Is Lehman The Next Bear Stearns? (LEH, JPM)

The financial services sector has gone from horrible to somewhat stabilizing and back to horrible and then looking even worse.  When you think of an old mantra that "Failure isn’t an option" that just isn’t looking to be the case in the sector.  Lehman Brothers Holdings Inc. (NYSE: LEH) is down well over 10% again today and the stock hit a new 52-week low (multi-year actually).

Part of this is the rumor mill back in full force. We don’t even want to fan those flames nor do we wish to participate in that.  But part of this daily drop is from legitimate fears and some Fed-Speak that might scare you into thinking they aren’t just going to bail out every institution that runs into financial trouble.  The fact that a stock keeps losing 10% or 20% of its value isn’t enough to throw up the red flag for a potential filing for bankruptcy protection.  But as soon as the fears set in to the point that other parties take aggressive defensive actions to insulate themselves then it’s too late.  That was the case with Bear Stearns even though many of the rumors floating around before may have helped lead to a self-fulfilling prophecy.  When key customers begin leaving and when counter-parties stop accepting a financial firm’s business or their paper, then they are as good as done.

Another notion here on Lehman is the action seen in the PUT OPTIONS.  We are seeing more and more PUT buying in July contracts which expire in only a week. Below is a brief matrix of this months PUTS with strikes and the open interest.  This isn’t looking that promising:

PUT/STRIKE   Volume  OpInt
JUL08 $5.00    2,517    8,422
JUL08 $7.50    2,919    19,698
JUL08 $10.00   6,815    29,377
JUL08 $12.50   5,730    23,655
JUL08 $15.00  10,716   63,370
JUL08 $17.50   2,515    63,973
JUL08 $20.00   1,158    60,566

Over the last week we have heard JPMorgan’s (NYSE: JPM) Jamie Dimon talking about dismissing the notion of TBTF (too big to fail).  We have heard Treasury’s Hank Paulson and other Fed officials discussing the "allowing institutions to fail" and "allowing them to seek bankruptcy protection" as part of the course of the free markets.  Dimon might want to gobble up another bank in trouble to get the deposit and banking base, but he’s unlikely to want to buy another troubled brokerage firm.

Unfortunately, there are a handful of large financial companies out there where this notion of failure or bankruptcy protection or another Draconian measure is at least becoming a stronger and stronger possibility.  It seems that in today’s troubled financial markets that failure is actually an option, albeit a painful one.

Jon C. Ogg
July 11, 2008