The drumbeat of negativity driving down the shares of Lehman Brothers (LEH) has been growing louder, with reports on June 3 that it is likely to seek $3 billion to $4 billion in additional capital. As of that day, Lehman's market cap was down almost 60% from a year earlier and its stock was off more than 18% over three trading days. One of the chief drummer boys has been David Einhorn of Greenlight Capital, a hedge fund shorting the stock. In an interview with me on May 28, Einhorn suggested Lehman was not being forthright about soured investments. Lehman CFO Erin Callan has been trying to calm nervous investors, and her face-off with Einhorn was the subject of a story in The New York Times on June 4. For a less passionate perspective on Lehman, I called brokerage analyst Brad Hintz of Sanford C. Bernstein. In the late '90s, Hintz was Lehman's CFO.
Why is Lehman getting hit so hard and losing so much market value?
What you're getting now are equity investors who are very nervous about brokerage firms. They don't like surprises. They're acting first and asking questions later. Why take a chance when so many of them got hurt by Bear Stearns (BSC)? The interesting thing is the fixed-income investors are much more sanguine…. Part of it is they know that brokers can survive a funding problem if counterparties have confidence in the balance sheets. And right now, what you've got is an ironclad commitment from the Federal Reserve to back up the brokerage firms at least through the middle of September.
Lehman has been issuing massive amounts of long-term debt and raising capital since the failure of Bear. What are you doing when you're doing that? You are building a cushion of cash so you don't have to rely on short-term funding. Now, I spoke to the treasurer of Lehman on the Friday before Memorial Day. He said Lehman had $8.5 billion in commercial paper outstanding at the end of the first quarter and less than a billion dollars of commercial paper outstanding now. That's very important because commercial paper is the most credit-sensitive money—the money that's most likely to go away in a crisis. They've done away with it.
Press reports and your own research suggest that Lehman will try to raise $3 billion to $4 billion in capital. Will it be closer to three or four, and will that be enough?
I think it's going to be closer to $3 billion because Lehman is talking about the end of June. That's when the firm will have taken its risk levels down and will be positioned for the future. Why do they want to do it rapidly? Because mid-September is when the Fed discount window is going to go away. So you want a bulletproof balance sheet by mid-September.
Some people will say, "Look, there are so many bad assets on the balance sheet. Why don't they just bite the bullet and take another charge or writedown and get them off the balance sheet?"
Here's the problem: I met with the head of risk management for one of the top four brokerage firms, and the comment he made was, talking about his residential mortgage bank portfolio, "We know what the value of the bottom tranche is, we know what the value of the top tranche is. But we have no idea what the value of the middle tranches are." You've got knowledgeable people trying to make the best assumptions, but it has the accuracy of horseshoes. You've got no way to get rid of the stuff, and so the problem for all the Wall Street firms is there's really no place to go on this.
Einhorn of Greenlight Capital has led the charge against Lehman, and the Street seems to be listening. Is Lehman's situation as dire as he has been painting it?
Einhorn is basically saying that what Lehman said in the first quarter is not what it's saying now with regard to its portfolio. He's all but said Lehman is deceiving investors. Do you think CEO Dick Fuld and CFO Erin Callan have been as forthright as they might have been?
If you're asking me whether Lehman will win an award for best disclosure, the answer is no. But I don't think any brokerage firm will get that. Are there numbers gaps? Absolutely. I don't doubt that.
But it sounds like you think some of this is overdone.
Oh, on the concerns from the shorts, absolutely. There's no question it's overdone.
According to The New York Times, the Securities & Exchange Commission is investigating whether hedge funds helped drive down the shares of Bear Stearns and essentially put it out of business. Do you think that could be happening to Lehman today? And would [Treasury Secretary] Hank Paulson and regulators let another bank go down?
No, Lehman will not go down. We have the Federal Reserve behind it. By the Fed opening the discount window, it has injected a little bit of courage into the counterparties. So when Lehman says, "We're not borrowing much from the Fed," that's technically very true. But they are borrowing courage. Still, the earnings of the company aren't going to be stellar in the near-future. So I don't know whether it's an equity play at this point.
A lot of people have been suggesting that the worst on Wall Street is over, but then you look at Lehman's market cap and stock. Do you think we're on the edge of another market-crushing moment?
No. I think there's a realization that the rally that we saw in the credit markets this spring wasn't the sign of an imminent recovery of all the credit markets. It'll take us more time on that one. A number of the managements of these firms were saying, "We're in the seventh inning, we're in the eighth inning." We joked and said: "Sorry, but it's a doubleheader." The doubleheader is that, yes, the worst of the writedowns in the mortgage market are over. But the problem that we have is that in a slowing economy, bankruptcies rise; consumer credit losses rise. And we still have that ahead of us.