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Ten days that shook the world

The 7 September rescue of half of the American mortgage industry in the form
of Fannie Mae and Freddie Mac might have looked like the biggest single
catastrophe to hit the financial markets, against which any subsequent collapse
would pale in comparison.

Not quite true. In terms of sheer dollar weight propping them up, the $300bn
of US Treasury money is certainly the largest bailout in the history of pretty
much everything. But what happened next still created huge shock waves.

Lehman Brothers had been fighting a rearguard action for weeks, trying to
shore up a balance sheet that was holed below the waterline. Things weren’t
helped by the highly-respected think tank, the Brookings Institution, saying,
“If I were at the Fed I would be hoping for an opportunity to show the world
that the Fed will not rescue every ailing institution, but will let some go.”

On Sunday 14 September, Barclays turned its back on an opportunity to rescue
Lehmans, seemingly preferring to pick up just the bits it really wanted once the
158-year-old firm went belly-up. And Bank of America, according to the Wall
Street Journal Europe, didn’t want anything to do with Lehmans unless the US
government was prepared to provide assistance. Deal or no deal?

Don’t like Mondays
No deal. As credit derivatives dealers and everyone else scrambled on Monday
morning to unwind their positions with the firm, it went into Chapter 11
bankruptancy protection. Newspapers showed photographs of sullen bankers
carrying out their personal belongings in boxes.

Later that day, an almost equally momentous event was overlooked by the
non-financial press as the revered investment bank Merrill Lynch was forced into
the arms of Bank of America. The loss of independence at Merrills, self-styled
as “The thundering herd”, shocked many, even more than the wholesale collapse of

But it was at least a dignified market-originated solution, with BofA of
fering $29 a share for the investment bank whose shares had closed on Friday at
just over $17. There was “always the possibility of someone else making a
strategic investment,” said BofA chief executive Ken Lewis in defence of his
$50bn offer.

On this side of the Atlantic, HBoS watched its share price slide and slide.
The combination of what was once Britain’s biggest building society, the
Halifax, and the conservative Bank of Scotland, was “securitised up to the
hilt”, as one commentator put it. On 17 September HBoS confirmed it was in
merger talks with Lloyds TSB. The government seems content to wave away any
competition objections.

The reluctance of US authorities to prop up the market didn’t last long. Also
on the 17th, insurance group AIG received $85bn in emergency funding from the
Federal Reserve in return for giving the government a 79.9% stake. AIG was
stymied by its exposure to products that pay out to lenders who find themselves
with dud mortgages.

It also had huge exposure to credit default swaps. What seems to have killed
it was a downgrading by credit rating agencies that resulted in a need for
further capital ­ and even allowed customers to cancel their policies and
reclaim unearned premiums. The worse things got, the worse that made things.

It’s not over yet. As we write on 18 September, Morgan Stanley is in merger
talks with US Wachovia ­ which has its own troubles. Overnight, dollar interbank
rates soared to 6% above the Fed Funds rate of 2% while the scramble for some US
bonds sent yields below 0%. The Fed is pumping $180bn into money markets while
all five other major central banks around the world are also working together
and taking “appropriate steps to address the ongoing pressures” ­ to the tune of
almost $100bn. But despite the funding, those pressures seem unlikely to
disappear overnight.

See out blog, Shareholder Values, at

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