Another Heavyweight on the Ropes?

Lehman Brothers Could Be Next

First Bear, Then Fannie and Freddie... Is Lehman

Next?
Some Question If the Bank Can Save Itself; Are There More Shoes to
Drop?

By ALICE GOMSTYN ABC NEWS Business Unit

Sept. 9, 2008 —

As the government proceeds with its bailout of ailing mortgage giants Fannie Mae and Freddie Mac,
Wall Street is abuzz about the fate of another financial heavyweight: Lehman Brothers.

Shares of the country's fourth largest brokerage firm dropped more than 12 percent Monday as investors
worried about whether Lehman would be able to cover the losses it continues to sustain from its
mortgage holdings.

"There's a strong suspicion in the marketplace that a lot of their assets, which are related to residential
and commercial mortgages, are not worth what they're being carried on the balance sheet for," said
Lawrence J. White, an economics professor at New York University's Stern School of Business. "One of
these days, Lehman is going to have to recognize that."

White said that if Lehman doesn't resolve its asset problems, the government might eventually step in to
shore up the bank like it did Bear Stearns. In March, the failing investment bank was purchased by JP
Morgan in a $240 million deal backed by the federal government.

A Lehman spokesman declined to comment.

Lehman this year posted a second-quarter loss of nearly $3 billion. Analysts expect to see the bank report
more losses when it releases its third-quarter earnings report next week.

But not everyone agrees that Lehman could be subject to a Bear Stearns-style treatment. Bear's bailout
happened under "very narrow circumstances," said Peter Wallison, a senior fellow at the American
Enterprise Institute, a conservative think tank.

At the time of the Bear Stearns rescue, he said, many major financial institutions were considered to be

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 Another Heavyweight on the Ropes? Lehman Brothers Could Be Next

instable. If the government hadn't intervened and Bear Stearns had been allowed to fail, he said, there
would have been a run on banks around the world.

Since then, Wallison said, financial institutions have made adjustments that would allow them to weather
another bank failure. If Lehman did fail, he said, the same kind of domino effect would be unlikely and
government intervention wouldn't be as necessary.

"I don't see a real danger in the same kind of panicky run on financial institutions," he said.

Lehman, meanwhile, has reportedly been considering moves to shore up its balance sheet without the
U.S. government's help.

The bank had reportedly been in talks with South Korea's Korea Development Bank about the bank
investing in Lehman, but hopes for a deal were dampened on Monday after a South Korean regulator
urged KDB to be cautious about any such investment.

Meanwhile, there has been speculation that Lehman will reach for other lifelines, including the idea of
splitting into a "good bank" and "bad bank": concentrating all of Lehman's troubled assets into a separate
entity -- the "bad bank" -- that would focus solely on mitigating its losses while Lehman's healthy assets
would remain in the "good bank."

White said he doesn't see that solution working out for Lehman because the bank simply doesn't have
enough capital to add to a "bad bank."

He said that Lehman's best bet is to raise capital by selling Neuberger Berman, a profitable division of
Lehman that manages mutual funds and private wealth.

If Lehman doesn't settle on a solution to its asset woes by the time of its third-quarter earnings report, the
bank could start seeing some pressure to act from the Federal Reserve, which could threaten to stop
lending money to the bank. After the Bear Stearns collapse, the Federal Reserve opened its discount
lending window, once available only to commercial banks, to investment banks.

"[There are] going to be some big losses that are likely going to be announced. It might be the case that
the Fed would say at that point, 'Gee, maybe we don't want to continue lending to you,'" White said.

It's unclear, however, how reliant Lehman will be on Fed loans in the future. A person familiar with the
situation said that the last time Lehman borrowed from the Fed was in April and that it quickly repaid the
loan.

That's a good sign for Lehman, Wallison said.

"That would suggest that they're able to finance themselves in the market," he said.

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 Another Heavyweight on the Ropes? Lehman Brothers Could Be Next

More Bank Troubles

Experts say that small government bailouts are taking place frequently these days as the Federal Deposit
Insurance Corp. takes control of failing small- to midsize commercial banks that have also been hit by
the nation's mortgage meltdown.

But large banks aren't off the hook either: White said that Washington Mutual, which provided more than
$150 billion in home loans in 2006, might be vulnerable to an FDIC takeover.

In July, the bank reported a $3.3 billion loss for the second quarter of the year and Monday announced it
was replacing its longtime CEO.

"This is a financially troubled institution right now," White said.

The bank did not immediately return a call for comment but in a statement Monday new chief executive
Alan H. Fishman said he was intent on "returning the company to profitability as quickly as possible."

The FDIC, which insures deposits of up to $100,000 at commercial banks, has taken control of 11 banks
this year, including, most recently, Silver State Bank in Henderson, Nev. An additional 117 unnamed
banks are on the corporation's "watch list."

But some question whether the FDIC might need a bailout of sorts.

The FDIC's insurance trust fund is supported by fees charged to U.S. banks. Mark Zandi, chief economist
at Moody's Economy.com, said that the FDIC will raise its fees later this year but the increase might not
be enough.

"If there are too many bank failures, it could overwhelm the FDIC's financial resources to digest those
failures," Zandi said.

In that case, he said, the corporation would replenish its insurance fund with a cash infusion from the
Treasury Department.

A Bailout for Car Companies?

Outside the financial sector, experts say that among the most obvious prospective government bailouts is
one for the U.S. auto industry.

According to published reports, the industry will lobby Congress this week for as much as $50 billion in
low-cost, government-backed loans.

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 Another Heavyweight on the Ropes? Lehman Brothers Could Be Next

Zandi said that one of the arguments in support of government aid is that auto companies, which have
seen consecutive quarters of sagging sales, could use the loans "to tide themselves over until business
improves."

There is precedent for an auto-industry bailout: In 1980, the federal government backed $1.5 billion in
loans for Chrysler, helping the company to avoid bankruptcy.

But it's unclear whether the federal government would approve a loan package for the auto industry this
year. Some argue that it would be too expensive while others say that political motivations -- Michigan, a
major auto industry state, is also expected to be a swing state in the presidential election -- will prompt
leaders from both parties to embrace the proposal.

Richard A. D'Aveni, a professor of strategic management at the Tuck School of Business at Dartmouth
College, said the major automakers might be better off going bankrupt instead of asking for government
help.

"They need a chance to clear the decks and start over again," he said.

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