The horror, the horror

Well, if you're reading this it means you weren't standing too close to Wall Street yesterday, where an enormous hole opened in the earth and swallowed up much of what was left of the American financial industry. With Lehman gone and Merrill in the hands of Bank of America, that leaves pretty much nothing but the cockroaches, and oh, Goldman Sachs, Citigroup, JP Morgan Chase and Morgan Stanley. So perhaps the end is not nigh, but it's going to seem like that for a while. Lehman's failure is like a redwood falling in the forest: it is likely to take down more than a few smaller, but still quite large, trees with it as it falls. Here are the ways that the Lehman implosion will unfold: first, there is the immediate impact of its absence from the markets. Lehman is a key player in making stock and bond markets world-wide function, and is relied upon by some of the world's biggest financial institutions to execute their trades. They will now have to turn to someone else, who is very likely going to be working frantically to save their own posteriors and those of their clients. This will contribute to an air of gridlock and then panic in markets this week. The Fed and other financial regulators will very probably step in to provide even more unprecedented liquidity, add more circuit breakers and restrictions on selling in markets. This will only add to the sense of crisis. Worse, there will be a sudden reduction of intelligence about just what is happening in the crisis and where to go. Lehman, despite its many faults and poor investment decisions, employed a great many very intelligent professionals whose advice to clients was essential. They will now be silence as they clear out their desks and frantically work the phones to find a new job in an industry that has already been shedding them. Liquidity will be in short supply: Lehman was the counterparty to a great many derivatives contracts. With it facing bankruptcy, there will be a long line of bankers and investors trying to get their money back. In the meantime, that money won't be available. Some are even predicting a run on the remaining brokerages, the names of which I listed above, as banks reel in credit. The purchase of Lehman's assets is supposed to happen now in an orderly fashion. I don't imagine there will be anything orderly about it. The sale of those assets will take place at cents on the dollar - a fire sale. For buyers, that will create the potential for huge windfalls at some point down the road. In the meantime, however, it will put a value on securities that haven't traded much in the past year. That's a good thing in terms of dispelling the dread over how little they may be worth. But it's a bad thing in that it will establish a benchmark for how little they are worth. Banks world wide will be compelled to mark down the value of their remaining mortgage-backed securities, not to mention a host of other assets that will suddenly flood into the markets. What is perhaps most important is not the way that Lehman's collapse is likely to affect America and its financial system. That will be truly breathtaking, but what is likely to prove more significant is how widely it affects investors and institutions elsewhere around the world, particularly dollar-linked economies like those herein the Gulf and in Europe, whose banks and economy are already looking poised to suffer the same drop whose consequences the US is now suffering (It isn't the fall. It's the sudden stop). The dollar is already plunging. For international borrowers in need of cash (like Dubai Inc.), the demise of one of the biggest market makers, investors and lenders is not good news. Even if there are willing lenders, they will be able to extract much higher interest rates to refinance that debt. One thing that could happen is a sudden reappraisal of risk and safe havens. At first, most asset classes are likely to fall amid the panic and forced selling. The dollar is already plunging, implying perhaps that it has lost its status as a reserve currency. But shortly thereafter, commodities may again come into favor and emerging market stocks. Longer-term, one less player in investment banking means less competition and higher costs for companies trying to raise funds. Ultimately, Lehman's failure will help hasten an end to the financial crisis, in the same way that a house burning down helps stop the fire that consumed it.