Who’s Next?

NEW YORK (Reuters) – As Lehman Brothers Holdings stared failure in the face on Sunday, anxiety intensified about the health of several other big U.S. financial institutions.

“We will see other major financial firms fail,” former Federal Reserve Chairman Alan Greenspan said.

“Indeed, we shouldn’t try to protect every single institution. The ordinary course of financial change has winners and losers,” he said on the ABC program “This Week.”

The implosion of Lehman, wracked by worries about losses in its portfolio of tens of billions of dollars of mortgages and real estate, comes six months after rival Bear Stearns collapsed and a week after the government took over mortgage companies Fannie Mae and Freddie Mac.

Lehman’s travails have already heightened concerns about American International Group Inc, Merrill Lynch & Co and Washington Mutual Inc, whose shares all lost more than one-third of their value last week.

Merrill is in merger talks with Bank of America, the Wall Street Journal said on Sunday, citing people familiar with the matter.

Nouriel Roubini, a New York University economics professor who predicted the U.S. housing crisis, said the government lacks the wherewithal to step in every time a big financial firm fails.

“I don’t see any simple solution to this mess,” he said.

As stock prices fall, it becomes harder to raise capital.

And with recent capital injections into Citigroup, Merrill, Wachovia Corp and Washington Mutual under water, investors may conclude that further infusions may be a case of throwing good money after bad — especially with the value, and perceived future value, of real estate assets heading south.

“That appears to be the major stumbling block for the commercial banks,” said Gerard Cassidy, an analyst at RBC Capital Markets.

“If you were to truly mark them to market, the decline in value could be too large for them to be able to digest without raising equity capital.”

So far this year, 11 mostly smaller lenders have failed and dozens may also go under in the next two years, analysts say.


Roubini cited Merrill as being under particular stress, and said the problems could even spread to other big investment banks, Morgan Stanley and Goldman Sachs.”The fundamental model of the broker-dealer is flawed,” he said.

AIG, Bank of America, Goldman, Merrill, Morgan Stanley and Washington Mutual did not immediately return calls for comment.

Predicting which companies may be next to go under is a little like shouting fire in a crowded theater. A shout can sow panic. And if enough people react in fear, they can create their own catastrophes, even if there is no fire.

In July, after IndyMac Bancorp Inc became the biggest U.S. banking failure in two decades, analyst Richard Bove issued a report titled “Who Is Next?”

While not saying which lenders would fail, he named many that were in a “danger zone,” as reflected by various financial metrics.

One of those lenders sued him for defamation and negligence. Ladenburg Thalmann Financial Services Inc, Bove’s employer, called the lawsuit meritless.

But even when there is no new fundamental news about a company, panicked investors may extrapolate the worst, causing more level-headed investors to sell before their losses mount. A company’s decline thus becomes a self-fulfilling prophecy.

Many financial companies long maintain — as did Lehman, Bear Stearns and Fannie and Freddie at various times this year — that they have a grip on their problems.

But the growing list of imploding companies makes investors more suspicious of those that remain, making them less likely to buy their shares.

At the same time many hedge funds are selling those shares “short,” betting on and often exacerbating those declines.

In some cases, this ties companies’ hands, forcing them into discussing their business plans before they’re ready, setting the market up for even further disappointment.

Lehman decided to release results and its business plans eight days early — eight days that it might have used to get its future in better order.

Now AIG, which had planned to release its own turnaround plan September 25, may release part of its plan as soon as Monday, the Wall Street Journal said on Sunday.


AIG’s credit ratings were put on review for downgrade late Friday by Standard & Poor’s.

The New York Times, citing people briefed on the situation, said the insurer could be forced to raise $40 billion to avoid a severe downgrade.

But AIG isn’t subject to a run on its standard insurance policies, as IndyMac was to a run on deposits. It also has many profitable businesses it could sell, such as life insurance, property and casualty insurance, and aircraft leasing.

Merrill has purged its own balance sheet of some bad assets after losing $19.2 billion in the last year.

In July, it decided to sell $30.6 billion of mortgage assets at just 22 cents on the dollar and raise $8.5 billion by selling stock, a controversial announcement coming less than two weeks after saying it was “comfortable” with its capital.

But it still ended the second quarter with $5.4 billion of commercial mortgage-backed securities and $5.9 billion of “Alt-A” mortgages. The latter go to borrowers who don’t fully document income or assets.

Washington Mutual, meanwhile, held $227 billion of real estate loans in its portfolio, including $60.4 billion of home equity loans, $52.9 billion of adjustable-rate mortgages that let borrowers pay less than interest and principal due, and $16.1 billion of subprime loans and home equity loans.

But Washington Mutual also ended June with $181.9 billion of deposits, and said retail deposits on August 31 were “essentially unchanged” from the start of the year.

Craig Emrick, a senior credit officer at Moody’s Investors Service, said on Friday that WaMu had some protections because “the Federal Home Loan Bank has been a stable source of funding for WaMu throughout the credit crisis.”

He said, though, that the thrift’s liquidity resources were “concentrated” in the FHLB because “the company is suffering from a lack of confidence in the debt markets.” Moody’s downgraded Washington Mutual to “junk” status on Friday.

Cassidy has said that 300 lenders could fail before the crisis ends. “There are no easy answers,” he said. “There’s going to be pain inflicted on many players.”

By Elinor Comlay and Jonathan Stempel

(Additional reporting by Emily Kaiser in Washington, DC; Editing by Ted Kerr)