Lehman No Bear Stearns as Money Markets Show No Panic

By Pierre Paulden and Bryan Keogh

Sept. 12 (Bloomberg) -- Rising speculation that Lehman Brothers Holdings Inc. may fail is generating less concern among investors than when Bear Stearns Cos. imploded in March.

Unlike the days leading up to the forced sale of Bear Stearns to JPMorgan Chase & Co., volatility in the money markets remains relatively muted. The difference between what the U.S. government and banks pay to borrow in dollars for three months, the so-called TED spread, rose 13 points in the past two weeks to 123 basis points, compared with an increase of 38 basis points to 160 basis points in the period leading up to Bear's failure.

Investors are showing less fear after the Fed set up special lending facilities following the Bear Stearns bailout, giving securities firms the same access to its cash as commercial banks. The ability to tap the Fed for funds means financial troubles at one investment bank are unlikely to bring down others.

``We've learned that no dealer's going to fail,'' said Julian Mann, a bond manager at First Pacific Advisors LLC in Los Angeles, which oversees $11 billion. ``The equity may be worthless, but the trades are honored.''

Lehman announced a $3.9 billion loss, the biggest in its 158-year history on Sept. 10, after $5.6 billion of writedowns on real-estate loans and mortgage assets. Lehman fell more than 93 percent on the New York Stock Exchange this year and is valued below $3 billion, less than St. Petersburg, Florida-based Raymond James Financial Inc., the largest regional brokerage.

`Much More Patient'

``One of the interesting things about Lehman versus Bear Stearns is that the world is being much more patient,'' said Michael Shaoul, chief executive officer of Oscar Gruss & Son Inc., a New York-based brokerage. ``People aren't going home at night and saying, `Is there going to be a counterparty failure across the street?' There's a sort of willingness to trust the system to find a solution.''

The collapse of Bear Stearns and its sale to rival New York-firm JPMorgan in a bailout brokered by the Fed on March 16 forced the Fed to open its discount window to securities firms.

``There's a very good chance Lehman wouldn't even exist if the Fed window weren't in place,'' said David Kotok, chief investment officer of Vineland, New Jersey-based Cumberland Advisors Inc., which manages $1 billion.

Since June, the TED spread has averaged 112 basis points, compared with 116 basis points in the first half, when it reached 204 basis points in March, after the Bear Stearns sale.

Even though swings have been muted, the difference is still relatively wide. In the five years before the credit markets seized up in August 2007, the gap averaged 29 basis points.

Libor-OIS Spread

Another measure of fear in the market, the premium banks charge for lending short-term cash to each other over the Fed's expected target rate for overnight loans between banks, also isn't rising as fast as in March.

The difference between the three-month London interbank offered rate for dollars and what traders predict the central bank's daily effective federal funds rate will average over the next three months is 85 basis points. The spread was 78 basis points at the end of August.

In the days before Bear Stearns was sold, the so-called Libor-OIS spread surged to 82 basis points from 60 basis points. Between January and April, the spread ranged from 24 basis points to 90 basis points. Since June, the spread has traded within a range of about 12 basis points.

Even as the cost to protect Lehman's bonds from default rose to a record, credit-default swaps tied to the debt of Goldman Sachs Group Inc. and Morgan Stanley remained below levels reached in March. A spokesman for Lehman declined to comment. All the firms are based in New York.

Lehman Default Swaps

Five-year contracts tied to Lehman securities widened to a record 790 basis points on Sept. 11, before falling to 500 basis points on speculation the firm may be bought by Charlotte, North Carolina-based Bank of America Corp. They rose to 505 basis points in early New York trading today, according to CMA Datavision.

Contracts on Goldman debt were little changed at 180, more than 77 basis points below the March peak. Morgan Stanley contracts dropped 3 basis points to 235, CMA prices show, about 100 basis points below their high.

Credit-default swaps are contracts conceived to protect bondholders against default. They pay the buyer face value in exchange for the underlying securities or the cash equivalent should a company fail to adhere to its debt agreements.

A basis point on a credit-default swap contract protecting $10 million of debt from default for five years is equivalent to $1,000 annually. That means it costs $500,000 a year to protect $10 million of Lehman bonds from default.

Moral Hazard

Any Fed rescue of Lehman may deepen criticism about the danger of moral hazard -- where firms take on more risk in anticipation of government aid if their bets go wrong. The Treasury and the Fed have been working with Lehman on a sale, and a deal may be announced before Asian markets open Sept. 15, a person with knowledge of the matter said yesterday.

``The market's become used to it,'' Ed Grebeck, the chief executive officer of credit market strategy at Tempus Advisors in Stamford, Connecticut, said of the Fed's likely intervention in times of financial crisis.

Rates on three-month Treasury bills fell 2 basis points to 1.59 percent today, according to data compiled by Bloomberg, compared with 1.16 percent in the two days before the Bear Stearns takeover. The rate hit a five-decade low of 0.56 percent on March 19.

To contact the reporters on this story: Pierre Paulden in New York at ppaulden@bloomberg.net; Bryan Keogh in New York at bkeogh4@bloomberg.net