March 17 (Bloomberg) -- Richard Fuld forever rues the day in July 1998 when, faced with daily rumors that his beloved Lehman Brothers Holdings Inc. was on the verge of insolvency, he decided to say nothing and do nothing knowing Lehman was fine.

``I kept my head down and just worked harder, and it was a big mistake,'' Fuld has told colleagues many times since then. Lehman dropped 63 percent in New York trading in the ensuing four months and Fuld belatedly devoted his entire work week to reassuring lenders.

Today, the 61-year-old Fuld can't hesitate to show that Lehman is equipped to weather a credit crisis that drove smaller Bear Stearns Cos. to the brink of collapse and a takeover by JPMorgan Chase & Co., with financial backing from the U.S. Federal Reserve. Speculation that Bear Stearns was running short of cash led clients and creditors to withdraw $17 billion in two days last week, wiping out the New York-based company's reserves.

As Bear Stearns shares plummeted a record 47 percent on March 14, investors showed their doubts about Lehman, pushing the stock down 15 percent. Lehman fell a further 19 percent today in New York trading.

Lehman said in a statement that its cash position ``has been and continues to be very strong.'' Moody's Investors Service affirmed Lehman's credit rating at A1, the fifth-best investment grade on the agency's scale.

`Lack of Confidence'

The Fed, acting to stave off a broader market panic, cut the rate on loans to banks yesterday and became lender of last resort to the biggest dealers in U.S. government bonds.

The decision to ``create a lending facility for primary dealers and permit a broad range of investment-grade securities to serve as collateral improves the liquidity picture and, from my perspective, takes the liquidity issue for the entire industry off the table,'' Fuld said an e-mailed statement today.

Fuld, who has expanded overseas, increased equity trading, reduced headcount and closed the firm's subprime mortgage unit, is being forced once again have to convince lenders and customers that Lehman's finances are sound.

``Lehman has probably the best risk management and has been diversifying for years,'' said Mark Williams, a former Federal Reserve official who teaches finance at Boston University School of Management. ``But this is no longer about Bear or Lehman. It's about the erosion and lack of confidence in the financial system. The Wall Street business model is based on ready capital. With rumors, that liquidity they rely on dries up very fast.''

Market Risks

Lehman's stock is the worst performer this year of the four largest Wall Street firms, and now trades at five times analysts' estimates for 2008 earnings and just below its book value. By contrast, Goldman Sachs Group Inc., Wall Street's biggest firm by market value, trades at six times profit estimates and 1.7 times book value.

Lehman is probably the best bargain in the securities industry right now, according to Oppenheimer & Co. analyst Meredith Whitney in New York.

``It has a more diversified business model than people think,'' said Glenn Schorr, a New York-based analyst at UBS AG, who recommends clients invest in Lehman. ``They've got a bunch of exposures people are scared about, but at the level it's trading at now, the downside risk is reflected in today's valuation.''

The cost of credit default swaps used to speculate on Lehman's ability to repay debt jumped 55 basis points to 450 basis points on March 14, the second-widest level after Bear Stearns of the five biggest U.S. securities firms, according to broker Phoenix Partners Group. The contracts traded as high as 480 basis points that day, after Bear Stearns's bailout by the Fed and New York-based JPMorgan Chase & Co. was announced.

Bear Stearns Takeover

Swaps are financial instruments based on bonds and loans that pay the buyer face value in exchange for the underlying securities or the cash equivalent should a borrower fail to adhere to its debt agreements. A decline indicates improvement in the perception of credit quality; an increase means the opposite.

Fuld cut short a trip to India and returned to New York yesterday to address potential fallout from Bear Stearns's near collapse, the Wall Street Journal reported, citing people familiar with the matter. The decision followed telephone conversations with senior Lehman executives and U.S. Treasury Secretary Henry Paulson, the report said.

JPMorgan agreed yesterday to buy Bear Stearns for about $240 million in stock, less than a tenth of its value last week. The Fed will provide financing for the transaction.

Contracts protecting investors from a default by Bear Stearns in the next year traded at distressed levels last week on concern the company was running out of money. Five-year contracts rose 55 basis points to 730 basis points on March 14.

Prospects for 2009

While investors focus on losses in Lehman's mortgage business from the collapse of the subprime market, they're overlooking gains from equities and interest-rate derivatives and fees from advising on mergers, said Roger Lister, the New York- based chief credit officer for financial institutions at DBRS.

Lehman probably will say tomorrow that as much as $3.5 billion of mortgage-related writedowns led to an almost 50 percent drop in first-quarter earnings, according to the average estimate of 10 analysts surveyed by Bloomberg. Oppenheimer's Whitney reduced her first-quarter estimate to 50 cents a share last week after Lehman disclosed a further 1,400 job reductions as losses in the credit markets widen.

Yet the company may report record earnings in 2009 after this year's setback, according to analysts' estimates. By contrast, Merrill Lynch & Co. may just return to its 2005 level and even Goldman Sachs Group Inc., the most profitable securities firm, probably won't match last year's earnings, analysts say.

`More Cognizant'

``When things bottom out, Lehman and Goldman will be the best broker stocks to own,'' said Christopher Wiles, who helps oversee about $30 billion at Allegiant Asset Management in Pittsburgh. ``Their quality of management and ability to take advantage of the turmoil has stood out.''

The two funds Wiles manages own Goldman shares; other Allegiant funds also hold Lehman stock. Wiles says he'll be looking to buy Lehman when the housing market stabilizes.

Fuld has reduced the firm's ranks by 5,300 since August, more than any Wall Street competitor, a move that may help profitability over time by reducing payroll costs. He also shuttered Lehman's subprime mortgage unit in August, eight months before New York-based Merrill closed its money-losing subprime business.

``Lehman has shown that they were more cognizant of what they were doing,'' said Matthew Albrecht, an equity analyst at Standard & Poor's. ``When Morgan Stanley and Merrill were getting into these markets, Lehman was getting out. They've been more adaptive too, hedging earlier, reducing their exposures when there were opportunities to do so.''

Overseas Markets

As the biggest underwriter of mortgage-backed bonds last year, Lehman owned $80 billion of the assets at the end of November. Half were tied to commercial mortgages, whose prices declined by 19 percent in the past three months. About $5.3 billion of the holdings were backed by loans to subprime borrowers at greatest risk of default. Lehman limited its writedowns to $1.5 billion last year by using financial hedges.

When the leveraged loan market recovered briefly in the fourth quarter, Lehman sold almost two-thirds of its holdings, reducing its risk of loss when prices retreated again this year.

``It'll be tough for anyone to avoid further writedowns,'' said Lister of DBRS. ``In the long term for Lehman though, the trajectory of the franchise is up. They're able to use the whole firm to generate business, which you don't see at the other firms except Goldman.''

Stock Trader

Following Goldman's lead, Fuld has expanded into areas where Lehman was weak a decade ago. To reduce Lehman's reliance on the U.S. fixed-income market, he has reached out to overseas markets and boosted the equities, asset management and advisory businesses. About half of Lehman's income came from outside the U.S. last year, a larger percentage than Goldman.

``Lehman was a bond house; today it's not,'' said Walter Gerasimowicz, who worked at Lehman from 1995 to 2003, including in the unit that manages the richest clients' investments. ``It has diversified a lot.''

Gerasimowicz's current firm, Meditron Asset Management in New York, manages $1 billion and doesn't hold shares of Lehman.

Fuld's diversification has begun to produce results. Lehman has advised on $67 billion of U.S. mergers and acquisitions so far this year, topping the league tables with 39 percent of the market, data compiled by Bloomberg show. The company ranked sixth in the same period a year earlier, with 29 percent.

Fund Collapse

Lehman is now the largest trader of stocks on the London Stock Exchange and Euronext. Among traders on the New York Stock Exchange and Nasdaq, the broker has risen to fourth place from sixth. Even its share of U.S. bond trading has increased by 1 percentage point to 12 percent.

``Their growth outside the U.S., their growth in investment banking and in equities is proof that Fuld's efforts have already paid off,'' said UBS's Schorr. ``That franchise will be there when markets calm down to continue higher growth.''

The 1998 crisis that prompted Fuld to diversify was triggered by the collapse of hedge fund Long-Term Capital Management LP. Lehman, Goldman, JPMorgan and other LTCM lenders bailed out the fund, at the urging of the New York Federal Reserve, because of concern that its demise would destabilize the financial system. LTCM's failure was hastened by Russia's default on its debt, which sent bond and stock markets around the world into a tailspin.

Cash Infusions

Speculation that Lehman was reeling from bond market losses spread at the time, prompting some creditors to stop lending to the firm. To dispel the rumors, Fuld had to visit his creditors one by one to convince them that the losses weren't as big as observers feared and the investment bank's balance sheet was strong.

Once again, Lehman finds itself forced to reassure investors that its losses aren't worse than reported. Executives at the company have repeatedly said its writedowns on mortgage-related assets reflect the fair value of the holdings and there are no hidden losses.

Fuld, like Lloyd Blankfein, his counterpart at Goldman, has avoided diluting shareholder value, while rivals have had to seek cash infusions to shore up capital. Merrill raised $12 billion from outside investors following subprime writedowns. Morgan Stanley sold $5 billion of debt convertible to stock.

``Lehman's management has been able to focus on gaining market share because they didn't have to spend energy raising capital,'' said S&P's Albrecht.

`Across the Board'

Goldman, which also reports earnings tomorrow, may say first-quarter profit dropped 62 percent, analysts estimate. Morgan Stanley will publish its figures the next day, likely saying net income fell 57 percent, according to analysts. Bear Stearns, which moved up its release of results by three days, may say later today that earnings dropped 75 percent. All the companies are based in New York.

Investors, including Jon Fisher, are still wary of Lehman and other brokers because they expect more asset writedowns and don't see signs that the markets are poised to recover.

``The issues have moved beyond subprime,'' said Fisher, who helps oversee $22 billion at Fifth Third Asset Management in Minneapolis. ``Business is down across the board. I'm not buying brokers until things recover.''

At Lehman, Fuld is already working on that.

To contact the reporter on this story: Yalman Onaran in New York at yonaran@bloomberg.net.

Last Updated: March 17, 2008 09:48 EDT