Lehman Falls Into the Grip of Investor Hysteria

Seemingly with every passing moment, the gap between the reality of Lehman Brothers's financial situation and the fears surrounding it widen. And the wider the gap, the more irrational the financial markets get -- or the better will be the deal the eventual buyer of the investment bank will score.

Lehman's market quandry centers on its commercial and residential real estate holdings. Part of the unknown equation about Lehman is how much are its assets worth? How many more writedowns or losses will Lehman be forced to take as a result of its value-ambiguous portfolio?

At the end of August, Lehman held $17.2 billion of residential mortgage assets, down from $32.1 billion in November 2007, and $24 billion of commercial mortgage paper, $14.9 billion less than it held last November.

Let's first address valuation. In a conference call this morning, Tanya Azarchs, managing director of financial institutions ratings at Standard & Poor's, said the market was coming to a firm valuation. The price on syndicated loans: $0.90 for each dollar of face value. Subprime securities: $0.22 on the dollar. Triple-A, Alt-A mortgage securities: $0.50 on the dollar. These are hard numbers. Azarchs said "prices have stabalized," and she is among the first market participants to say so.

Furthermore, the enterprise value of Lehman is getting crushed, and we are not convinced it should be. The commercial mortgage portfolio is the avenue of particular focus for us. One of Wall Street's leading financial services traders told us that the Lehman commercial book is performing well, and that the investment bank "has taken conservative marks on everything." "Whoever buys it will be looking really smart in two years," he added.

We see his point. About 5% of Lehman's commercial book is not performing currently, a manageable number. And even if you think commercial defaults are going to go nuclear, Lehman said Tuesday that it would spin off all its commercial real estate assets into an entity called REI Global. So let's recap: Lehman cuts its exposure to residential mortgages; pricing is settling, so investors can finally call the bottom on valuation; and Lehman is ditching its commercial real estate assets, which are performing well anyway. To us, this seems like hysteria is getting the best of investors.

But hysteria matters in investing, unlike in, say, medicine. Investor fear becomes investor reality, especially when it comes to financial institutions. In the case of Lehman, it almost seems as though the die was cast long ago when it bought a shlocky subprime mortgage company called BNC Mortgage in July 2000. Eventually, bad decisions take their ounce of blood.

Victoria Fierson contributed to this blog.

Tags: commercial, lehman, mortgage

Comment by JJ Hornblass on September 14, 2008 at 10:35am: Barclays is emerging this weekend as the leading bidder for the "good" portion of Lehman, with ownership of the "bad" Lehman, comprised of its unsavory assets, being dispersed among several Wall Street firms.

Comment by JJ Hornblass on September 14, 2008 at 7:47pm: The situation has changed dramatically today, with Lehman appearing to be headed for liquidation. A remarkable turn for the investment bank.

Comment by Michael Gibb on September 15, 2008 at 10:35am: Between Bear Stearns, Lehman Brothers, and Merrill Lynch, the investment banking world has lost 337 years of experience this year. Has Wall Street become a home for the aged?

Who's going to be left to do any advising?

Comment by Sharon Brooks on September 15, 2008 at 1:29pm: Is it such a bad thing-long term? Or were there to many wall street firms already doing the same thing?

Comment by JJ Hornblass on September 15, 2008 at 3:46pm: It is tough to say, Sharon. Over the last 15 years or so, Wall Street has consolidated around just a handful of firms. Yes, there are other investment banks on Wall Street, but Merrill, Lehman, Morgan Stanley and Goldman Sachs, as well as to some degree Bear, UBS and Credit Suisse, had become the great purveyors of high finance in the U.S. Clearly, other firms will step in to fill any gaps in service over the long term, but the near-term jolt to the system appears to be notable.

Comment by Victoria Fierson on September 15, 2008 at 4:07pm: I was listening to the S&P call that took place on Friday, which this blog was based on. What I took away from the call was that Lehman's situation was drawing more bad press because of fear and a repeat of the Bear situation. Lehman's financial troubles were apparent, but seemingly manageable. All parties involved on the call did not seem very concerned. S&P even classified Lehman's ratings to be on par with Merrill and not far behind Morgan and Goldman. Fast forward three days and Lehman's stocks plummeted and they are filing for bankruptcy protection. Something must have gotten lost in translation.

Comment by Jeff on September 15, 2008 at 4:26pm: Lehman Brothers in bankruptcy is not a good thing. A business that has been around for this long, really puts a dent in the old confidence of the economy thing. That said, most of those who will lose their jobs over Lehmans bad decisions are, by and large far from responsible for the present dilema, yet they are the ones who will suffer greatly. Those on top of the Lehman food chain will have a dent in their ego's but, ultimately will wind up OK. The little guys/gals who come in everyday and do their jobs, maynot be so OK. Couple that with the paper loss taken on their stock in Lehman and lets say this hasn't been a great couple of days. The greed that has been the focal point of the subprime catastrophe is not the greed of the little guy, its the greed of the really big guys. Its just the little guys who really pay for it.

Comment by JJ Hornblass on September 16, 2008 at 11:12am: 05. [LEH, BCS] Barclay seals deal to acquire parts of Lehman: report
10:42 AM ET, Sep 16, 2008

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