Black Sunday on Wall Street

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Somebody pinch me. Am I dreaming? Are there really only two remaining independent Wall Street investment banks? Did all of this really just happen?

Sadly, I'm afraid so
This weekend will go down as one of the most spectacular unravelings in financial history. In a nutshell:

  • The financial crisis just went supernova.
  • Talk of "Too big to fail"? Please. That was so two days ago.
  • The Federal Reserve's balance sheet will be doubling as a garbage dump until further notice.

Breaking news is coming in by the second, but here's the latest on Sunday's unprecedented blizzard of events:

Lehman Brothers (NYSE: LEH  ) , the 158-year-old firm that managed to survive the Civil War, the Wall Street panic of 1907, the crash of 1929, the Great Depression, and a handful of bond-trading scandals, hedge-fund collapses, and market panics, has filed for bankruptcy -- the largest bankruptcy in history. Attempts to line up a last-minute sale over the weekend crumbled as front-runners Bank of America (NYSE: BAC  ) and Barclays (NYSE: BCS  ) decided a Lehman takeover deal wasn't feasible without government backing.

Merrill Lynch (NYSE: MER  ) agreed to a shotgun marriage with Bank of America, selling itself for around $50 billion, or around $29 per share. The deal equates to nearly twice its Friday closing price and a premium to Merrill's most recent book value, making it a rather bizarre takeover in light of the current pandemonium. As far as independent firms go, Goldman Sachs (NYSE: GS  ) and Morgan Stanley (NYSE: MS  ) remain the last two amigos on Wall Street.

AIG (NYSE: AIG  ) , coming off last week's 50% swan dive, is scrambling to borrow as much as $40 billion from the Federal Reserve in order to stave off a credit downgrade that could seriously affect its ability to survive. In the event of a downgrade, some say AIG could survive for only a few days. It could also sell some prized assets, like its aircraft-leasing division, to shore up its books. Pay attention to AIG in the coming days -- its failure could relegate the Lehman failure to the status of an opening act.

In response to the cacophony of news, the Federal Reserve opened its arms to ailing financial firms, now accepting nearly any financial asset a firm can scrape together -- including stocks -- as collateral to borrow against its emergency discount lending window. While this should inject liquidity and make it easier for firms to unwind their entanglements with Lehman, it does so at taxpayers' risk -- and taxpayers are already pulling their pockets inside out over this year's other bailouts.

Madness. Absolute freakin' madness
A few notable points: Whether Lehman will be able to dismantle its balance sheet without sending the market into an orgy of forced selling will be the center of attention in the coming days. When so much leverage is employed on investments that are so intertwined with other financial firms, you get a situation where selling begets even more selling. If Lehman has to dump assets at fire-sale prices, that could cause other investors to mark down the value of their holdings, which could force them to sell assets to raise cash, causing even more selling ... the whole process feeds on itself like a cat chasing its tail. In fact, that kind of "feeding-on-itself" phenomenon is partially what caused the market crash of 1987, where the Dow Jones lost more than 20% in one day.

Another question is why Merrill was suddenly and unexpectedly thrown into Bank of America's arms. While everyone knew Lehman had it coming, Merrill's last-minute sale has many wondering if it too was teetering on collapse. As word emerged that Lehman wouldn't be bought by another firm, it's possible the shock waves of its collapse posed too great a risk to allow Merrill to stand on its own. You can take that as a positive (at least Merrill is off the table) or a negative (it shows that the vulnerability of financial firms is nowhere near over).

Buckle up, grab a drink, and stay calm
This is a good time to remind yourself of a cardinal investing rule -- it's never a good time to panic. Lehman has ended -- the world hasn't. Nonetheless, it is also important to realize the severity and ramifications of these events. It's perfectly healthy for excessive speculation to get purged out, but in this case, the purging went into overdrive. The chickens tried to come home to roost ... they just got slaughtered by a mob of paranoid investors along the way.

Stay tuned. We'll have more coverage of these historic events throughout the day.

For related Foolishness:

It'll take a few days for Fool contributor Morgan Housel's eyeballs to return to their normal size. He doesn't own shares in any of the companies mentioned in this article. Bank of America is a Motley Fool Income Investor recommendation. The Fool has a disclosure policy.

Read/Post Comments (7) | Recommend This Article (43)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On September 15, 2008, at 11:08 AM, prginww wrote:

    The question for BoA is, can they pull this off while they're still digesting the Countrywide acquisition? Did Ken Lewis manage to negotiate a sufficient discount to make it worth investors' while? Or will this turn out to be like Boston Sci buying Guidant? On one hand, an all stock deal won't dilute BoA shareholders as much. On the other hand, BoA's share price is falling, making Merrill shareholders less likely to vote yes.

  • Report this Comment On September 15, 2008, at 12:27 PM, prginww wrote:

    I'm sorry, but someone please explain to me, how this collapse is so. I just don't believe it!

    Wouldn't it be more sound to discount all these failing notes and rewrite the paper? Isn't all this just agreements to pay x amount over n years? Is it just easier for these companies to claim bankruptcy now and let the government bail them out.

    How is Bank of America so solid? This whole thing just keeps getting more and more fishy.

    I sure would like to see a open public review of all these failed notes that can't be renegotiated.

  • Report this Comment On September 15, 2008, at 1:01 PM, prginww wrote:

    I have a 30-year, $1,000,000 policy with AIG. I got it at a good rate as well a few years ago. They were listed as a AAA company (my how the mighty have fallen or on their knees). Now, I'm concerned that this policy may be worthless. Is there a chance that other companies could buy AIG's policies or will this division break away and remain solid. My current employer does not have a good life insurance program. I don't want to leave the wife and kids without a safety net if something befalls me. Any credible ideas out there?

  • Report this Comment On September 15, 2008, at 1:37 PM, prginww wrote:

    Which bank comes next? Europe? Japan? China? Who has overinvested in assets which may not give a return?

    Does anybody see a parallel between the Goldman Sachs magic of 2006 and the Chinese bank magic performance of 2008?

    Who will bail out Chineese banks if they go under?

    And who has invested money in the Chinese economy?

  • Report this Comment On September 15, 2008, at 3:17 PM, prginww wrote:

    Thinking about what may yet come: is it a reasonable play to short Goldman Sachs now? If AIG stumbles, what does that mean for the rest of the insurance industry? Also, if the insurance industry is pulled into the mess, does it only effect stock companies, or are mutual companies affected as well?

    This is more than my brain can handle at the moment.

  • Report this Comment On September 15, 2008, at 4:48 PM, prginww wrote:

    *Waiting for some nice discounts on possible additions to his portfolio*

    MUahahaha... =)

  • Report this Comment On September 15, 2008, at 5:37 PM, prginww wrote:

    so the biggest question then, now, is: Will Morgan Stanley buy a commercial bank or get bought by one?

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