly allow them to stay solvent longer. In my opinion, there will be one or more (possibly many) financial institutions that go under during this credit unwind, there just can’t be enough rescue capital to keep them all from peril. To wit, when I look at the Lehman Brothers' (LEH) balance sheet and see it levered 40 to 1, I wonder how on Earth did anyone allow it to get that leveraged? Consider that Lehman has four times as many ‘Level 3 Assets’ (those that are ‘hard to price’) as it does capital. Hard to price in my book equates to ‘hard to sell’.

Perhaps the most interesting part of all of this is that Lehman recently announced a share repurchase of 100 million of its shares for a cost of $5 billion or so. At the same time, it floated a preferred stock deal at 7.95% and issued billions of dollars of new debt for itself. This occurred just as the firm's mortgage and other debt related write-downs began that will likely run into the tens of billions of dollars. In other words, rather than de-leveraging, it's adding leverage. I guess this is why my firm is short Lehman debt.

The same goes for Bear Stearns (BSC) and many others. To prove the point, what do you think would happen if Lehman and Bear were told by regulators to sell its ‘hard to price’ assets? I find it highly doubtful it would be able to sell them and hence, this leads me to question their solvency. What about the other $600 billion of assets on Bear's balance sheet? Could it sell them? Doubtful. The reason is that everyone else owns the same type of securities and the company is being instructed to sell, yet cannot.

So the ‘daisy chain ‘has started whereby when one firm is forced to sell, it must ‘mark to market’ which means everyone else who owns the same security has to mark theirs down as well. Wouldn’t one conclude that firms like Lehman should have been shrinking its balance sheet over the past year? Of course, but lo and behold, its balance sheet grew by over 30% year over year. "

Full article:

Changing the Benchmark

Bennet Sedacca Mar 10, 2008 10:55 am

http://www.minyanville.com/articles/LEH-BSC-fre-fnm-MBI-abk/index/a/16202