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Here’s how I see the problem:

  1. The Fed and Treasury have set precedents of, for all practical purposes, wiping out shareholders when providing what they consider ‘taxpayer money at risk’.
  1. With FNMA, the Treasury provided funding on their own initiative without consent of management.

Therefore, while justified or not, this means the government can, on its own, decide to provide ‘taxpayer money’ AND eliminate all shareholder value.

This creates a serious risk for any shareholder for ANY business.

For an extreme example, the Treasury could decide unilaterally, that ANY corporation (including, for the strongest example, GE) needs a Treasury guarantee to be sure it can fund itself and won’t fail.

And any such action could carry with it eliminating any/all shareholder value.

This is the risk to Lehman shareholders.

Lehman may be perfectly able to function at some level without the need of new capital to survive.

But markets must now discount that possibility that the Treasury or Fed could decide Lehman’s counterparty risk poses sufficient systemic risk to justify intervention with ‘taxpayer money’ at risk, which would carry with it the elimination of all shareholder value.

The means the risk to shareholders from government intervention is much higher than the risk of bankruptcy or any other form of liquidation.

There was no economic reason for the Treasury to take 79.9% of the housing agencies capital. ‘Tax payer money’ was already as senior as the Treasury wanted it, and any funds added by Treasury also carried any type of interest and various other payments the Treasury desired.

All that wiping out most of the residual value for shareholders did was add a new element of catastrophic risk for all shareholders.

So when a stock like Lehman goes down, which increases the perception of risk of government intervention, the risk of shareholder value going to zero due to government intervention increases as well.

Not my first choice of institutional structure.


6 Responses

  1. “With FNMA, the Treasury provided funding on their own initiative without consent of management”

    Warren, you make it sound like some untouchable psuedo gubbment type thing, I want you to name names. Who are the few people responsible who made this decision that affected possibly hundreds of millions of other human beings that these actions will reverberate all through our world? When it comes time to tar and feather the idiots, crooks, fools, scammers, or just well meaning folks that paved the road to hell for us with good intentions, I need names to give to the rebellion soldiers not just “the treasury”

  2. Holy smokes Warren! How do they survive this?


    General Motors 27%
    Radian Group 26%
    Ford Motor 24%
    Hovnanian 23%
    Lehman brothers 23%
    Ford Motor credit 23%
    Other high yielding bonds are from United Airlines, Delta, Continental, Six Flags, Clear Channel, Rite Aid and quite many others well known corporations
    There is no bonds for Bkuna and DSL, but they are about to collapse

  3. now the govt is saying no public funds will be available for lehman, which in theory makes the stock more valuable as at least one path to eliminate shareholder value has been eliminated. Of course there are still several still open to the private sector…

  4. If lehman has access to the fed thru the pdcf, why couldn’t they have avoided banrkrupcy until January of 09 when the facility closes to them.

  5. good question.

    seems they were concerned they were losing their clients and the franchise value would only deteriorate with time.

    and that bankruptcy would maximize shareholder value.

    but i’m only guessing.

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