The case of Lehman Brothers proves that the bar for banks has just been raised. Until last week, financial institutions of such size were seen as being in the too-big-to-fail category.
Lehman found itself forced into bankruptcy as Barclays and Bank of America walked away from buyout talks. The failing firm listed more than $613 billion of debt.
The fact that the Federal Reserve and the U.S. government refrained from intervening to save Lehman has removed the perceived safety net that had rested under this type and size of institution.
Andrew Liegel, product management specialist in risk and reporting at FRSGlobal, believes that Lehman's fall might have saved investors billions of dollars. By stepping away, regulators have forced investors to readdress their outlook on risk measurement, management and reporting, as well as communication policies.
Measures are already being put in place by both regulators and investors to hopefully prevent a similar meltdown in the future. These should contribute to the development of new regulatory standards for global markets.
However, after walking away from Lehman, the U.S. government had to step in to bailout the world's biggest insurance company, AIG, in an $85 billion emergency rescue.
"The credit crunch has now moved into a phase where financial consolidation and failure has begun," said Paul Niven, head of asset allocation at F&C Management. "This potentially has some way (and time) to run. Looking at history as a guide, we will likely eventually see state-backed guarantees for depositors being extended, and more government intervention, such as the establishment of entities to work out loans and support asset values."
The risk posed by Lehman asset unwinds has taken European ABS spreads to their widest level ever. Spreads have catapulted beyond the wides reached in mid-March, setting a new historical price low for the ABS market, according to Deutsche Bank analysts, who also said that any further financial credit weakness would likely drag on ABS performance.
Meanwhile, the financial industry's total write-downs amounted to $519 billion, and loan-loss provisions increased to $119 billion. The International Monetary Fund expects losses to reach $945 billion globally, with 59.8% of the losses stemming from the residential mortgage market. Standard & Poor's said losses related to structured finance products with subprime exposure are likely to amount to as much as $550 billion.
As the pressure mounts, the U.K. government has held steadfast in its belief that government intervention would not be the best option to get the market back on track.
It's true that U.K. banks, as a result of the credit turmoil, are already lending more responsibly against sensible criteria, but there is no denying that the collapse of Lehman has started a chain reaction that could force more drastic measures from the government. By mid last week, shares in HBOS, Britain's biggest mortgage lender, fell as much as 50pc to 88pc.
Amidst this latest blow, even the Bank of England (BofE), which, up to last week, intended to end its Special Liquidity Scheme (SLS) according to deadline, has now found its back against the wall.
BofE announced that, given current market conditions, it would provide an extension of the drawdown period for its SLS. This move is intended to provide additional time for banks to plan their loss of access to the scheme in an orderly fashion. The drawdown period will now end on January 30, 2009.
As the turmoil intensifies and deteriorating credit and liquidity conditions lead to further negative reaction, the U.K. government, like the U.S. government, will find itself under increasing pressure to find ways to help its country out of its mounting financial crisis. The BofE said it will publish its consultation document on proposals for permanent reforms of its market operations at a later date.
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