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Wall Street, feds haggle over who swallows Lehman's junk

Section: Daily Dispatches

Wall Street Firms Could Buy Lehman 'Bad Bank'

By Francesco Guerrera, Peter Thal Larsen,
Krishna Guha, and Henny Sender
Financial Times, London
Saturday, September 13, 2008

Wall Street firms would buy the $30billion-plus of property assets held in Lehman Brothers' "bad bank" to facilitate a rescue takeover for the embattled financial group, under one of the options being discussed by industry executives and regulators.

Financial chiefs have so far expressed reluctance to back the plan but remained locked in discussions with Treasury and Federal Reserve officials in New York Saturday in an effort to solve the crisis at Lehman before the markets open on Monday, according to people close to the discussions.

They stressed that the plan to take the commercial assets of Lehman's balance sheet, modelled on the company's own proposal for a spinoff the assets into a listed company, was only one of the ideas being discussed and that no decision had been made.

This option remains live and is under active discussion at the moment. However it is not the only option put forward by the authorities, and other options -- including ideas put forward by the private sector -- remain under discussion as well.

In addition to exploring these various ways to support a deal, the authorities and the private-sector leaders are discussing how to deal with alternative scenarios in which there is no deal and Lehman could collapse.

A solution could come as early as Saturday night but it is more likely to come on Sunday, according to people familiar with the situation.

The sale of the "bad bank" to a Wall Street consortium would be similar to the government-brokered, industry-funded rescue plan for the failed hedge fund Long Term Capital Management in 1998.

Taking the toxic commercial assets off Lehman's books would make the investment bank more attractive to potential bidders.

Bank of America is seen as the leading candidate to buy Lehman. It is considering a possible joint takeover bid with JC Flowers, the financial investor, and China Investment Co., the Chinese sovereign wealth fund. UK bank Barclays is also interested. The three could combine, with the BofA consortium buying Lehman's investment bank and Barclays taking its asset management arm, which includes Neuberger Berman.

However, bankers close to the discussions said Wall Street firms were unwilling to finance a rescue plan that would enable BofA and possibly Barclays to buy a "clean" Lehman at a cut price.

But they would have to weigh the risks that failure to clinch a deal to rescue the 158-year-old investment bank by Monday morning could spark chaos in financial markets and deepen Lehman's plight.

Some of the Wall Street executives said they would not back the "bad bank" plan unless the government agreed to guarantee at least some of the losses on the assets, which could be vulnerable to a further fall in US property prices.

Other executives said that BoA, or any other Lehman buyer, would have to share the pain of the rescue by taking part in the purchase of the "bad bank," according to people briefed on the discussions.

BoA, Barclays, and Lehman are not represented in the meeting, which is taking place at the Manhattan headquarters of the New York Fed.

The banks, Treasury, and Fed declined to comment on the discussions.

As of 2 p.m. ET Saturday Hank Paulson was resolutely sticking to his position that the government would not contribute any public money to help facilitate a Lehman rescue.

The US authorities may offer other help, including flexibility on regulatory issues, such as treatment of private equity firms involved in a deal.

Mr Paulson believes that the systemic risks associated with the potential failure of Lehman have been reduced because the market has had time to prepare for its possible demise, and a new Fed funding facility would assist an orderly unwinding of its positions.

Some US officials still see a Lehman failure as a scary prospect and are wary of assuming that risk management exercises have removed all the dangers associated with the demise of a complex financial company operating in dozens of countries.

While other financial companies have been in a position to manage their direct exposures to Lehman, it was probable that no one was fully aware of indirect exposures -- through third parties or common positions.

The authorities' stance increases the likelihood that Lehman will be forced into a sale at a knock-down price. People close to the discussions said Lehman's risky $33 billion portfolio of commercial real estate could prove a stumbling block.

Many bankers believe Lehman must find a solution before the market opens on Monday or face a further loss of confidence.

The authorities resist the idea of a Monday deadline. Ratings agencies Moody's and Standard & Poor's have said they will cut Lehman's ratings if the bank fails to find a buyer. This would limit its ability to act as a counterparty.

Lehman shares fell 13.5 per cent to $3.65 Friday.

Christopher Flowers, a former Goldman Sachs partner who is close to BofA, manages about $3.2 billion of CIC's money in a fund dedicated to taking stakes in financial institutions.

A senior executive at CIC declined to comment. BofA and Lehman declined to comment. Mr Flowers could not be reached.

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