Lehman, Merrill, AIG Exacerbate Financial Sector Challenges

During the weekend, discussions took place between government officials and Wall Street executives at the Federal Reserve Bank of New York based in Lower Manhattan. While focusing on the problems facing Lehman Brothers, Merrill Lynch and AIG, the group analyzed other financial institutions, as well as the overall condition of the markets. The ongoing and far-reaching plight of the financial sector is seen as an indication that even the unprecedented measures taken by the U.S. government to rescue the likes of Bear Stearns, Freddie Mac and Fannie Mae, have not been able to prevent the downfall of companies that have widely been viewed as untouchable. These measures were largely taken in an effort to restore confidence in the markets, but it seems that as one hole in the dam wall is plugged, a leak springs up elsewhere. Certainly the concept of a company being too big to fail is no longer valid.

The supportive intervention in the case of Bear Stearns, which lost clients and its access to money markets in a matter of days, is not likely to be repeated in the case of Lehman. The Federal Reserve and Treasury expect Wall Street firms to come to the rescue, but many of these firms find themselves short on capital, which could mean that Lehman will be forced to liquidate. In view of the ongoing crisis, the U.S. government has to draw the line somewhere, and may not be able to save every large firm from failure, even if such failure poses a risk to the financial system.

As analysts point out, many financial companies need to raise capital to strengthen their position. However, with stock prices falling, raising capital becomes a greater challenge. The inability to raise the needed capital sends alarm signals to bondholders and credit rating companies, which causes stock prices to fall – and so the cycle continues in a downward spiral. While many expected the takeover of Freddie Mac and Fannie Mae to soothe investors’ frazzled nerves, the market has remained volatile. Nevertheless, it is believed that, to an extent, intervention prevented a domino effect taking place in the financial system – to what extent this has been effective, will likely be revealed in the days ahead.