Lehman's Fuld Races to Sell Firm as Fed Balks at Deal

By Yalman Onaran

Sept. 12 (Bloomberg) -- Lehman Brothers Holdings Inc. Chief Executive Officer Richard Fuld is seeking buyers for the investment bank amid signs that the U.S. government may balk at providing the funding that enabled Bear Stearns Cos. to sell itself and avoid bankruptcy.

Fuld, who built Lehman into the biggest U.S. underwriter of mortgage securities during his four decades at the firm, was cornered into a potential forced sale after talks about a cash infusion from Korea Development Bank ended, sparking a 70 percent drop in the firm's market value during the past three days. Unlike when JPMorgan Chase & Co. took over Bear Stearns, the Federal Reserve and Treasury aren't likely to put up money for a purchase of Lehman, people briefed on the matter said yesterday.

``Lehman's sale is likely to take a different form because there was serious political fallout from the JPMorgan-Bear deal,'' said Sean Egan, president of Egan-Jones Ratings Co. in Haverford, Pennsylvania. ``It could be a consortium that buys Lehman, with the Fed's help.''

Bankers from other firms were reviewing Lehman's books yesterday, according to people with knowledge of the situation, and a deal may be announced before Asian markets open Sept. 15, one of the people said. The New York-based investment bank announced the biggest loss in its 158-year history on Sept. 10, as devalued real estate assets led to $5.6 billion of writedowns in the third quarter.

Downgrade Looms

Without a ``strategic arrangement'' in the ``near term,'' Lehman's credit ratings may be downgraded, Moody's Investors Service said after Lehman reported the results. A downgrade could ratchet up Lehman's borrowing costs and deter others from trading with the firm.

Bank of America Corp., the biggest U.S. consumer bank, is among the possible buyers, the Wall Street Journal reported yesterday, citing unidentified people. Spokesmen for the Charlotte, North Carolina-based lender, Lehman and the Fed declined to comment. Treasury is ``in regular contact'' with market participants, spokeswoman Jennifer Zuccarelli said.

Lehman shares rose to $4.72 as of 9:25 a.m. in Frankfurt, 12 percent up from their $4.22 close in New York yesterday.

When Bear Stearns collapsed in March after customers and lenders deserted the firm on concern it was running out of cash, the Fed agreed to take on $29 billion of hard-to-sell assets from the company to induce JPMorgan Chase & Co. to buy it. At the same time, the central bank opened a lending facility for brokerages, including Lehman.

Moral Hazard

The decisions prompted warnings from current and former regulators, who said that the Fed was creating a so-called moral hazard by encouraging firms to take on excessive risk in anticipation of government aid in the event their bets fail.

Richmond Fed President Jeffrey Lacker and his Philadelphia counterpart Charles Plosser raised concerns about moral hazard in June, urging that lines be set for any central bank intervention. U.S. regulators reluctant to backstop another investment bank may point to the fact that speculation about Lehman's potential failure hasn't generated as much concern among investors as Bear Stearns's implosion.

Unlike the days leading up to the forced sale of Bear Stearns, 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 11 points the past two weeks to 121 basis points, compared with an increase of 38 basis points to 160 basis points in the period leading up to Bear Stearns's collapse.

``What would be best is to alter the precedent with Bear Stearns,'' said former Fed governor Laurence Meyer, who is now vice chairman of Macroeconomic Advisers LLC, an economic forecasting firm in Washington.

Lehman's Mortgage Portfolio

Meyer said a preferable model would be the Fed's 1998 coordination of a rescue for hedge fund Long-Term Capital Management LP. In that case, officials convened bankers to forge a resolution without contributing Fed funds.

Potential buyers demanded some sort of government protection in the Bear Stearns case because of the mortgage- related assets the firm owned, which had plummeted in value. Since the collapse of the subprime mortgage market last year, banks have reported more than $510 billion of writedowns and credit losses on such assets.

Lehman still had a $50 billion mortgage portfolio at the end of August, and any would-be buyer would likely seek Fed backing, according to David Hendler, an analyst at CreditSights Inc.

Korea Development Talks

``It'll have to be a joint public-private solution because the buyers aren't going to take these hits on the troubled assets,'' Hendler said.

Lehman had advanced discussions about a deal with state- owned Korea Development Bank, which offered as much as $6 billion for a 25 percent stake in the firm, or about $26 a share, people briefed on the talks said last week. Lehman fell to $4.22 in New York Stock Exchange composite trading yesterday.

Goldman Sachs Group Inc., the biggest U.S. securities firm, has no plan to buy Lehman without financial backing from the Fed or Treasury, a person briefed on the matter said yesterday. Goldman spokesman Michael DuVally said the investment bank ``continues to do business'' with Lehman.

Several of the largest European banks may be tempted to buy Lehman to bolster their presence in the U.S., analyst Richard Bove said earlier this week. Ladenburg Thalmann & Co.'s Bove speculated that HSBC Holdings Plc, Europe's biggest bank by market value, could be a suitor.

HSBC, Deutsche Bank

London-based HSBC said on Sept. 10 it was ``highly unlikely'' to buy an investment bank while Josef Ackermann, the CEO of Deutsche Bank AG said he wasn't interested in ``parts or all of Lehman.''

Fuld, 62, is the longest-serving CEO on Wall Street, having been in charge of Lehman since 1993. James ``Jimmy'' Cayne, who resigned as Bear Stearns's CEO two months before the firm collapsed, was at the helm for 15 years.

``I have always said that if anybody came with an attractive proposition that made it compelling for shareholder value, that would be brought to the board, discussed with the board and evaluated, and that has not changed,'' Fuld said on a conference call with analysts on Sept. 10.

To contact the reporter on this story: Yalman Onaran in New York at yonaran@bloomberg.net