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Fed holds emergency meeting on market developments

NEW YORK/WASHINGTON —“Senior representatives of major financial markets met at the Federal Reserve Bank of New York Friday evening to discuss recent market developments,” a Fed official told Reuters.

Financial markets have been on tenterhooks over the future of Lehman Brothers Holdings Inc. and whether the struggling firm, whose stock value has collapsed, may or may not be able to find a buyer.

The U.S. Treasury and Fed have been involved in talks regarding Lehman's future. Earlier on Friday, a source familiar with the thinking of Treasury Secretary Henry Paulson said Mr. Paulson was “adamant” no public funds be put on the line to help facilitate a sale.

Concerns are growing that Lehman Brothersmay fail to find a willing buyer due to U.S. government reluctance to provide financial backing for the deal, sending its shares to a 14-year low.

Lehman executives, potential buyers and government officials struggled on Friday to craft a buyout plan, ahead of what is expected to be a series of increasingly frantic calls this weekend between Lehman and potential bidders.

“I think they're going to have to draw a line at some point,” Rose Grant, managing director of Eastern Investment Advisors in Boston, said of Washington regulators' role in bailing out financial institutions. “This could be the point.”

Bank of America Corp. is widely seen as a leading contender, with British bank Barclays PLC also considered a possibility.

Time is of the essence for Lehman. Since Monday, the firm's market capitalization has lost 78 per cent, to about $2.5-billion (U.S.) from $11.2-billion. Its shares fell 13.5 per cent on Friday to close at $3.65 on the New York Stock Exchange. Its bonds also dropped.

The uncertainty surrounding Lehman underscores how the U.S. banking system as a whole does not have the capital needed to get through the current credit crunch, an influential investor said on Friday.

“Recent developments highlight the extent to which the banking system as a whole lacks sufficient capital to comfortably navigate this period of sharp de-leveraging,” Mohamed El-Erian, co-CEO of Pacific Investment Management Co. (Pimco), said in an interview. Pimco oversees more than $812-billion in assets.

Other financial companies' shares also plunged on Friday, including leading brokerage Merrill Lynch & Co. Inc. and American International Group Inc., once the world's largest insurer by market capitalization. AIG lost as much as a third of its value, while Merrill slid 11 per cent.

Credit protection costs also rose for AIG, Lehman and JPMorgan Chase & Co., with investors paying $715,000 to protect $10-million of Lehman debt, and $1.2 -million to protect the same amount of AIG debt.

The Financial Times reported that BofA, the No. 2 U.S. bank by assets, was considering a joint bid for Lehman along with private equity investor JC Flowers and sovereign wealth fund China Investment Co. Lehman declined to comment.

Adding doubts about the possibility of a quick rescue for Lehman, a source familiar with U.S. Treasury Secretary Henry Paulson's thinking said he was “adamant” that no government money be used in any deal.

U.S. Sen. Richard Shelby, the top Republican on the Senate Banking Committee, told CNBC that the Treasury and the Federal Reserve were trying to work a deal that involved no U.S. government money.

“I'm hoping that some big firm will want them more than the Fed wants them,” he said.

The investment bank is struggling to find a solution to the worst crisis in its 158-year history. Lehman wrote down its assets by $5.6-billion in the third quarter, triggering a second straight quarterly loss.

Lehman has so far failed to attract investors to shore up its capital position, weakened this year by its outsized exposure to commercial real estate and residential mortgage assets hard hit by the continuing credit crunch.

Standard & Poor's analyst Scott Sprinzen said on Friday he did not expect Lehman to fail and said its near-term liquidity was satisfactory. But S&P analyst Tanya Azarchs said concerns are “very, very high” because of skittish market conditions.

A Fitch analyst said the failure of Lehman to reach a deal would result in a ratings cut in the “near term.” If its ratings were cut, it could be forced to post as much as $2.9-billion in collateral to counterparties, according to research from CreditSights.

Bank of America, the largest U.S. bank by market value, has emerged as the most likely suitor for Lehman, according to various reports and analysts. BofA declined to comment.

“I believe that Bank of America will win the auction for Lehman Brothers. There is a natural fit between the two companies,” banking analyst Richard Bove said in a note.

HSBC PLC has also been linked with Lehman, but in recent weeks executives at the London-based bank have distanced themselves from a possible deal.

By buying Lehman, BofA would get access to one of the best fixed-income trading desks, Mr. Bove said. “It immediately becomes a first-rank player in the equity investment banking sector.”

But a takeover by BofA, which took on a huge restructuring burden in troubled mortgage company Countrywide earlier this year, was far from a sure thing.

In a sense, Charlotte, North Carolina-based BofA could snag Lehman for a bargain as its market capitalization is now less than investment banks that were once much smaller than Lehman, such as Raymond James Financial and Jefferies Group Inc.

But BofA and other bidders were said to be concerned about potential losses on Lehman's $45.8-billion of mortgage and asset-backed securities.

Lehman Chief Executive Richard Fuld, who had vowed never to sell the firm in his lifetime, has been trying to unload just a part of the company rather than the whole thing, sources familiar with the situation said.

But investors gave a thumbs-down to revival plans unveiled by Lehman on Wednesday, saying they lacked real progress. It prompted fears that clients and trading partners might take their business to more stable firms. Major Wall Street firms have said they continue to do business with Lehman.

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