Lehman Announces $3.9 Billion 3Q Loss, Will Sell Off Assets to Raise Cash

Struggling investment bank sheds assets in an effort to shore up balance sheet.

Sept. 10, 2008 — -- Lehman Brothers Holdings said today that it lost $3.9 billion in the third quarter and announced a plan to sell some of its assets to raise cash, a move that comes after months of heavy losses related to the mortgage crisis.

In a statement released this morning, the company announced that it would spin off much of its troubled real estate portfolio into a new company and also sell a majority stake in its investment management division, including Neuberger Berman, a profitable division of Lehman that manages mutual funds and private wealth. In addition, the company said it was in talks with BlackRock Financial Management Inc. to sell about $4.0 billion of its United Kingdom residential mortgage portfolio.

Lehman's multi-faceted plan and its earnings report -- which was released a week ahead of schedule Wednesday morning -- hasn't satisfied Wall Street so far. By mid-morning Wednesday, the share price for Lehman Brothers Holdings Inc. teetered around $8, not high above where Lehman's stock price settled the day before after falling more than 40 percent.

Investors are still worried that Lehman, the country's fourth-largest brokerage firm, still might not be able to save itself from failure, said Douglas McIntyre, the editor of the financial Web site 247WallSt.com.

"People are looking at what Lehman did -- spinning off a dangerous part of their business, selling a majority in their money management firm -- that's a lot of fairly good stuff," McIntyre said, "but the market is saying it isn't enough. The mortgage market and the derivative market is so bad that even if you do all that, there's still a lot of risk."

Lehman's spin-off, to be called Real Estate Investments Global, will include $25 billion to $30 billion of its commercial real estate portfolio, the company said.

"The concentration of positions in commercial real estate-related assets has become a significant concern for investors and creditors," the company said in a statement. "Therefore, Lehman Brothers believes that it is in the best interests of all its constituents to separate these assets from the rest of the Firm.

Isolating its troubled real estate assets into a separate entity is a strategy some analysts have called a "good bank/bad bank" solution. The "bad bank" would hold the troubled assets.

"Fundamental accounting says you can't make the bad assets disappear -- they have to wind up somewhere," said Lawrence J. White, an economics professor at New York University's Stern School of Business.

The move, he said, could give Lehman some "organizational gains" by allowing the new company -- Real Estate Investments Global -- to focus squarely on making the most of its ailing portfolio.

White said that Lehman's sale of the stake in its investment management division could help the bank provide capital for the spin-off.

"It provides the net worth so as to allow it to be a feasible transaction," he said.

White said that if Lehman didn't resolve its asset problems, the government could eventually step in to shore up the bank like it did Bear Stearns. In March, the failing investment bank was purchased by JP Morgan in a $240 million deal backed by the federal government.

Not everyone agreed that Lehman could be subject to a Bear Stearns-style treatment. Bear's bailout happened under "very narrow circumstances," said Peter Wallison, a senior fellow at the American Enterprise Institute, a conservative think tank.

At the time of the Bear Stearns rescue, he said, many major financial institutions were considered to be unstable. If the government hadn't intervened and Bear Stearns had been allowed to fail, he said, there would have been a run on banks around the world.

Since then, Wallison said, financial institutions have made adjustments that would allow them to weather another bank failure. If Lehman did fail, he said, the same kind of domino effect would be unlikely and government intervention would not be as necessary.

"I don't see a real danger in the same kind of panicky run on financial institutions," he said.

More Bank Troubles

Experts say that small government bailouts are taking place frequently these days as the Federal Deposit Insurance Corp. takes control of failing small- to midsize commercial banks that have also been hit by the nation's mortgage meltdown.

But large banks aren't off the hook either. White said that Washington Mutual, which provided more than $150 billion in home loans in 2006, might be vulnerable to an FDIC takeover.

In July, the bank reported a $3.3 billion loss for the second quarter of the year and Monday announced it was replacing its longtime CEO.

"This is a financially troubled institution right now," White said.

The bank did not immediately return a call for comment, but in a statement Monday, new chief executive Alan H. Fishman said he was intent on "returning the company to profitability as quickly as possible."

The FDIC, which insures deposits of up to $100,000 at commercial banks, has taken control of 11 banks this year, including, most recently, Silver State Bank in Henderson, Nev. An additional 117 unnamed banks are on the corporation's "watch list."

But some question whether the FDIC might need a bailout of sorts.

The FDIC's insurance trust fund is supported by fees charged to U.S. banks. Mark Zandi, chief economist at Moody's Economy.com, said that the FDIC will raise its fees later this year but the increase might not be enough.

"If there are too many bank failures, it could overwhelm the FDIC's financial resources to digest those failures," Zandi said.

In that case, he said, the corporation would replenish its insurance fund with a cash infusion from the Treasury Department.

A Bailout for Car Companies?

Outside the financial sector, experts say that among the most obvious prospective government bailouts is one for the U.S. auto industry.

According to published reports, the industry will lobby Congress this week for as much as $50 billion in low-cost, government-backed loans.

Zandi said that one of the arguments in support of government aid is that auto companies, which have seen consecutive quarters of sagging sales, could use the loans "to tide themselves over until business improves."

There is precedent for an auto-industry bailout. In 1980, the federal government backed $1.5 billion in loans for Chrysler, helping the company avoid bankruptcy.

But it's unclear whether the federal government would approve a loan package for the auto industry this year. Some argue that it would be too expensive, while others say that political motivations -- Michigan, a major auto industry state, is also expected to be a swing state in the presidential election -- will prompt leaders from both parties to embrace the proposal.

Richard A. D'Aveni, a professor of strategic management at the Tuck School of Business at Dartmouth College, said the major automakers might be better off going bankrupt instead of asking for government help.

He said, "They need a chance to clear the decks and start over again."