TOPICS > Economy

Wall Street Turmoil Forces Change to Banking Landscape

September 15, 2008 at 6:15 PM EDT
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After a frantic weekend on Wall Street, Lehman Brothers filed for bankruptcy and Bank of America moved to buy Merill Lynch -- all of which sent the Dow Jones industrial average plunging on Monday. Reporters from the New York Times and the Wall Street Journal detail the shockwaves rattling the financial sector.

GWEN IFILL: Now, an in-depth look at the crisis on Wall Street and the fallout, beginning with a report on what transpired today and this past weekend, one of the most tumultuous in Wall Street history.

HENRY PAULSON, U.S. Treasury Secretary: I hope you all had an enjoyable weekend.

GWEN IFILL: This morning’s rude awakening — news of the disintegration of two Wall Street investment houses — sent Treasury Secretary Henry Paulson to the White House to try to calm the waters.

HENRY PAULSON: Well, as you know, we’re working through a difficult period in our financial markets right now as we work off some of the past excesses. But the American people can remain confident in the soundness and the resilience of our financial system.

GWEN IFILL: But the markets skidded all day after Paulson and Federal Reserve Chief Ben Bernanke spent the weekend in New York, but would not commit to government aid.

As a result, Merrill Lynch was sold; 158-year-old Lehman Brothers, carrying $613 billion in debt, declared bankruptcy.

HENRY PAULSON: Nothing is more important right now than our stability of our capital markets. And so I think it’s important that regulators remain very vigilant. We’re very vigilant. But we do not take — and I don’t take lightly — ever putting the taxpayer on the line to support an institution.

JOURNALIST: Should we read that as “no more”?

HENRY PAULSON: Don’t read it as “no more.” Read it as that, you know, it’s important, I think, for us to maintain the stability and orderliness of our financial system.

GWEN IFILL: Lehman gave way as a result of billions of dollars in bad bets on the subprime mortgage market. Paulson declined to use taxpayer dollars to help.

Merrill Lynch was saved only by a late-night agreement to merge with Bank of America. The $50 billion all-stock transaction reassured shareholders and the millions of Americans who use its huge network of stockbrokers.

Bank of America CEO Ken Lewis and Merrill Chief John Thain said the deal came together quickly.

KEN LEWIS, Bank of America CEO: John called me on Saturday morning, and we began to talk about this opportunity over the phone. And then, a few hours later, we were talking about it in person, and then basically went from there.

GWEN IFILL: This is the second time Bank of America has come to the rescue of another failing institution caught in the grip of the mortgage credit crisis. Earlier this year, it purchased lender Countrywide Financial for pennies on the dollar.

Merrill CEO Thain was asked what he would say to a nervous public.

JOHN THAIN, Merrill Lynch Chairman: This is probably the most difficult environment in the financial markets that I’ve experienced in my 30 years in the business. But it is a cycle, and we will get through it. It will get better.

And when it gets better, I think this combination will be incredibly strong and do very, very well. But it is definitely a very, very difficult time, and it’s not going to get better quickly.

GWEN IFILL: With the government-backed sale of Bear Stearns in March, three principal independent investment banks are now going or gone.

Contributing to the uncertainty this weekend was the financial health of insurer American International Group, which is now seeking $40 billion in federal assistance to shore up its faltering balance sheet.

Late today, the Wall Street Journal reported that the federal government had asked two other firms, Goldman Sachs and JPMorgan, to help raise the money.

And last week, the government agreed to take over the congressionally chartered lenders Fannie Mae and Freddie Mac. Together, they hold about half of the outstanding mortgages in the United States.

The underlying concern: that the slide in the housing credit market has not yet hit bottom.

Domestic fallout of crisis

HENRY PAULSON: The root of the problem lies in this housing correction. And until we stem the housing correction, until the biggest part of that is behind us and we have more stability in housing prices, we're going to continue to have turmoil in the financial markets.

And that is why the actions with respect to Freddie Mac and Fannie Mae are so extraordinarily important, not only to our capital markets, but to making sure we have plenty of finance in housing, because that, in my judgment, is going to be the key to turning the corner here.

GWEN IFILL: Over the weekend, former Federal Reserve Chief Alan Greenspan also offered a dour assessment.

ALAN GREENSPAN, Former Federal Reserve Chairman: But this is a once-and-a-half-century, probably once-in-a-century type of event.

JOURNALIST: Is it the worst you've ever seen in your career?

ALAN GREENSPAN: Oh, by far. There is no question that this is in the process of outstripping anything I've seen. And it still is not resolved, and it still has a way to go. And, indeed, it will continue to be a corrosive force until the price of homes in the United States stabilizes.

GWEN IFILL: Both major candidates weighed in on the expanding financial turmoil today. Republican John McCain spoke to voters this afternoon in Orlando, Florida.

SEN. JOHN MCCAIN (R), Arizona: The first thing I think that we should note is that the action taken on Lehman was not backed by taxpayers' dollars. The taxpayers are not involved, and I think that was a very important step forward, because if we had had the taxpayers back Lehman Brothers, then it would have just been a slippery slope.

And so, unlike Bear Stearns, that first one, there is no taxpayers' money at risk. I recently -- I just an hour or so ago talked to Secretary Paulson about this.

As I mentioned early in my remarks, the regulatory system is broken. It was designed for the days in the stock market when they used to hold up cards and they would yell back and forth at each other.

Now the global economy is instantaneous. Around the world, this trading goes on. So they -- we've got to catch up the regulatory bodies to make sure that there is the proper oversight and regulation and transparency.

GWEN IFILL: Barack Obama campaigned in Grand Junction, Colorado.

SEN. BARACK OBAMA (D), Illinois: Too many folks in Washington and on Wall Street weren't minding the store. Now, for eight years, we have had policies that have shredded consumer protections, that have loosened oversight and regulation, and encouraged outsized bonuses to CEOs while ignoring middle-class Americans. The result is the most serious financial crisis since the Great Depression.

GWEN IFILL: Treasury Secretary Paulson said investors and taxpayers should separate rhetoric from reality as they begin to assess the fallout from today's bad news.

HENRY PAULSON: We're not going to move through this in a straight line. There are going to be some real rough spots along the road, but I believe we're making progress.

And when I look at the way the markets are performing today, I think it's a testament to the way the financial industry has come together, because they're dealing with an extraordinary set of circumstances and they're dealing in a way we should all be proud of.

GWEN IFILL: Jeffrey Brown has a closer look at the dramatic turn of events in New York.

Lehman had no options left

JEFFREY BROWN: And for that look behind the scenes, I'm joined by Jenny Anderson, business reporter for the New York Times, and David Wessel, economics editor for the Wall Street Journal.

Well, David, Lehman Brothers had been in trouble for a while. Was there any one thing that finally brought it to the brink this weekend?

DAVID WESSEL, Wall Street Journal: It doesn't seem like there was a straw that broke the camel's back. They had basically engaged in some wishful thinking, that some deal was going to come through. Their luck ran out.

They hoped over the weekend, as you know, to find a buyer so they wouldn't have to go bankrupt. In the end, neither of the potential buyers, Barclays, the British bank, or Bank of America, was willing to do a deal without substantial help from the Fed and the taxpayers. The Fed and the Treasury said no, so the last resort was to file for bankruptcy, which is what they did.

JEFFREY BROWN: Jenny Anderson, as we heard, the federal government, federal officials were pretty clear from the start that they were not going to step in this time, but they had to convince Wall Street of that, right, so it sounds as though there were some very dramatic meetings over the weekend.

Tell us what was going on.

JENNY ANDERSON, New York Times: I think there was a little bit of horse-trading going on. I think the government was very adamant that they didn't want to do a direct bailout program for Lehman Brothers, and they didn't do that. They stuck to their guns on that.

But in the end, there was a little bit of give-and-take. The Fed actually agreed to expand the lending facility that they had already put in place that was already in expanded facility. So they've made it a little bit easier for Wall Street firms, in the wake of the collapse of Lehman Brothers, to borrow a little bit more money. So that is -- you know, that is a taxpayer issue.

But at the end of the day, they didn't actually go forward with the full-blown bailout. I think the government really tried to stick to that.

And in the end, Wall Street actually also stepped forward and put $77 billion up and said, "We're going to create another facility behind the Fed facility in case that's not enough."

So they're trying to just throw capital at the problem and say, "We can deal with this. There's going to be enough money." I don't know that the markets actually bought that today, but that was the message.

JEFFREY BROWN: And all this was hashed out in some very high-powered meetings, it sounds like?

JENNY ANDERSON: These were around-the-clock meetings all weekend long. It started on a rainy evening on Friday night with these guys shuffling in, and it lasted all weekend long.

There were people there at the wee hours on the morning on Sunday morning. And there were a lot of dramatic turns. I mean, at one point, it looked as if there was going to be a rescue of Lehman Brothers. And it looked as if Barclays was going to step up.

And then Barclays walked away, and suddenly it looked like Wall Street had to come up with its own solution, and then the government stepped up. And, I mean, there was lot of give-and-take. It was a fascinating weekend.

No bail-out, Merrill makes a deal

JEFFREY BROWN: David, what does your reporting tell you about why the government decided not to step in, in this case, given what they did with Bear Stearns, given what we saw real recently with Fannie Mae and Freddie Mac? What happened this time?

DAVID WESSEL: Well, I think there were a number of differences. One is I think both Secretary Paulson and Fed Chairman Ben Bernanke and his New York Fed president, Tim Geithner, really wanted a place where they could draw a line in the sand for the reasons that Mr. Paulson said.

At some point, if you keep bailing out these banks, if you keep doing these assisted transitions, it's like you can't say no to anybody.

But, secondly, my sense is that they didn't really think that Barclays or Bank of America were serious bidders for -- for Lehman Brothers. It was only with a huge amount of money -- basically, a bargain basement price would they have come forward.

So I think there was both those specifics and the general attempt to set a rule to draw a line in the sand and say, "Basta. Enough."

JEFFREY BROWN: Now, David, let me stay with you, and let's turn to Merrill Lynch, because, again, we knew that it was in some trouble. But why the very sudden move to sell itself to Bank of America?

DAVID WESSEL: Well, I think that they saw what happened to Lehman Brothers when they waited too long. If you wait too long and your market value goes down, you're less and less of an attractive target, apparently.

So I think that they had a CEO who was not -- who was a newcomer, who was a --the CEO at Lehman had been there for a long time, very emotionally involved in the firm. John Thain at Merrill Lynch, he clearly thought it was in his interest to sell and sell now before things got worse.

Everybody knows that, when Lehman went down, the other sequoias on Wall Street, Merrill Lynch and AIG, the insurance company, would be shaking. And Mr. Thain made a move to get the deal done before that could happen to him.

JEFFREY BROWN: Jenny Anderson, do you have anything to add on what you saw happened with Merrill Lynch?

JENNY ANDERSON: Well, I think David makes a very good point. I think Dick was -- Dick Fuld, the CEO of Lehman Brothers, was -- he held out to the bitter end. I mean, late on Sunday night, he didn't want to file for bankruptcy. He did not. He was not ready for this move.

And this is an extension of what's been going on for a long time. These assets have been deteriorating. The value of their stock price has gotten hammered. They've needed more and more capital. And it seems like there's just been a denial at work.

And I think John Thain saw the writing on the wall. He said, "I don't want to be Dick Fuld. I don't want to be in the same situation. This is -- I'm not going to put the firm at risk. I'm going to do a deal."

I mean, what's interesting is Bank of America had approached Merrill Lynch before and John Thain had said no. But let's look at Merrill Lynch, a year ago, was a $100 billion company. It's a $50 billion company today. He didn't want to see it go to $25 billion on Monday morning when Lehman Brothers announced its liquidation, so he moved fast.

Fears over stability of AIG

JEFFREY BROWN: All right, Jenny. Then to add on to all of that, we start hearing about AIG. Now, this is an insurance company, a very big one. How did it get into trouble? And what's the situation there now?

JENNY ANDERSON: Well, the situation I think is very dire. I mean, I think they need to raise a lot of capital. They weren't able to come up with the money today in a timely fashion.

I think there were, you know, too many crises for one weekend. I mean, it was sort of one thing after another. It was Lehman, and then it was Merrill, and then it got to AIG. And time ran out, and they just couldn't get the financing lined up. And now they're having to cast a wider net for that financing.

They got into trouble on a lot of the same issues that Lehman and Merrill did, which is toxic real estate securities packaged into very complex securities that appears a lot of the CEOs didn't really understand how they worked and how they would fall apart, more importantly.

A lot of these firms were very levered. They'd borrowed a lot of money. And as these things started to fall apart, it's created huge problems for the companies and a need for capital that they just can't find now. The capital is running out.

JEFFREY BROWN: So, David, it added up today to a more than 500-point drop. So from people you're talking to, what's the mood? Is there any sense that this is a bottom or do we expect more?

DAVID WESSEL: Well, I think it was pretty much of a disappointment that the market turned so sour at the end of the day. Early in the day, people were kind of relieved that the stock market was performing better, you know, down only 300 points, which seemed modest compared to the size of the headlines in our papers.

I think there are two views on this. One view is that this is just going to get worse and worse as more and more banks and financial firms hunker down, unable to raise enough capital to expand lending. They contract their lending and choke off growth. That's the pessimistic scenario.

The optimistic scenario is that maybe the last couple of days have been the cathartic event where everybody faces reality, takes their losses, puts this behind them. We now know what the rules are. The government isn't going to bail anybody else out, unless they have a dire emergency that shakes the system.

And maybe this can be seen as the darkest day and things get better. I honestly don't know which it is; I know what we all hope it is.

JEFFREY BROWN: Jenny Anderson, in the short term, what happens to Lehman's employees, investors? And the same thing for Merrill. What happens to the investors there?

JENNY ANDERSON: Well, I think Lehman shareholders have effectively been wiped out. Their employees are having a terrible day. I mean, it's a real tragedy. This is a very storied firm. And there are some incredibly distraught people today. It's not a great job market on Wall Street already.

Everyone else is laying people off. To sort of flood the market with another 25,000 people is pretty severe. They are looking to sell their asset management business, Neuberger Berman, which they will probably be able to do. This is a valuable business.

They will attempt to sell the broker-dealer business, but they've put sort of the holding company into bankruptcy, but there are some assets that they will try to sell. But I think shareholders are pretty much done in.

As for Merrill Lynch, it's unclear how severe the layoffs will be in a Bank of America-Merrill Lynch combination. It's interesting that Ken Lewis not very long ago commented that he was done with investment banking. Investment bankers can be very expensive to hold on to, and he had experimented with that and it was very expensive.

And now he is back in the game with a whole investment bank for Merrill Lynch. And he'll have to see what to do with those bankers in a market where there is not a lot of activity. But what he did get is he got the 16,000 thundering herd brokers, and that's what he wanted.

JEFFREY BROWN: All right, Jenny Anderson of New York Times, David Wessel with the Wall Street Journal, thanks both very much.

JENNY ANDERSON: Thanks for having us.