Lehman Uses Securities Backed By Unsold Loans To Borrow From The Fed
In an effort to raise cash, Lehman Brothers recently packaged $2.8 billion of unsold loans into bonds and then used some of the securities as collateral to borrow from the Federal Reserve. The new investment entity called, Freedom, issued securities in the amount of $2.26 billion, which were rated investment-grade by Moody's Investors Service and Standard & Poor's. The transaction enabled Lehman to turn loans shunned by investors into cash to finance its operations. Transferred loans included risky leveraged buyout debt.
At this point, it is unclear how many Fed loans to investment banks have been collateralized by assets like subprime mortgage bonds or loans used to finance leveraged buyouts. With their balance sheets under pressure, banks may be inclined to take on more risks if they believe the Fed will bail them out. Alternatively, if the perception arose that the Federal Reserve's balance sheets have too many bad assets, the dollar could weaken.
Lehman’s actions have drawn mixed reviews from market observers and shows how some of the issues brought to light by the credit crunch are still very much a part of current market activity. The market’s dependence on credit-rating firms and Wall Street’s fondness for complex investment structures seems habitual.
“It’s a very creative way for investment banks to get liquidity from assets that they don’t want to sell at fire-sale prices,” says managing director of Precision Capital, Todd Kesselman. Inspired by Lehman’s “brilliant” move, a number of Wall Street executives may follow suit, which will put taxpayers at greater risk.
Skeptics argue that the move is similar to subprime lending where risky securities were repackaged into “safe” investments that lost value when the housing bubble burst. "There's a significant hazard to the Federal Reserve taking poor assets onto its balance sheet," said James Ellman, president of hedge fund Seacliff Capital in San Francisco.
Ed Grebeck, chief executive of Tempus Advisors summarized the situation. “The loss of confidence in structured-finance ratings is at the heart of the current market crisis. For investment banks to go back to the ratings firms and say, ‘Here’s [yet another] new structure for you to rate investment grade’—[is] shocking to me,” Grebeck said.
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