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Fire Sale for Financials on Wall Street


In high-stakes poker, you’d better be able to lose the pot every now and then because at some point you will lose no matter how good you are. That is the circumstance Lehman Brothers (LEH) faced this weekend in a race for survival. With no buyers or investors willing to pump in needed capital, LEH was forced to put itself up for sale.

As the dominoes fell, the value of LEH assets became less and less. Even worse, the potential for a ratings downgrade rattled LEH business partners created a run-on-the-bank mentality that would have destroyed the company without intervention.

Have you ever felt like you were being chased? Imagine what LEH top brass felt this weekend.

Meetings were held, and suitors pursued. At the front of the line were Bank of America (BAC) and Barclays PLC (BSC). The hang-up of course was that each potential buyer desired government security against toxic assets on LEH’s balance sheet.

I’ve written before about the government handout when Bear Stearns was saved by intervention (see "Stock Market Predictions: Financial Arma… Bottom"). The problem is where do you stop? Never in my wildest dreams did I think we would be forced to answer that question so soon.

The verdict? No more handouts. LEH will have to fend for itself. Find a buyer or perish.

Today we now know that LEH will cease to exist. Banks and governments around the world scramble on the news. What will it all mean? Who will fall next?

In an attempt to bandage the wounded financial system and the expected vacuum left by a LEH collapse, a plan was put in place to protect the global financial system with a pool of capital of $100 billion.

How nice to see a private solution to a private problem. This government bailout path was not going to end well. We need to take our medicine for irresponsible behavior.

That medicine is the end of one of the oldest investment banks on Wall Street… >

Attention on Merrill

Merrill Lynch (MER) shares a balance sheet pockmarked with derivative securities that are losing value by the minute. The pressure of short sellers makes raising capital even more difficult. Add in the threat of a ratings downgrade, and the house of cards collapses.

Late Sunday, MER found its white knight. After its stock dropped hard last week closing at $17.05, some, including me, pondered if MER would be the next shoe.

Low and behold, Bank of America walked away from LEH talks and cut a deal to buy Merrill for $29 per share. If the deal closes, such a transaction would be a minor miracle in this difficult market.

The huge premium offered raises questions. Did MER secretly liquidate bad assets last week in anticipation of this move? If so, I say brilliant.

The cards were lining up against MER, and their management did a fantastic job to avoid the very real possibility of a forced bankruptcy and liquidation of their own.

A fire wall has been built.

What About AIG?

Ah, but what about American International Group, Inc. (AIG)? Will those dastardly short sellers outflank the fire wall by moving straight to AIG?

I think so. We already know AIG is furiously attempting to raise capital to avoid a ratings downgrade.

Have they been successful? At this point, it is hard to tell. What we do know is that they made the very unusual request of the Federal Reserve for a bridge loan to raise capital.

Can you say desperate? The shorts are licking their chops. They know darn well that the government has drawn the line in the sand. Will they grant a lifeline to one of the country’s largest insurance companies?

For now, we do not know. What we do know is… >

…that the futures market opened Sunday night with a 3-4% haircut across they board.

The LEH news and the AIG news are clearly negative for the market. The MER deal will be positive.

What does this all mean for you, the individual investor?

Interestingly, this is one of the rare moments when the little guy should make out much better than the fat cats on Wall Street. This is our time!

The impact on companies outside of this financial crisis is minimal if that. Thus, if stock prices drop, investors should view the decline as an opportunity to buy shares.

The pendulum is swinging too far here. Yes, there was rot on the Street, but the market is ridding itself of that rot.

We may lose some venerable firms along the way, but history suggests that collapses like these are excellent buying opportunities.

Richard Band, editor of Profitable Investing has been watching the market closely in the wake of the Lehman bankruptcy filing. To get Richard’s latest advice about AIG and other financial stocks, sign up today for Profitable Investing. Richard Band’s Profitable Investing strategy helps investors grow their portfolios safely and securely, while taking advantage of solid growth opportunities. Now is the time to both protect your investments and position yourself for the gains you need. Start building up your portfolio now.

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