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The shape of the river, basically, is that Lehmann Brothers, an investment bank that mainly lends to large institutions, is going bankrupt. Merrill Lynch, an investment bank that lends to people, is doing rather the same thing. And there's a non-trivial chance that AIG and Washington Mutual are going to follow suit. But this latest round of fiscal catastrophe is interesting for the role the government isn't playing. Where they stepped in to midwife the sale of Bear-Stearns, and pushed forward with a bailout for Fannie Mae and Freddie Mac, the New York Times reports that the bankers were told early today that the Fed would not be providing the same backstop.
The weekend that humbled Lehman and Merrill Lynch and rewarded Bank of America, based in Charlotte, N.C., began at 6 p.m. Friday in the first of a series of emergency meetings at the Federal Reserve building in Downtown Manhattan.The meeting was called by Fed officials, with Treasury Secretary Henry M. Paulson Jr. in attendance, and it included top bankers. The Treasury and Federal Reserve had already stepped in on several occasions to rescue the financial system, forcing a shotgun marriage between Bear Stearns and JPMorgan Chase this year and backstopping $29 billion worth of troubled assets — and then agreeing to bail out Fannie Mae and Freddie Mac.The bankers were told that the government would not bail out Lehman and that it was up to Wall Street to solve its problems. Lehman’s stock tumbled sharply last week as concerns about its financial condition grew and other firms started to pull back from doing business with it, threatening its viability.A judgment was made that Merrill Lynch was both more profitable and more important to consumer confidence than Lehman Brothers, so Bank of America bought Merrill Lynch outright. They were thinking of snatching up Lehman, too, but balked when the Feds said they would not assume the riskiest portions of Lehman's portfolio. So Lehman Brothers is likely to be liquidated and others will probably follow.This marks a change in strategy for the Fed, which appears to be putting an end to its efforts to save individual banks. There's a lot of talk right now of a "systemic fix." Rather than saving the institutions, the Fed might attack what's making them fail. That would probably mean they begin buying huge quantities of mortgage-backed securities in a broad rescue attempt. It would be virtually unprecedented -- government intervention at a level we've not seen since, arguably, the Great Depression.
