TOPICS > Economy

Lehman Reports $3 Billion in Losses Due to Bad Mortgage Investments

June 16, 2008 at 2:28 PM EST
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Lehman Brothers chief Richard Fuld took responsibility Monday for a staggering $3 billion in losses in the second quarter, saying the company was too slow to react to the unfolding credit and mortgage crisis. Roben Farzad of BusinessWeek magazine outlines how the news may affect Wall Street and Main Street.
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GWEN IFILL: Now, turmoil in the housing and credit market spells more trouble for Wall Street. Ray Suarez has that story.

RAY SUAREZ: The almost $3 billion loss by Lehman Brothers reported today was mostly due to an erosion in the value of the bank’s mortgage investments.

Today, Lehman’s chief executive, Richard Fuld, said some of the investment decisions the company made “in hindsight were poor choices.”

The Wall Street gods are angry

RAY SUAREZ: Joining us once again tonight to help us sort through it all is Roben Farzad of BusinessWeek magazine.

Roben, how does a company like Lehman go in such a short time from a healthy profit to this huge quarterly loss?

ROBEN FARZAD, Editor, BusinessWeek: Wall Street is a merciless place. And it almost helps to use the angry god imagery of old Aztec lore. At the end of every boom cycle, the gods are very angry. And not only do they want layoffs, but assets and entire firms to be sacrificed, kind of as retribution and as indication of the creative destruction.

We saw what happened to Bear Stearns in March. In a matter of minutes, hours, its stock fell from the $50s and $60s to $2. It was forced at gunpoint, essentially, by the Federal Reserve to be taken over by JPMorgan Chase, in kind of a near-death experience.

And you saw something similar happen last week with hedge fund managers, and skeptics, and hecklers on the sidelines call into question the quality of assets on Lehman Brothers' balance sheet and essentially try to push the company over the edge, as well.

RAY SUAREZ: Well, is Lehman unusually exposed when compared to the other companies that are in this line of work?

ROBEN FARZAD: It is, indeed. It's always been known as a bond shop more than the others, a master of all things credit. And in recent years, it parlayed that to expand kind of hesitatingly into asset management, investment banking, and really come into its own.

But we didn't realize until the credit crisis of this past year to what extent it had levered up, it taken borrowed money to buy speculative assets linked to commercial and residential real estate, linked to leveraged buyouts.

And when the market completely froze up for these things, it was stuck with assets on its books, many exotic assets, tens of billions in exotic assets that it couldn't price.

So you throw in the fact that hedge fund managers are out there betting that the company's condition is actually worse than it appears, are forcing management to step up and tell them, "What exactly do you have on your balance sheet?"

You saw this happen with the hedge fund manager David Einhorn, who really forced the issue, forced the reckoning of last week, and got very much what he wanted.

The danger of exotic assets

RAY SUAREZ: Well, Roben, you mentioned those exotic assets, hard to price. Isn't this a case where you take the hit for a couple of bad quarters, strip out those non-performing assets, write them down, and then you're a healthier, leaner country at the end of it -- company at the end of it, or is this something more dangerous than that to Lehman?

ROBEN FARZAD: It is more dangerous, because we didn't realize that the assets can't really be cordoned off that neatly. Leverage, as I've said before, has really long tentacles. It's almost like rust in a car. You know, the more you scratch away the rust, you find the rust deeper into the car.

And, unfortunately, this is entailing a lot of counterparty risk. Look what took down Bear Stearns. It's that other firms didn't want to trade with Bear Stearns. It was a perception thing. They didn't buy Bear Stearns' credit worthiness at the end of the day.

So in that similar respect, Lehman Brothers here is acting out of, you know, a conservative preemption, to write down more than it has to necessarily, to telegraph to other people on Wall Street, other institutional investors that it's willing to find religion in the hopes that it doesn't lose customers, that it doesn't lose its reputation in minutes the way Bear Stearns did.

RAY SUAREZ: Well, waiting in line behind Lehman, other companies that are going to report their profits and losses in the next days and week. Are there expectations that there are some really horrendous stories coming out of those reports?

ROBEN FARZAD: There are. Unfortunately, it's really a continued purging. And the unfortunate thing is it happens in seeming lockstep. When you have someone like a Lehman Brothers step forward and say, "If we can't price these assets, OK, you win. We're going to write them down. Here they are," essentially taking $147 billion of assets off their books.

That inevitably affects another weak player, a Merrill Lynch, a lot of the commercial banks out there that relied on Lehman to buy up and securitize some of its mortgage debt.

Remember, we're all related in this. The mortgage loans that the Countrywides and the Bank of Americas of the world made were then sold, shipped to Wall Street. Wall Street sold those loans in different packaged instruments to institutional investors.

And then all that just suddenly stopped last summer, and it hasn't unlocked since. And it's a continued unwinding. And it's going to recourse back to Main Street, to other firms.

Now, this is a question of how conservative other firms have been. If they thought at the top of the real estate bubble, "Listen, we'd better take some chips off the table and maybe diversify," out of kind of a preemptive worry, that remains to be seen.

Hitting close to home

RAY SUAREZ: Well, there are people listening to you right now, and they may think of themselves as bystanders. If they don't own stock in one of these listed companies that's having these very bad quarters, if they're not being directly affected today, why should they worry about the problems of a faraway company on Wall Street?

ROBEN FARZAD: Well, Ray, never before -- I mean, maybe not since the Great Depression has the fate of Wall Street and Main Street been so interconnected. Almost metaphorically, there's a traffic jam or traffic wreck at the intersection of Main and Wall Street, because of, essentially, what I described there.

The real estate boom, which we thought was decidedly Main Street and, you know, apple pie on the windowsill, and the American dream, that had the support of Wall Street wholeheartedly. This was a boom that it latched onto.

And the securitization boom is something that Wall Street did in cahoots with neighborhood banks, with regional banks.

Look, Wachovia has been scathed in this. We saw Countrywide essentially forced to merge and be taken out by Bank of America. We saw essentially every regional bank have to fess up and say that, "We have a lot of non-performing loans."

You know, Washington Mutual is a savings and loan that's in a lot of hot water now. And these guys were all related.

And, look, when it works, it's great. And Wall Street eggs you on to take on these risks. But when it doesn't work, we see how brutally it unwinds. And the creative destruction is really merciless and relentless.

RAY SUAREZ: Roben Farzad of BusinessWeek, thanks for joining us.

ROBEN FARZAD: Thank you, Ray.