Lehman files Chapter 11 bankruptcy, trying to sell assets

Lehman Bros. filed for bankruptcy protection Monday, becoming the second major Wall Street firm to disintegrate under the weight of the deepening credit crunch.

The company filed for Chapter 11 protection in the U.S. Bankruptcy Court in the Southern District of New York.

Filing for Chapter 11 protection allows a company to restructure while creditor claims are held at bay.

The company most likely chose to file under Chapter 11 rather than a Chapter 7 liquidation so it could retain more control of the sale of assets, said Stephen Lubben, a professor at Seton Hall Law School. In a Chapter 7 filing, the court would immediately appoint a trustee to take over the case. "I'm sure they think they could conduct a better liquidation themselves, and that's probably true," he said.

Lehman said none of its broker-dealer subsidiaries or other units would be included in the filing. It says it's exploring the sale of its broker-dealer operations and is in "advanced discussions" to sell its investment management unit.

Based on its assets at the time of filing, Lehman surpassed WorldCom as the largest U.S. bankruptcy. Lehman had about $639 billion in assets at the time of filing, while WorldCom had about $107 billion when it filed for Chapter 11 in 2002.

In its bankruptcy petition, Lehman listed Citigroup among its biggest unsecured creditors, with about $138 billion in bonds as of July 2. The Bank of New York Mellon was listed as holding about $17 billion in debt. Lehman said as of May 31, it had assets of $639 billion and debt of $613 billion.

The filing was made so hastily that the company had not filed motions Monday that are typically made on the first day, such as asking court permission to pay employees.

Many Lehman employees seen entering its headquarters in Midtown Manhattan tucked their chins down to avoid talking to the media and others who lined up behind metal barriers in front of the building. Some carried empty shopping bags, tote bags or gym bags into the office.

Lehman Bros. International Europe's administrators said they don't know if some employees will be paid at the end of this week after its U.S. parent filed for bankruptcy.

"We still don't know what the position is, or whether or not there are funds to be paid," said PricewaterhouseCoopers partner Tony Lomas at a press briefing in London on Monday. "The outcome for the majority of staff has yet to be determined," Lomas said. A "couple dozen" U.K. Lehman workers lost their jobs today, the administrators said.

Lehman's membership on the IntercontinentalExchange, which includes access to the European Climate Exchange, the world's largest emissions trading exchange, was suspended, an ICE spokesman said. This effectively disallows Lehman from closing positions on its trading books.

CME Group, the world's largest futures market, and its New York Mercantile Exchange unit, the world's largest energy market, said on Monday that Lehman "continues to meet all its obligations" and is operating as normal. Options Clearing Corp., which guarantees all trades in the $1.6 trillion U.S. options market, also said Lehman remains in good standing.

In a press release Monday, Lehman said, "Customers of Lehman Brothers, including customers of its wholly owned subsidiary, Neuberger Berman Holdings LLC, may continue to trade or take other actions with respect to their accounts."

The announcement came at the end of a wild weekend, full of intense negotiations at the offices of the Federal Reserve Bank of New York, one that drove home just how difficult it will be for banks and financial institutions to return to health.

Lehman, one of Wall Street's oldest and most-storied investment banks, ran into trouble by investing too riskily in real estate, failed to strike a deal with a number of potential bidders. Barclays, Britain's third-biggest bank, was the last potential white knight to decline a deal.

The failure to get a deal was due largely to the federal government's refusal to provide interested buyers with the kind of support that JPMorgan Chase received when it bought troubled investment bank Bear Stearns.

In that controversial deal, the Fed extended what amounted to a $30 billion loan to JPMorgan that reduced some of the risk. This time, the Fed put none of taxpayers' money on the line.

Briefing reporters at the White House on Monday, Treasury Secretary Henry Paulson said he "never once" considered it appropriate to put taxpayer money at risk to resolve the problems at Lehman.

Paulson explained his decision by telling White House reporters he did not "take lightly" any decision to put taxpayer money at risk to prop up a private company.

The fact that a Lehman rescue didn't occur "will send shivers down the spines of investors," says Jack Ablin, chief investment officer of Harris Private Bank.

How severe is the crisis? Former Federal Reserve chairman Alan Greenspan, appearing on This Week with George Stephanopoulos, said: "It's a once-in-a-century type of financial crisis." Greenspan said he expects other financial institutions to fail.

Weekend negotiations

The attempted rescue plan for Lehman — along with wider discussions with many banking leaders about shoring up the financial system — was debated in New York over the weekend in high-level meetings that began Friday and included top government officials from the Federal Reserve, Treasury and the Securities and Exchange Commission, as well as executives from Wall Street's top investment banks.

The biggest stumbling block was the government's reluctance to contribute financially to a rescue package, protecting suitors from potential losses surrounding Lehman's so-called bad bank assets. These include toxic real estate securities, which have a face value of about $77 billion, and about $53 billion if write-offs are taken into account.

Buyers were comfortable with buying Lehman's so-called good assets, such as its investment management division and equities business.

Lehman was deemed vulnerable because it was the smallest of the major investment banks still standing and because it had massive investments in troubled real estate and mortgage-related securities. Its hopes of remaining independent were squashed last week when talks with a sovereign wealth fund from South Korea, which was considering injecting much-needed capital into Lehman, broke down.

Hopes were dashed for good when Wall Street gave a thumbs down to a plan the firm rolled out Wednesday to try to fix its problems. The plan, which investors thought was too late, included selling a majority stake in its asset management division, slashing its dividends and spinning off toxic real estate assets.

Lehman's troubles morphed into a crisis late last week due in large part to the sharp decline of its stock price and a sharp increase in its borrowing costs.

The stock plunged 77% last week to $3.65, and its borrowing costs ballooned to 8 full percentage points above a comparable government bond. The combination of higher costs to access capital, coupled with the loss of collateral value of its stock, put Lehman in a vulnerable position.

Investors were also afraid Lehman would announce bigger losses in the quarters ahead, beyond the nearly $7 billion in write-downs it's suffered the past two quarters.

"It was a run on confidence," says Chris Whalen, managing director at Institutional Risk Analytics. Whalen says Lehman was being hurt by fears that other financial companies will cease doing business with it.

The endgame for Lehman comes after a turbulent week on Wall Street, where the spotlight on troubled financial firms spread to a wider number of players. Jittery investors fear that the steep stock price declines in the firms could make it more difficult for them to raise capital.

It also follows on the heels of the Treasury Department's seizure last week of the nation's two mortgage giants, Freddie Mac and Fannie Mae. Both were reeling from bad housing investments caused by falling home prices and failed mortgages.

Despite massive government intervention in the past six months, fears of credit problems infecting the broader financial system are still palpable.

Wall Street is still having problems valuing toxic real estate assets, which makes big investors leery of putting more capital at risk and investing in troubled financial companies.

Financial institutions around the globe have already booked losses totaling more than $473 billion, according to Bespoke Investment Group. And while they have been able to raise more than $350 billion to offset those losses, it is getting more difficult for battered institutions to raise much-needed cash, notes Paul Hickey of Bespoke.

The government's decision not to put taxpayer money at risk was a departure from its prior interventions in the crisis. Debate has been raging on Wall Street as to which institutions are "too big too fail."

But in the case of Lehman, Treasury Secretary Henry Paulson has made it clear the government did not want to use taxpayer money to rescue the firm.

Unlike in the case of Bear Stearns, the market has had ample time to prepare for troubles at Lehman. What's more, Lehman has direct access to short-term funds from the Fed. When it announced the Bear deal, the Fed also created a special facility that enables investment banks for the first time to access the Fed's cash for short-term needs.

Fallout and confidence

Many critics of early government bailouts say it would be a mistake for the government to send the message that it will bail out everyone. Anthony Sabino, a law and business professor at St. Johns University, says the bailouts must stop. "The government is keeping the free in free markets," he says. "And free means free to succeed and free to fail. If you bail out Lehman, then you have to bail out everyone. Who's next? Does it go beyond the next financial institution? The automakers?"

Critics of CEO Richard Fuld's strategy to save Lehman say he waited too long to strike a deal with a deep-pocketed suitor.

Because Lehman's banking business is geared mainly to institutional investors and not mom-and-pop investors depositing money in the bank, its fallout on Main Street is likely to be more of a confidence issue.

But the messier the company's death, the greater the effect on Wall Street and Main Street.

Shell and Chu reported from New York, Kirchhoff from Washington, and Waggoner from McLean, Va. Contributing: Barbara Hagenbaugh in Washington; Bruce Horovitz in McLean, Va.; Reuters; Bloomberg News: and the Associated Press