Lehman Is Toxic at Any Price

Saturday, efforts to find a buyer for Lehman Brothers or to dismember the company in an orderly fashion stalled for the same reasons that CEO Richard Fuld’s earlier proposal to reorganize Lehman generated little enthusiasm.

Lehman has a negative net worth. Any accounting that says otherwise to create a deal is the fantasy of Wall Street bankers who won’t reckon with the full scope of their conundrum.

Fuld proposed selling Lehman’s toxic real estate and mortgage-backed securities, the taking of huge write downs, plus the sale of its lucrative investment management unit, which includes Neuberger Berman, to offset those losses.

That would leave intact Lehman’s investment banking business.

An investment bank really only has three things—working capital, smart finance guys and client trust.

Capital can be raised and American business schools educate lots of sharp minds. Trust is tougher to find.

In the world of mergers and acquisitions and initial stock/bond offerings, clients often navigate complicated, perilous transactions requiring complete confidence in the integrity of their investment bankers.

Mr. Fuld has tried to rescue Lehman from disaster one too many times. Only a foolish corporate executive would trust Lehman to handle their most prized assets. Hence, Lehman's investment banking business is not worth much in the hands of its current management.

Less its toxic real estate assets and investment management unit, Lehman’s only real value is its client relationships. Those must be transferred to a more trustworthy firm to have any value.

No other large firm should buy Lehman whole—its real estate and securities are too difficult to value. Only a fool would think he could fairly assess their value, unless they were given a value of zero.

Most of the major banks hold similar toxic assets. If another major bank finds its way into similar straights as Lehman, which is likely, the second fire sale would mandate an even lower book value for Lehman’s mortgage-backed securities than could be assigned now.

This explains why one of the solutions offered stalled Saturday—peeling off Lehman’s investment bank and investment management unit for sale, creating another bank holding with its toxic assets, and shoring up the latter with cash injections from other banks.

Most other banks need all the cash they have to cover their own bad securities, and any money they put into a crippled holding company would likely just be lost.

What’s more, Mr. Fuld likely has an outsized view of what Lehman is worth, less the bad assets, and he is likely seeking too much to compensate himself and his band of co-conspirators. We should never underestimate the hubris of a New York banker.

The Federal Reserve, which is propping up the banks and securities companies with huge loans, should require them to reveal their counterparty deals with Lehman and broker pairing of those deals to unwind transactions with Lehman. That would minimize the destabilizing impact on credit markets of closing Lehman. Then the Treasury can introduce Fuld to a good bankruptcy lawyer.

Lehman executives would find it difficult to replicate their compensation elsewhere, and the re-adjustment of banking compensation to more realistic levels and responsible schemes is necessary to return Wall Street to sanity.

Performance-based compensation that pays big bonuses when bankers bet right, but that only imposes losses on shareholders when bankers bet wrong has propagated the kind of toxic financial engineering that caused a mortgage-backed securities meltdown, a general credit crisis, and the near death experience of many Wall Street banks and securities dealers.

Paying bankers more reasonably is as necessary to restoring the operation of credit markets as the general deleveraging Ben Bernanke talks about.

Sadly, Vikram Pandit at Citigroup, John Thane at Merrill Lynch, and others can’t let go of the fantasy that their 35-year old MBAs are worth as much as Yankee shortstop Derek Jeter, and that they in turn are worth multiples of that.

All the shareholder value they have destroyed offers another conclusion.

It is time to toss in the towel on Lehman, unwind the counterparty trades and march it through Chapter 7. Unemployed brethren at Lehman may cause Pandit, Thane and others to finally see the need to genuinely reform compensation and business practices.

Weyerhaeuser can provide the rest--plywood and nails. Board up the windows and send the Lehman bankers home.