Jay Currie

Okay, Ike turned out to be a mess…quite a big mess; but not the economy wrecking, gas price goosing, hurricane from Hell which it was looking like on Friday. Houston is a mess but the refineries should be online in a matter of five to ten days.

So we can turn our attention back to the financial markets which are having a rather rough ride.

#1 Merrill Lynch, another investment bank laid low by the crisis that was triggered by rising mortgage defaults and plunging home values in the U.S., was in talks to be acquired by Bank of America, a marriage apparently brokered by the federal government. (Not quite that “Bullish on America”.)

#2 New York Insurance Superintendent Eric Dinallo and a representative of the governor’s office spent the weekend at the headquarters of insurer AIG, hit hard by deterioration in the credit markets, trying to craft a solution that protects policyholders, according to Dinallo’s spokesman David Neustadt.

#3 Lehman Brothers may be forced to seek an orderly unwinding of its businesses. All potential buyers walked away after the U.S. Treasury refused to budge on its refusal to provide any takeover aid, as it had done six months ago when Bear Stearns faltered.

Expectations that the 158-year-old Lehman would survive dimmed after Barclays PLC withdrew its bid to buy the investment bank. Barclays and Bank of America were considered front-runners to buy Lehman, which is foundering under the weight of $60 billion in soured real estate holdings.

(all from an AP round-up article.)

The unwinding of the broker dealer business and the investment banking business has a lot to do with amazingly optimistic bets Merrill and Lehman mad on the mortgage backed securities market in the US. But the ugliness goes beyond doubtful mortgages. The exposure of the financial community to any amount of doubtful debt bundles is, even now, virtually impossible to determine.

Plus, and this is where its gets really messy, virtually all financial institutions hold the debts of other financial institutions. They are “counterparties” in various transactions. Normally, this is a relatively risk free means to spread and share risk; but “normally” takes for granted that the counterparties do not default, do not go bankrupt. If Lehmans goes down it has a small, but real, potential to take a good sized chunk of the currently undercapitalized world banking system down with it.

Like Ike the potential for a truly catastrophic banking collapse is very real. Not entirely likely, but real enough that the stock market is likely to be very spooked tomorrow morning.

Hold on because this is a financial storm surge of potentially lethal proportions.

Update: “The Lehman board authorized the filing of the Chapter 11 petition in order to protect its assets and maximize value, the firm said. In conjunction with the filing, Lehman intends to file a variety of first-day motions that will allow it to continue to manage operations in the ordinary course.” wsj”

No more “golden crumbs” at Lehman’s.