Toomre Capital Markets LLC

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Lehman Brothers Worried About Bear Stearns Fallout

Lehman Brothers is a former employer of both Aldon Hynes and Lars Toomre. At one point, Lars reported directly to Joe Gregory who has gone on to become President of the much larger firm that Lehman Brothers Kuhn Loeb has evolved into today. Aldon in fact was being wooed by Joe Gregory and Christopher Pettit when the new story ran across the scrolling Dow Jones News boards that Lars had left the company. Many people commented at the time that they never remembered a time in the previous decade when the fixed-income trading floor simply went deathly silent. During that same period in the late 1980s, Dick Fuld still was very intimately involved in the growth of the mortgage business and how its contribution to the larger Lehman Commercial Paper Inc. helped propel the Lehman management team to eventually take over all of the Capital Markets operations hence completing the 1984 Shearson American Express / Lehman Brothers Kuhn Loeb merger.

Over the past several days, there has been considerable speculation about what other firms might be impacted by the liquidity concerns that befell Bear Stearns in the past week. Much of that speculation has centered on Lehman Brothers since that global investment bank was the largest underwriter of residential mortgage-backed securities ("RMBS") during the 2005-2007 boom years and it also has a substantial commercial mortgage-backed securities business ("CMBS"). The CMBS underwriting business has also dramatically slowed and with the announcement of its fourth quarter results, Lehman Brothers has admitted that it has been caught with a decidedly large commercial mortgage inventory.

In its coverage about the Bear Stearns purchase by JPMorgan for the surprising low price of $2 per share, The Wall Street Journal in the article J.P. Morgan Rescues Bear Stearns reveals the following about Lehman Brothers:

Meanwhile, worries are deepening that other securities firms and commercial banks might be on shaky ground. Lehman Brothers Holdings Inc. Chief Executive Richard Fuld, concerned about the markets and possible fallout from Bear Stearns's troubles, cut short a trip to India and returned home Sunday, ahead of schedule, according to people familiar with the matter. The decision came after a series of calls Saturday to both senior executives at the firm and Treasury Secretary Henry Paulson, these people say.

Investors' concerns that the flight of worried Bear Stearns customers last week might spread to other firms is likely to make for a tense opening today on Wall Street. Yesterday, Mr. Paulson said in a TV interview that the government "would do what it takes" to protect the integrity of the financial system.

On several occasions over the weekend, Mr. Paulson spoke about the Bear Stearns negotiations with Federal Reserve Chairman Ben Bernanke and New York Federal Reserve Bank President Timothy Geithner, according to people familiar with the matter.

It is quite telling that senior Lehman executives and Secretary of Treasury Paulson are speaking several times over the weekend. If this is indeed true, what already was likely to be a very difficult St. Patrick's Day in the Capital Markets is likely to be even more so. The lack of transparency and concern about what else might happen is likely to cause the fixed-income markets to freeze up yet further. It will certainly be interesting to see just what Henry Paulson means when the government "would do what it takes" to protect the integrity of the financial system.

Will Lehman Brothers survive this current crisis of confidence? For sentimental reasons, Toomre Capital Markets LLC certainly hopes that Lehman does. What the new world of debt securities is like will be anybody's guess. The losses in current positions for all fixed-income dealers are likely to be staggering. Pity those dealers, banks and brokers that have on the trades that hedge any type of spread product against U.S. Treasuries or Treasury futures. The mark-to-market pain in the next few days is likely to be very intense as everything widens relative to Treasuries. Reader comments and thoughts are always welcome.