Weighing Outcomes for Lehman, WaMu

Pat Dorsey: Hi, I'm Pat Dorsey, director of equity research at Morningstar. Looks to me like financial regulators are pretty much playing "whack-a-mole" with the financial services market right now. On Monday they thought they'd kind of cleaned up the Fannie and Freddie mess and removed a lot of uncertainty for the markets and what happens, Lehman  and WaMu (WM) pop their heads up and have to be dealt with. Let's talk about those two in sequence.

Lehman, you know, the survival is looking fairly uncertain at this point, lot of rumors about whether the company will be purchased in whole or in part, the company has obviously been shopping itself and various bits of itself, especially its valuable Neuberger Berman asset management unit for some time. Hasn't been able to get a deal done and you know the problem when you're trying to do a deal, lots and lots of people say no and the next folks she talked to, they're probably going to wind up at a lower price.

So CEO Dick Fuld's negotiating hand at Lehman, not very strong right now. Odds are good that something will happen over the weekend, these things seem to happen over the weekends, while people have time to kind of take a deep breath and put things together. You know as treasury secretary Paulson has been out saying we will not be back stopping this one, we will not be doing the same thing that we did with Bear Stearns, personally I think that's a negotiating tactic, of course he's going to say that, he sort of has to say that in a way and you know even though he'd make the argument that today we have the Fed liquidity window open to back stop Lehman, didn't have that when Bear Stearns went through its troubles back in March.

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You know the issue is that you know if people will cease trading with Lehman Brothers then that business is hurting pretty bad, pretty quickly. We have seen some expressions of support from other investment banks like Goldman Sachs (GS) and Citigroup (C), that's kind of to be expected, because if you're Goldman or Citi, you just want this whole thing to go away. You want the Lehman mess to just get solved one way or the other.

You know hedge funds that might be trading through Lehman don't have the same incentives at all, they may very well just pull back and you're already hearing some anecdotal evidence that they are seeing a decline in their trading operations as people kind of pull back from trading with them.

You know there's pretty big counterparty risk here, similar to Bear Stearns, Lehman is very tangled up in the financial system, so personally I think the odds that they just--the regulators just let Lehman go and let it kind of file for bankruptcy are very, very slim, I think you will see some kind of orchestrated bailout package where the company is either sold in whole or sold in pieces and where the Fed has probably some kind of hand in things in some way, shape or form.

Moving from Lehman to Washington Mutual, the beleaguered mortgage lender, you know it's an interesting scenario because they finally booted out shareholder, wealth destroyer of the decade Kerry Killinger, not too long ago and you would have expected that to be sort of a positive event for the company. Killinger had been hanging on by his finger nails, refusing to sell the bank, refusing reasonable offers from say J.P. Morgan back in the spring and pretty much running the company into a ditch, but at the same time he got booted out by the board which should have been a positive event for Washington Mutual.

Well, the news also came out that Washington Mutual had a memorandum of understanding with banking regulators. Now some parts of this were pretty you know, not very unusual at all but the one unusual part of this memorandum of understanding was the regulator's request for a multi-year plan for how our WaMu basically plans to get itself out of this mess and that's not something the regulators ask for very often, so it was a bit of a unpleasant signal to people that perhaps WaMu is in not so--is in not as good or bad, is in even worse shape rather than people had initially suspected.

And we got some fairly unpleasant news about WaMu as well on the deposit fund and of course if your deposits start heading out the door as a bank, you know things can get unpleasant very, very quickly. You know from last December to June, WaMu had actually been gaining deposits as they should be, they're offering some very, very high rates on CDs and deposits, however, from June through early September, they lost about $5 billion in deposit.

Now that's kind of worrisome because if deposits start going out the door, that's kind of the core of a bank's asset base and those numbers don't include unfortunately what might have been happening to their deposits in the past few weeks as the news, the headlines on WaMu have gotten worse and worse and worse and worse.

Our current estimates whether the company could sustain about $25 billion in cumulative losses over the next three years, and still pull through you know as surviving as an independent entity. You know their current projections are that they will incur about $18-19 billion in losses. So there is a little bit of a cushion there, not much of one but this outflow of deposits, if it is indeed happening, may very well force the hand of the company and or regulators, certainly there are banks and especially J.P. Morgan Chase would love to get their hands on WaMu's massive retail branch network, it would be very, very valuable to them, the question is whether they want to come in and you know buy it here or wait for the company to go into receivership and just purchase the assets in that case.

It's a very fluid situation right now, obviously we're getting new rumors, new anecdotes every few hours, but again, like Lehman, things should get resolved one way or another this weekend.

I am Pat Dorsey and thanks for listening.