Lehman Brothers demise triggers huge default

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Tom Bawden in New York and Suzy Jagger in Washington

Lehman Brothers, the bust investment bank, triggered one of the biggest corporate debt defaults in history yesterday as it emerged that the US Federal Reserve is harbouring grave concerns about whether Washington’s $700 billion (£413 billion) bailout fund will avert a financial meltdown.

An auction of Lehman’s bonds yesterday determined that the bank’s borrowings were worth only 8.625 cents on the dollar. The valuation leaves the insurers of the debt a bill of about $365 billion. It is not clear whether the insurers, which are required to settle the bill in the next two weeks, will be able to pay – a development that could further undermine increasingly stressed capital markets.

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Amid the mayhem across the world’s stock markets, senior Fed officials now doubt whether Washington’s bailout fund will work unless it is launched in some form in the next two weeks. The Times has learnt that central bankers in America are anxious that if the Treasury is not able to accelerate the speed at which it launches its rescue scheme, it will have no effect. At the moment, the Treasury, which controls the fund, is working to a five-week schedule to get the rescue package up and running. Under present plans, the bailout fund is not expected to buy its first distressed mortgage-backed bonds until after the US elections on November 4.

It is understood that the Fed believes that this will be too late to help the banks that are suffocating under market conditions. Credit markets have frozen up and many banks have been cut off from being able to borrow from one another.

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About 350 banks and investors are thought to have insured an estimated $400 billion of Lehman’s debt through complex derivatives, known as credit default swaps. These include Pacific Investment Management, the manager of the world’s largest bond fund, Citadel, the US hedge fund, and American International Group, the insurer that the US Government recently bailed out with two loans totalling about $123 billion.

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http://business.timesonline.co.uk/tol/business/industry_sectors/banking_and_finance/article4922981.ece