Lehman enters distressed realm, market ponders what is yet to come

By Stephanie N. Rotondo

Portland, Ore., Sept. 15 - After months of speculation about its future, Lehman Brothers Holdings, Inc. finally filed for bankruptcy Monday. As a result, equities and bonds took a massive hit.

But the filing was not a complete surprise, noted one analyst. "A lot of people saw this coming," he said.

Distressed bond traders have already begun to see Lehman notes float across their desks. The debt fell to the 30s from the 80 level, literally overnight. Its stock fell to around the $0.20 level from Friday's $3.65 close.

But questions regarding the investment firm, as well as the market in general, remain. With Bank of America taking over Merrill Lynch & Co. and American International Group, Inc. on the brink of destruction, what comes next is up in the air.

"Deleveraging is always going to be a pain," the analyst said. "And all these guys are way levered."

"Once [investor] confidence is gone, the gig is up," he added.

"It is a huge add-on to the distressed world," said one bond trader of Lehman's situation. Still, another trader said it is "hard to know what all is there, claims, where they sit, etc."

"Bankruptcy is going to prove out what [Lehman's] assets are really worth," said the analyst.

Now that Lehman has bit the bankruptcy apple, some believe that AIG will be the next on the block.

"AIG is clearly in trouble," said a trader. "It is just a question of if they go down or get taken over by a few of the major insurance companies."

"AIG is definitely next," said another source. "They need to raise $20 billion. I don't think they would raise $5 billion in this market."

"I think they have already died," said a trader. "The issue is whether they clean it up in an orderly fashion and parcel out the liabilities or if they let it fail completely and then pick up the pieces.

"The good news is that either way, once AIG is determined, we will have hit bottom and I would expect the markets to spend the next six months to unravel fully and after that I think the country gets back on economic track."

Getting on track

As AIG's predicament remains in limbo, some market sources have said that the situation would be better resolved if the government let the pieces fall where they may.

"Resolution would certainly come more quickly without [government intrusion]," the analyst said. However, he conceded that "maybe there is some reason they shouldn't be allowed to fail," given the scope of the business.

Still, "I definitely don't think that there was a stomach to bailout Lehman, especially after Freddie [Mac]/Fannie [Mae]. They had to stop it somewhere."

"There isn't anybody who knows how this all plays out," the analyst added. "I think there is some credence to the belief that Goldman [Sachs] and Morgan Stanley will have to find somebody to partner up with."

Assuming that the U.S. government does not step in this time around, how, then, will the economy be affected?

"There is more pain on the way," the analyst said.

"I think there is no one around who does not recognize that we have to let the markets fall and clean up the mess before we can get back on our feet," said one trader. "We need capitulation and then we can get back on with it. I expect three to six months of very ugly before we can stabilize."

But the news is not all bad. The trader said that panic has not yet taken over the market although a fair amount of fear is sinking in. But so far, the world has not yet collapsed.

"It looks like this is not the end of the world, although some people thought it would be," the analyst said. "I suspected things would be a bit worse, but it's not which is a good sign."

With the Dow Jones Industrial Average off about 2.5%, "that is not too bad," he said.

Still, caution is the name of the game.

"It's only been one day," he said. "We'll see where we are Friday or a month from now."

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