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ORIGINAL FRENCH ARTICLE: Sale temps pour le Gorille

by Bruno Odent

Tough Times in Store for the Gorilla

From a series of articles on Big Money

Translated Thursday 25 September 2008, by Henry Crapo

Richard Fuld is not, strictly speaking, someone likely to be overcome by his moods. In his office at the top of a glass sky-scraper in Manhattan, he pilots the 4th largest bank of the USA, Lehman Brothers. He is one of the leaders of global finance.

The chief officer of Lehman Brothers, Richard Fuld, whom Forbes magazine, considered to be the central mouth-piece of American capitalism, last year classed among the highest paid corporate officers worldwide, with salary plus bonus plus stock options valued at 122.67 million dollars, or about 90 million euros, according to the magazine, has frankly no reputation of being tender in business affairs. They nick-name him "the Gorilla", in a mixture, they say, of fear and veneration at the "global" headquarters of the bank. Profits in almost exponential rise since 2007, and even the crisis of sub-primes, which savaged one after another of the big companies on Wall Street, from the City Bank to Merryl Lynch, taking out Bear Stern along the way, seem to have no more than scratched the surface of Lehman Brothers.

Lehman Brothers overrun by the crisis

For several weeks already, however, the climate had begun abruptly to change.
Richard Fuld, who believed last April that he could safely announce, in the columns of Forbes that "the majority of the financial crisis" belonged to the past, had to swallow his words. The Gorilla has landed on the hot griddle, so watch out for his devastating humor. Because Lehman Brothers has been overrun by the crisis. And in no minor way. The bank is stuck holding tens of billions of dollars in "rotten" obligations. Not only in derivatives of the subprimes, those low-rated mortgages intended for the poor, but in higher rated debt for accession to property for the middle classes (the prime mortgages). Worse, it seems that no financial product, whether it be loans to companies or even credit card debt, now escapes a brisk acceleration of defaults in payment.

After a stormy meeting of the board of directors, the board of management of the bank, Fuld concluded that he had no choice but to sell, for 40 billion dolars (some 28 billion euros) his portfolio of holdings in commercial real estate credits (those less affected than others by the crisis) in order to wipe out losses that could exceed 30 billion dollars (20 billion euros). This news, coming on top of the announcement of the ruin of two agencies for refinancing mortgage debt, Fannie Mae [1] and Freddie Mac [2]
, caused a violent fall in prices on the markets on Wall Street and around the world.

The contagion of the crisis in credits in which the underlying values had initially seemed well assured, pushes the financial and banking system in the United States into a dizzying situation. Defaults in payment of mortgages rated Alt A [3], thought to be of moderate security, came to quadruple in April, as compared to a year earlier. And they have doubled among the primes, these being considered up until a short time ago to be the cream of the mortgage market, their estimated value in the US in excess of 12 trillion dollars. Which causes the analyst Thomas H. Attebery, cited in the New York Times to say that the breadth of the crisis would continue to grow, that the subprimes constitute, in the end, but the "tip of the iceberg".

Testimony of the unhappy middle class borrowers with a clean record, having had until now not even the slightest history of default in payments, now fills the pages of the US newspapers. Like the testimony of Ronald Lewis in a blog of the Seattle Times: this family man aged 52, computer engineer, employed by Lockheed Martin, is henceforth on the brink of personal bankruptcy. Three years ago, in order to pay the education of his daughter "at a good university" (costly affair it is, on that side of the Atlantic), had decided to take on a prime mortgage of 750,000 dollars) 500,000 euros) on his house, which he had just about managed to pay off.

The conditions of the loan offered him by the bank, an affiliate of a certain ... Lehman Brothers, seemed very advantageous. The rate of interest was promised to progress in the sense opposite to that of the market value of the house, and this value seemed always to increase, given the boom in the real estate market. Today, the bursting of that speculative bubble in housing has reversed the figures. "I’m completely caught in a trap", explains Lewis. "I can’t sell my house, except in a fire sale at below its purchase price, and the interest payments on the mortgage have exploded. The result: I have only just my head above water. All my savings have disappeared, and I’m working now just to pay my debts. With no assurance that I won’t find myself, some day, completely broke."

For the great majority of wage-earners, faced for years already with a quasi-stagnation of their salary, because of systematic policies of moderation in wages, the taking-out of loans for accession to property was not merely a way to achieve the "American dream", but also represented the only way open to improve one’s standard of living. While housing prices rose sharply,
they could in effect have access to larger mortgages, thus permitting them to offer themselves what seemed impermissible on their salaries alone.

The taxpayers called upon to wipe out the losses

Fannie Mae and Freddie Mac, the refinancing agencies mentioned above, constituted the cornerstone of this entire system. Their mission was to provide credit (fresh money) to the entire network of banks making loans to individuals wishing to purchase housing. This was according to a simple mechanism: they provided now-interest credits in return for a part of the stock of mortgages held by the various establishments. And the two super-banks financed themselves by raising funds on Wall Street.

During the real estate boom, their business succeeded like holy fireworks, their stock was much in demand, and their stock prices climbed sharply. Today, in contrast, everything falls apart, because their coffers are full of hundreds of thousands of mortgages virtually without value. No surprise, then, that "Fanny and Freddy", as the traders on the US exchange familiarly call them, are now among the worst hit victims of the banking and financial crash which started now already a year ago.

And the breadth of the damage is the spread of defaults in payment on debt reputed to be "solid", appears considerable. "Fanny and Freddie" have lost roughly 90% of their stock market value. And in the upper floors of the two establishments based in Washington, there is blowing, in these hours, a wind of panic. The two agencies need at least 15 billion dollars to pay off their debt. But every effort to raise capital (by the issuance of new shares on the market) seems certain to fail. And to boot, given the key position the sister companies play in the American financial system, it is Wall Street in its entirety that has cold shivers. To the extent that nationalization is widely rumored. The taxpayer will be asked to fork over what is needed. The federal reserve bank will purchase the majority of these mortgages. Tough luck if this flies in the face of the prevailing liberal doctrine, because, in the event of a total inability to pay, it would mean a total collapse of the banking system.

This is enough to make the Gorilla himself tremble. He, who manages no better to face up to his needs for recapitalization. The Financial Times revealed yesterday that the poor cornered animal, doubtlessly in despair, tried to negotiate, the first week in August, the sale of 50% of Lehman Brothers stock to South Korean and Chinese funds. In vain, because he set too high a price. The asiatic clients were not seduced by the condition of the bank, and politely declined the offer.

Editor’s notes:

[1The Federal National Mortgage Association (Fannie Mae) was a government-owned corporation, created in 1938, to help low- and middle-income people to buy homes. Privatized in 1968, equity shares of Fannie Mae trade on the New York Stock Exchange.

[2Freddie Mac—the Federal Home Loan Mortgage Corporation (FHLMC)
Freddie Mac, created in 1970, purchases mortgages from across the country that share similar characteristics – payment terms, interest rate, loan term – and yet may have other characteristics that vary. For example, some mortgages may carry greater credit risk than others, based on the type of property or the credit history of the borrowers. The corporation is held in trust by the Federal Home Loan Bank System and its stock is owned by its members, which include savings banks, savings and loan associations, cooperative banks, commercial banks, credit unions, and insurance companies that are active in housing finance.

[3Alternative Mortgage Instruments (AMI)
These mortgages, commonly called Alt-A mortgages, include any mortgages that are not fixed-rate, amortizing loans. The most common example of an AMI is the adjustable-rate mortgage.

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