Why Sarah Palin Has the Democrats Running Scared: Caroline Baum

Commentary by Caroline Baum

Sept. 15 (Bloomberg) -- Alaska Governor Sarah Palin electrified the Republican National Convention with her acceptance speech two weeks ago.

And why not? The GOP vice presidential candidate is attractive (hold the accusations of sexism, please), articulate, poised, enthusiastic, homespun, a fresh face with a girl-next- door appeal.

She's everything, in other words, that John McCain is not.

After watching the McCain campaign sleepwalk through the summer, the Democrats can't get their arms around the Palin phenomenon. Who is she -- a Mayor from Nowhere! -- to come along, light a fire under the GOP ticket and threaten our path to the White House?

The spirited response to Palin by the Republican delegates in St. Paul is one thing. These are her people, the almighty GOP base.

When her popularity spilled over to the public at large and manifested itself in fundraising and opinion polls -- the GOP ticket is now tied with or ahead of the Democrats -- it was a real affront to the Democrats.

After all, ``this is our moment,'' ``this is our time,'' Barack Obama said in a June 3 speech after wrapping up the Democratic presidential nomination.

He's right. The 2008 presidential election is the Democrats to lose.

An attitude of inevitability, of entitlement even, pervaded the Democratic Party -- until it was rudely punctured two weeks ago by the Palin phenom.

Co-Opting Change

The bursting of the inevitability bubble was on view in the real-time reaction to Palin's acceptance speech. The liberal pundits on cable news were clearly caught off guard by Palin's poise in front of an audience just a bit larger than the population of Wasilla. They were speechless. Seriously. Their jaws were moving, but nothing comprehensible was coming out.

It was on view in Barack Obama's demeanor on the campaign trail following the GOP convention. The candidate has gone flat.

And it was on view in the sheer glee the press took in turning over rocks, or icebergs, in Alaska to find some contradictions in Palin's assertions about the fabled Bridge to Nowhere.

On top of that, McCain and Palin have insinuated ``change'' into their campaign. How dare they steal our thunder, the Dems complain. We're the party of change. We're running against the incumbent president. They can't run as anti-incumbents, too.

Experience Boomerang

In short, the Democrats are running scared. And it's not for the reasons you think.

The fear has nothing to do with Palin's views. She likes guns, opposes abortion, wants to drill, is against a windfall profits tax on oil companies, wants to cut spending and earmarks, believes raising taxes hurts small business. She pretty much shares McCain's views on those issues.

The fear has nothing to do with Palin's inexperience -- six years as mayor of small-town Wasilla and two years as governor of Alaska, the largest, albeit a sparsely populated, state. If elected, Palin would be a ``heartbeat away'' from the Oval Office, her critics like to point out.

If she's a heartbeat away on Day Two, President Obama, with zero executive experience, is at mission control on Day One. Accusations of Palin's inexperience ultimately boomerang back to Obama's slim resume.

Loser Image

Besides, no one votes for vice president. The last time a vice presidential pick had a clear impact on the election outcome was John F. Kennedy's selection of Lyndon B. Johnson, who helped JFK carry Texas, according to presidential historians. (Why, then, do we spend endless hours handicapping and analyzing the VP choice every four years?)

No, the real reason the Democrats are scared to death of Palin's popularity is because if they lose this election, it will mean they are bankrupt as a party.

If the Democrats can't win a presidential election after eight years of an unpopular president, five years of an unpopular war, in the face of a lousy economy, a collapse in the housing market and overwhelming sentiment that the country is on the wrong track, it means something is terribly wrong.

This is as good as it gets for a party out of power. A loss in November would be embarrassing -- no, humiliating -- to the Democrats.

If they lose in '08, they will have no one to blame but themselves. Sarah Palin has raised the odds of a Democratic loss. That's why she has to be destroyed.

Lehman Files Biggest Bankruptcy Case as Suitors Balk (Update4)

Sept. 15 (Bloomberg) -- Lehman Brothers Holdings Inc., the fourth-largest U.S. investment bank, succumbed to the subprime mortgage crisis it helped create in the biggest bankruptcy filing in history.

The 158-year-old firm, which survived railroad bankruptcies of the 1800s, the Great Depression in the 1930s and the collapse of Long-Term Capital Management a decade ago, filed a Chapter 11 petition with U.S. Bankruptcy Court in Manhattan today. The collapse of Lehman, which listed more than $613 billion of debt, dwarfs WorldCom Inc.'s insolvency in 2002 and Drexel Burnham Lambert's failure in 1990.

Lehman was forced into bankruptcy after Barclays Plc and Bank of America Corp. abandoned takeover talks yesterday and the company lost 94 percent of its market value this year. Chief Executive Officer Richard Fuld, who turned the New York-based firm into the biggest underwriter of mortgage-backed securities at the top of the U.S. real estate market, joins his counterparts at Bear Stearns Cos., Merrill Lynch & Co. and more than 10 banks that couldn't survive this year's credit crunch.

``There is likely to be a domino effect as other firms and individuals who relied on Lehman for financing feel the effects of its meltdown,'' said Charles ``Chuck'' Tatelbaum, a bankruptcy lawyer with Adorno & Yoss in Florida and former editor of the American Bankruptcy Institute Journal. ``The whole thing is frankly frightening for the U.S. economy.''

Shares, Bonds

Lehman's filing was made by lawyers from New York-based Weil Gotshal & Manges, led by bankruptcy lawyer Harvey Miller. The case was assigned to U.S. Bankruptcy Judge James Peck, according to court records. Peck was sworn in as a judge in January 2006. Before taking the bench, he served as co-chair of business reorganization at Schulte Roth & Zabel, and prior to that was a partner at Duane Morris, according to the court's web page.

Lehman shares at 9:39 a.m. dropped 92 percent in New York trading to 29 cents from their $3.65 close on Sept. 12. UBS AG, HBOS Plc and Axa SA led a decline of more than 3 percent for European stock markets on speculation a forced sale of Lehman's assets may lead to further writedowns at other banks.

Benchmark gauges of corporate credit risk rose by a record in Europe, and traded at an all-time high in North America as investment banks sought to minimize losses from Lehman's collapse. U.S. two-year Treasuries climbed, pushing yields below 2 percent for the first time since April, as investors sought the relative safety of government debt.

60 Cents

Lehman bondholders may get about 60 cents on the dollar if the investment bank is forced into liquidation, analysts at CreditSights Inc. said. The filing is by Lehman's holding company and won't include any of its subsidiaries. Lehman owes its 10 largest unsecured creditors more than $157 billion, including debts to bondholders totaling $155 billion.

The largest single creditor listed in today's filing is Tokyo-based Aozora Bank Ltd., owed $463 million for a bank loan. Other top creditors include Mizuho Corporate Bank Ltd., owed $382 million, and a Citigroup Inc. unit based in Hong Kong owed an estimated $275 million. Lehman listed $639 billion of assets. New York-based Citigroup and The Bank of New York Mellon Corp. are among trustees for bondholders who Lehman owed about $155 billion.

London-based Barclays, which emerged as a leading candidate to acquire Lehman, pulled out first yesterday, saying it couldn't obtain guarantees from the U.S. government or other Wall Street firms to protect against losses on Lehman's assets.

Three Hours Later

Bank of America Corp. withdrew about three hours later, before saying it would acquire New York-based Merrill Lynch. Brokers sought yesterday to consolidate trades linked to Lehman to minimize the impact of a bankruptcy filing.

Founded in 1850 by three immigrants from Germany, Lehman has managed to avert previous potential disasters and was among the handful of U.S. financial firms that had endured for more than a century.

Fuld, the longest-serving CEO on Wall Street, attempted to shore up the firm's finances in the second quarter by raising $14 billion of capital, selling $147 billion of assets, increasing cash holdings and reducing reliance on short-term funding to create a buffer against a bank run.

Instability in the financial and credit markets left Lehman officials struggling to keep the firm afloat, Ian Lowitt, the firm's chief financial officer, said in a court filing in the bankruptcy case. Liquidity problems plagued Lehman earlier this year, he said.

``This loss of liquidity created a chain reaction of adverse economic consequences,'' Lowitt said.

25,000 Employees

Lehman, which has about 25,000 employees worldwide, last week reported the biggest loss in its history and said it planned to sell a majority stake in its asset-management unit, spin off real-estate holdings and cut the dividend in an effort to shore up capital and regain investor confidence. The efforts failed to stem speculation that the firm's mortgage holdings would lead to more losses.

``The uncertainty, particularly among the banks through which the company clears securities trades, ultimately made it impossible for the company to continue to operate its business,'' Lowitt said in the filing. The firm had sought about $4 billion for the asset-management unit, he added.

The U.S. Treasury and the Federal Reserve negotiated with Wall Street executives for the past three days in New York, trying to strike a deal that would prevent the investment bank from failing before markets open today. Treasury Secretary Henry Paulson indicated that he didn't want to use U.S. taxpayer funds to ease a sale of the company.

Exploring the Sale

Fuld, 62, is exploring the sale of its broker-dealer operation and continues to hold talks on the sale of its asset- management unit, including fund manager Neuberger Berman, the company said today in the statement.

The U.S. Securities and Exchange Commission said customer accounts at Lehman are protected and agency staff will remain at the brokerage firm in the coming weeks.

Securities rules require segregation of Lehman's securities and cash, and accounts are covered by insurance provided by the Securities Investor Protection Corp., the Washington-based agency said last night. SEC employees working inside the broker's office will continue that assignment, the agency said.

``We are committed to using our regulatory and supervisory authorities to reduce the potential for dislocations from recent events, and to maintain the smooth functioning of the financial markets,'' said SEC Chairman Christopher Cox in a statement yesterday.

Units That Fail

Brokerage units that fail usually are handled by the SIPC, which appoints a trustee to liquidate the business and protect its customers. Lehman's customer accounts may also be farmed out to other firms that may protect cash and securities, on the model of the failed junk-bond firm Drexel Burnham Lambert, which filed for bankruptcy in 1990.

Lehman's trades in commodities, derivatives and other financial instruments may be unwound by the bank's counterparties, said Andrew Rahl, co-head of bankruptcy in New York at law firm Reed Smith and a specialist in financial companies.

A liquidation of the brokerage unit might be ``a big mess'' if Lehman used customer accounts to raise cash, and sale and repurchase agreements had to be unwound, Rahl said.

Take Over

The trigger for SIPC to take over the Lehman brokerage would be a freezing of customer accounts, or a Chapter 11 filing that implied the unit was insolvent and its customers might not be able to access their property, the official said.

``First there will be chaos and then an adjustment process as losses distribute themselves through the market,'' said Gilbert Schwartz, a former Federal Reserve attorney and now a partner at Schwartz & Ballen in Washington. ``There won't be any lasting turmoil. Treasury and the Fed have determined that markets have adjusted to the situation since Bear Stearns. If every time a big institution went bust the markets expected the government to step in, no one would ever adapt.''

Ladenburg Thalmann & Co. analyst Richard Bove wasn't as sanguine.

``We will be entering uncharted territory,'' he said. ``Forcing liquidation will set off problems in other companies and markets everywhere.''

Rival Banks

Rival banks and brokers yesterday held a session for netting derivatives transactions with Lehman to reduce uncertainty in that market. That move means canceling trades that offset each other, the International Swaps and Derivatives Association said in a statement. The ISDA includes 218 banks, brokerages, insurance companies and other financial institutions from the U.S. and abroad.

In the U.K., the Financial Services Authority asked banks to disclose their exposure to Lehman, spokeswoman Teresa LaThangue said in a statement today.

Any sale of Lehman's investment management units is subject to court approval and creditor scrutiny under bankruptcy rules, according to Tatelbaum.

``Bankruptcy severs all counterparty contracts, and therein lies the systemic risk,'' said David Kotok, chief investment officer of Vineland, New Jersey-based Cumberland Advisors Inc., which manages $1 billion. ``This would be the first time we've tested how much damage will be done by a bankruptcy.''

Wake-Up Call: Lehman's Mortgage Marks

By DAVID REILLY and PETER EAVIS

The weekend's momentous developments -- Lehman Brothers Holdings' looming collapse, Merrill Lynch's merger talks with Bank of America and American International Group's plans to sell assets -- all have one thing in common: The firms couldn't deal with tens of billions of dollars in mortgage exposure left on their balance sheets from the credit boom.

Anyone else holding large amounts of tainted mortgages has to worry. Lehman's potential unwinding, along with any aggressive actions by Merrill and AIG to offload mortgage assets, could mean widespread losses as other banks mark down their own holdings.

Even before this weekend, that threat had weighed on financial stocks.

It started last week with Lehman, which surprised markets with savage cuts to the value of its residential-mortgage holdings. These were sharply lower than previous values, or marks, and helped drive Lehman's $3.9 billion loss for the quarter ended in August.

Investors were quick to connect the dots. If Lehman set a new benchmark with those values, others with big portfolios could be in for more pain, especially AIG and Citigroup.

If AIG sells relatively attractive assets like its aircraft leasing business, it may be able to plug a hole resulting from marking down its mortgage book. For instance, applying some of Lehman's latest marks to AIG's holdings could result in at least $15 billion in additional write-downs to the insurer's residential portfolio, which has a face value of $88 billion.

"We consider those kind of broad, simplistic comparisons to be unreliable," an AIG spokesman said. "We have a thorough process for pricing and marking our portfolio."

Citi, meanwhile, could face around $7 billion in additional write-downs if it applied Lehman's math to only its "Alt-A" portfolio of mortgage-backed securities. The banking giant hasn't come under the same pressure as AIG or other financial firms in recent days, but has taken big hits over the past year due to certain toxic holdings.

How severe were Lehman's marks? Consider that even longtime bears on the stock thought the firm was finally marking its residential portfolio to realistic levels last week.

Lehman Chief Financial Officer Ian Lowitt said on the firm's investor call that the firm was marking Alt-A exposures at about 39% of face value, compared with about 63% at the end of the second quarter. Alt-A mortgages are loans given to borrowers who, while not necessarily subprime, lack documentation to verify their financial condition or other information.

The firm took nearly as big a hit on subprime securities and those backed by second-lien loans, or those second in line to an original mortgage. The value of these holdings hit 34% of face value, from 55% at the end of the second quarter.

That isn't to say that other firms will blindly follow Lehman's lead. Marks are influenced by a range of factors, including the year the mortgage-backed securities were issued, the characteristics of the underlying borrowers and the extent to which securities are exposed to loan defaults. In addition, other firms may have insured their holdings against losses.

Still, Lehman has thrown down a marker. At the end of June, AIG's marks on Alt-A securities were about 67%. Citigroup, meanwhile, appeared to be valuing its $16.4 billion in Alt-A exposure at just over 80 cents on the dollar.

That could put Citi's shares under more pressure. However, there might be a silver lining to firms taking deep marks. It could actually set the sort of prices that finally lure more buyers to distressed mortgages.

Bank of America to Acquire Merrill as Crisis Deepens (Update2)

Sept. 15 (Bloomberg) -- Bank of America Corp., the biggest U.S. consumer bank, agreed to acquire Merrill Lynch & Co. for about $50 billion as the credit crisis claimed another of America's oldest financial companies.

Bank of America will pay $29 a share for New York-based Merrill in stock, 70 percent more than the Sept. 12 closing price, the company said in a statement today. Merrill, battered by $52.2 billion in losses and writedowns from subprime- mortgage-contaminated securities, has plunged more than 80 percent from its peak of $97.53 at the start of last year.

The takeover ends 94 years of independence for Merrill and gives Charlotte, North Carolina-based Bank of America a sales force with 16,690 brokers who manage $1.6 trillion for customers. Merrill, led by Chief Executive Officer John Thain, was in danger of becoming the next subprime casualty after Lehman Brothers Holdings Inc. filed for bankruptcy court protection earlier today.

``If Bank of America can put a fence around the bad assets, that retail distribution is a powerhouse,'' said Peter Sorrentino, senior portfolio manager at Huntington Asset Advisors in Cincinnati, which oversees $16.5 billion in assets. ``The Merrill Lynch combination makes more sense than a Lehman deal.''

Countrywide Deal

Merrill is the second bargain picked up this year by Bank of America Chief Executive Officer Kenneth Lewis tied to the collapse of the mortgage markets. The bank bought Countrywide Financial Corp. for $2.5 billion in stock last July to become the nation's biggest home lender. As recently as Sept. 12, Bank of America was considering making a bid for New York-based Lehman.

Bank of America and Merrill said they both have ``nominal'' exposure to Lehman. Lewis and Thain made the comments on a conference call with analysts and investors.

Bank of America fell $3.99, or 12 percent, to $29.75 at 9:54 a.m. in New York Stock Exchange composite trading. Merrill rose $5.15, or 30 percent, to $22.20.

Each Merrill share will be exchanged for 0.8595 shares of Bank of America stock, according to Bank of America's statement. That works out to $29 a share, based on Bank of America's closing price of $33.74 on Sept. 12. Because the payment is in stock, Merrill shareholders would get less if Bank of America's share price falls. The deal is scheduled to close in the first quarter of next year.

S&P Rating

Standard & Poor's cut its long-term counterparty credit rating on Bank of America Corp. to AA- from AA and the credit ratings on the holding company were put on CreditWatch with ``negative implications.'' Moody's Investors Service also said it's considering cutting Bank of America's rating.

``Acquiring one of the premier wealth management, capital markets, and advisory companies is a great opportunity for our shareholders,'' Lewis, 61, said in the statement.

The Merrill takeover would be the largest in the financial- services industry this year, data compiled by Bloomberg show. It's the fifth-largest transaction since Bank of America bought FleetBoston Financial Corp. in 2003 for about $48 billion in 2003.

The deal would mark the end of Merrill's almost century- long history as an independent company. According to Merrill's Web site, founder Charles Merrill solidified his reputation by advising clients to sell stocks prior to the crash of 1929. The firm went public in 1971 and in 1974 introduced its corporate logo -- a bull that Merrill executives say embodies one of the most recognizable brands in the world.

Housing Market

Merrill's stock returned more than 13 percent a year from 2000 through 2006. Then last year, the housing market began to falter, and investments linked to the subprime mortgage market made under then-CEO Stan O'Neal tumbled in value. The firm posted a loss of more than $2 billion in last year's second quarter, and O'Neal was dismissed in October 2007.

The board replaced him with Thain, 53, a former Goldman Sachs Group Inc. executive who earned the moniker ``Mr. Fixit'' for his stewardship of the New York Stock Exchange for four years beginning in January 2004. Thain took over Dec. 1.

Lewis has made more than $100 billion of acquisitions since becoming CEO seven years ago, including the purchases of FleetBoston and credit-card issuer MBNA Corp.

``This creates the company that instantly would have taken a decade to build,'' Lewis said on the conference call.

Wealth Management

In Merrill's case, he's buying assets worth more than $40 a share, according to a Sept. 12 Citigroup Inc. analysis. The wealth management unit alone is worth $16 a share, said the report by Prashant Bhatia.

Merrill also owns about half of BlackRock Inc., the New York-based money-management company that had a market value of $24 billion as of Sept. 12.

Bank of America employed about 207,000 people at midyear, compared with Merrill Lynch's 61,900.

Bank of America will take a restructuring charge of $2 billion for the purchase, executives said on a conference call.

``The fact that the biggest brokerage would be bought by the biggest retail bank is certainly historic,'' said John Medlin Jr., 74, retired chief executive officer at Wachovia Corp. ``Bank of America decided they weren't going to take on the Lehman risk, but they concluded the risk wasn't as severe at Merrill Lynch.''

`Big Cuts'

Bank of America paid $3.3 billion in July 2007 for U.S. Trust Corp. to expand its wealth management business. The company had $589 billion in assets under management as of June 30 and its full-service brokerage, Banc of America Investments, employs about 5,600 financial advisers. The wealth management business contributed 14 percent of Bank of America's profit last year.

The bank said today it expects to cut $7 billion of costs by 2012.

``B of A is known for making big cuts,'' said John Challenger at Challenger, Gray & Christmas Inc., the Chicago- based placement firm. ``They go in and thin it out,'' moving some functions to the bank's headquarters, he said.

Fusing the two companies' investment banks transforms Bank of America into a bigger player in several of Wall Street's most lucrative businesses, CreditSights Inc. analyst David Hendler said yesterday in a report.

Merrill is the world's sixth-biggest adviser on corporate mergers this year and Bank of America ranks 18th, Bloomberg data show. Together, Bank of America would climb to ninth, according to the statement. Bank of America is the biggest arranger of U.S. loans to companies with junk credit ratings, or those below investment grade. Merrill is the third-biggest stock underwriter.

Securities Unit Shakeup

The Merrill purchase comes less than a year after Lewis, frustrated by proprietary trading losses at his company, said on a conference call, ``I've had all the fun I can stand in investment banking'' and vowed to scale back the unit.

Lewis said today his opinion has changed.

``I like it again,'' Lewis said on the conference call.

Lewis previously replaced the head of investment banking and eliminated staff, citing slower demand for many capital markets businesses. He promoted former wealth management division leader Brian Moynihan as president of the corporate and investment bank.

Moynihan has recruited more than two dozen people since March, including senior investment bankers and analysts from Bear Stearns Cos., Morgan Stanley and other Wall Street firms. The hires include David Glaser, former co-head of investment banking at Bear Stearns, and David Flannery, former head of leveraged capital markets at Deutsche Bank Securities.

Trading Losses

``It's a puzzle that Ken Lewis said he didn't want to be in the investment banking business and here he is jumping in with both feet,'' said Jack Ablin, who helps manage $65 billion as chief investment officer at Harris Private Bank, including shares of Merrill and Bank of America. ``Maybe by harnessing the brain power of Merrill they can become a player.''

Lewis's willingness to buy Merrill comes 2 1/2 months after Bank of America completed its $2.5 billion purchase of Calabasas, California-based Countrywide, which was forced to sell due to mounting losses on subprime home loans -- the same assets that led to four straight quarterly losses at Merrill. Subprime loans go to home buyers with the weakest credit, and defaults are running at record rates.

Because of its trading losses and slumping demand in capital markets, Bank of America's corporate and investment bank made up 4 percent of the company's profit last year, down from 25 percent in 2006. The company is the dominant U.S. retail bank, accounting for almost 10 percent of the nation's bank deposits and about one of every five newly issued home mortgages.

Stock Drops

Merrill posted a $9.8 billion loss in the fourth quarter, and Thain had to sell about $12 billion of equity in Merrill to bolster its capital base. At the time, Thain said he thought Merrill's troubles were mostly behind it.

``We're very comfortable with our position,'' Thain said on Jan. 30.

Merrill posted another $6.6 billion of losses in the first and second quarters, and in July Thain announced the sale of $31 billion of collateralized debt obligations for 22 cents on the dollar, resulting in another $4.4 billion of writedowns. With the prospect of more losses -- Oppenheimer & Co. analyst Meredith Whitney predicted last week Merrill would post a $6.87 billion deficit for the third quarter -- the stock plunged 36 percent to $17.05, adding pressure on Thain to act and avoid the fate of Bear Stearns, which collapsed in March, and Lehman.

``The potential of a Bank of America-Merrill deal is very positive for the market,'' said Peter Kenny, a managing director at Knight Capital Group Inc., the Jersey City, New Jersey-based brokerage that handles about $1 trillion of stock transactions a quarter. ``It's a stronger balance sheet, and brings more certainty and confidence in the counterparty of trades.''

U.S. Stocks Decline as Lehman Bankruptcy Deepens Market Turmoil

Sept. 15 (Bloomberg) -- U.S. stocks tumbled, erasing more than $300 billion in market value, as Lehman Brothers Holdings Inc.'s bankruptcy fueled speculation credit-market turmoil will deepen.

Lehman plunged 95 percent after the 158-year-old investment bank's subprime mortgage losses pushed it into the biggest Chapter 11 filing. American International Group Inc. retreated 42 percent on funding concerns, while Bank of America Corp. slumped 14 percent after agreeing to buy Merrill Lynch & Co. for $50 billion. Exxon Mobil Corp. and Valero Energy Corp. sent energy shares to a 3.7 percent retreat as oil fell below $95 a barrel.

``Until you get some panic out of those equities, it's going to be hard to get any sustainable rallies,'' said Bruce McCain, the Cleveland-based chief investment strategist at Key Private Bank, which oversees about $30 billion. ``We need to get to the bottom of the credit crisis before financials are the sort of place that we want to put a lot of money.''

Stocks fell across Europe and Asia, the dollar lost the most against the yen in a decade and Treasuries surged. The Standard & Poor's 500 Index declined 27.31 points, or 2.2 percent, to 1,224.39 at 10:27 a.m. in New York. December futures on the benchmark index had fallen as much as 4.4 percent. The Dow Jones Industrial Average sank 279.03 to 11,142.96. Seven stocks slipped for each the rose on the New York Stock Exchange.

The S&P 500 has decreased more than 20 percent since an October record as worldwide bank losses from the first nationwide decline in U.S. home values since the Great Depression reached $513.6 billion. Financial shares led the retreat, losing 41 percent through last week. Plunging profit at banks and brokers drove the price-to-earnings ratio of the S&P 500 to an almost five-year high of 26 last month.

Rate-Cut Odds

The Chicago Board Options Exchange Volatility, or VIX, jumped 12 percent to 28.70 and earlier rose as high as 30,96, the highest since the Federal Reserve's rescue of Bear Stearns Cos. in March. The index has averaged 23.20 this year.

Yields on two-year Treasury notes fell below 2 percent for the first time since April, as traders in futures contracts gave 64 percent odds the Federal Reserve will cut its benchmark interest rate to 1.75 percent from 2 percent by tomorrow. The yen gained as much as 3.4 percent to 104.54 per dollar.

September VIX futures rose 2.5 percent to 27.20. December futures gained 0.6 percent to 24.56.

Lehman was forced into bankruptcy after Barclays Plc and Bank of America abandoned takeover talks yesterday and the company lost 94 percent of its market value this year.

`Down the Drain'

``It's all basically going down the drain,'' said Franz Wenzel, who helps oversee about $830 billion as deputy director for investment strategy at Axa Investment Managers in Paris. ``The rhythm of the shoes that drop has accelerated. That's what we follow with caution.''

Lehman sank $3.45 to 20 cents. JPMorgan Chase & Co., whose March takeover prevented Lehman rival Bear Stearns Cos.'s bankruptcy, fell 2.2 percent to $40.26. Citigroup Inc., the largest U.S. bank by assets, declined 5.1 percent to $17.05.

Lehman's bankruptcy is ``quite favorable,'' said Gloom, Boom & Doom Report publisher Marc Faber.

``The air will be clean within the next one month and we can get a fairly good rebound starting from the middle of October until the spring of next year,'' he said in a Bloomberg Television interview from Thailand.

AIG Tumbles

AIG lost $5.09 to $7.46. The biggest U.S. insurer was working on plans late yesterday to raise capital and sell units to forestall credit downgrades from hobbling the company. Billionaire Warren Buffett's Berkshire Hathaway Inc. ``is thought to be in talks'' with AIG about a possible investment, the Insurance Insider reported, citing unidentified sources.

Goldman Sachs Group Inc. and JPMorgan were downgraded by Merrill Lynch analysts. Goldman Sachs, which lost 5.2 percent to $146.24, was lowered to ``neutral'' on the likelihood Lehman's bankruptcy will reduce profitability for the biggest U.S. securities firm. The analysts cut their JPMorgan recommendation to ``underperform'' and predicted the lender will report a third- quarter loss.

The Financial Select Sector SPDR Fund, an exchange-traded fund linked to financial companies, had 42.6 million shares on loan on Sept. 11, or 87 percent more than a week earlier, according to Alexander Hofmann, an analyst at Data Explorers in London. Shares on loan can be an indication of short positions.

`Once in a Century'

Former Federal Reserve Chairman Alan Greenspan said the financial crisis that began with the collapse of the subprime- mortgage market last year ``is probably a once in a century event'' that will lead to the failure of more firms.

``There's no question that this is in the process of outstripping anything I've seen, and it is still not resolved,'' Greenspan said in an interview today on ABC's ``This Week with George Stephanopoulos.'' Greenspan, 82, retired from the Fed in January 2006 after serving for 18 years as chairman.

Merrill climbed 31 percent to $22.34. Bank of America, the biggest U.S. consumer bank, will pay $29 a share to buy the company as the credit crisis claimed another of America's oldest financial institutions. Bank of America shares fell $4.70 to $29.04.

Washington Mutual retreated 14 percent to $2.35. The company may cost taxpayers as much as $24 billion in the event of a U.S. government bailout, said Richard Bove, an analyst at Ladenburg Thalmann & Co. The federal government may have to provide that much in mortgage guarantees in order to attract a buyer for the Seattle-based bank, Bove said.

``You may get an assisted merger with a limit on how much the private buyer would pay for the bank with the government giving a guarantee for the rest,'' Bove said in an interview with Bloomberg Radio.

The S&P 500 Energy Index lost 3.7 percent. Exxon fell 2.5 percent to $75.54, and Valero declined 9.9 percent to $32.31.

Crude oil plunged as much as 7 percent to $94.13 a barrel in New York as refineries along the Gulf of Mexico escaped major damage from Hurricane Ike.

The NYSE will halt trading for 1 hour if the Dow tumbles more than 1,200 points before 2 p.m., or for 30 minutes if falls that much between 2 and 2:30 p.m., according to its Web site. There is no halt if the Dow slides that much after that period. The Big Board closes for the day if the Dow loses 2,400 points after 2 p.m. or 3,600 points at any time.

Lehman Files Biggest Bankruptcy Case as Suitors Balk (Update4)

Sept. 15 (Bloomberg) -- Lehman Brothers Holdings Inc., the fourth-largest U.S. investment bank, succumbed to the subprime mortgage crisis it helped create in the biggest bankruptcy filing in history.

Shares, Bonds

60 Cents

Three Hours Later

Founded in 1850 by three immigrants from Germany, Lehman has managed to avert previous potential disasters and was among the handful of U.S. financial firms that had endured for more than a century.

``This loss of liquidity created a chain reaction of adverse economic consequences,'' Lowitt said.

25,000 Employees

Exploring the Sale

The U.S. Securities and Exchange Commission said customer accounts at Lehman are protected and agency staff will remain at the brokerage firm in the coming weeks.

Units That Fail

A liquidation of the brokerage unit might be ``a big mess'' if Lehman used customer accounts to raise cash, and sale and repurchase agreements had to be unwound, Rahl said.

Take Over

Ladenburg Thalmann & Co. analyst Richard Bove wasn't as sanguine.

``We will be entering uncharted territory,'' he said. ``Forcing liquidation will set off problems in other companies and markets everywhere.''

Rival Banks

In the U.K., the Financial Services Authority asked banks to disclose their exposure to Lehman, spokeswoman Teresa LaThangue said in a statement today.

Any sale of Lehman's investment management units is subject to court approval and creditor scrutiny under bankruptcy rules, according to Tatelbaum.

The case is In re Lehman Brothers Holdings Inc., 08-13555, U.S. Bankruptcy Court, Southern District of New York (Manhattan).

Lehman bankruptcy shakes world financial system

A man carrying a box leaves the Lehman Brothers European Headquarters building in Canary Wharf in London
©AFP - Ben Stansall

NEW YORK (AFP) - Lehman Brothers declared bankruptcy Monday and Wall Street rival Merrill Lynch was taken over in a new financial earthquake driving a global stocks plunge and central bank intervention.

The US Federal Reserve, European Central Bank and Bank of England injected tens of billions of dollars into money markets after the fall of the finance titans under the weight of massive bad loans.

Lehman Brothers file for bankruptcy on Monday after a frantic weekend of negotiations failed to arrange a rescue.

In the fallout, Bank of America took over Merrill Lynch in a 50-billion-dollar deal, insurance giant AIG was reported to have sought a massive emergency loan to head off its own crisis and a group of banks set up a 70 billion dollars global emergency fund.

"You've probably seen more in one day of financial history than we've seen since the great crash of 1929," Macquarie Private Wealth associate director Marcus Droga said.

"I'm not suggesting the US market will crash tonight, but in terms of landmark events, it's an historic day," Droga told Dow Jones Newswires.

Despite reassurance from central banks, major European and Asian stock markets plunged by five percent, the dollar fell and oil went below 93 dollars a barrel over fears for the international economy.

The Federal Reserve eased conditions for collateral in return for the provision of funds to banks and said it was working "to identify potential market vulnerabilities."

The European Central Bank said it injected 30 billion euros (43 billion dollars) into money markets to keep them going after the Lehman collapse.

The Bank of England injected 5.0 billion pounds (6.3 billion euros/9.0 billion dollars) into short-term money markets. Switzerland's central bank also reportedly offered a money injection.

The European Commission expressed confidence in central banks and other agencies to contain contagion from the crisis.

"It seems clear that a category five storm is making landfall in the US financial system and a lot of very messy stuff is hitting the fan," Michael Panzer, author of the book "Financial Armageddon," said on his blog.

Lehman filed for bankruptcy protection in New York. The bank said in a statement it was acting "in order to protect its assets and maximize value."

A consortium of banking firms, including Bank of America, have unveiled a US$70 billion credit package.
©AFP/Getty Images/File - Stephen Chernin

"Customers of Lehman Brothers, including customers of its wholly-owned subsidiary, Neuberger Berman Holdings LLC, may continue to trade or take other actions with respect to their accounts," the statement said.

The bank lost an estimated 3.9 billion dollars (2.7 billion euros) in its fiscal third quarter amid fresh writedowns on mortgage assets.

Last-ditch efforts to find a buyer collapsed Sunday. A London source at British bank Barclays said it walked away from negotiations because of concerns it would have to guarantee the 158-year-old US firm's trading commitments.

Bank of America said it was buying Merrill Lynch for 50 billion dollars in a transaction that creates the world's largest financial services company.

The acquisition gives Bank of America the largest brokerage in the world with more than 20,000 advisers and 2.5 trillion dollars in client assets.

Analysts expected Lehman's bankruptcy to hit a range of companies dealing with the Wall Street giant and could worsen the global credit crunch.

Unicredit economist Marco Annunziata in Frankfurt said: "The coming days and weeks will be truly crucial to the global economic outlook.

"The US Treasury has decided it was time for shock therapy, and taken an extremely gutsy gamble by letting Lehman fail."

US Treasury Secretary Henry Paulson vowed steps to maintain market stability however.

"I am committed to working with regulators and policymakers - including Congress - to take necessary and appropriate steps to maintain the stability and orderliness of our financial markets," Paulson said in a statement.

"And I will engage with regulators and policymakers around the world to that end," he said. "I am confident in the resilience of our capital markets, and in the commitment of US regulators and market participants to work together through this difficult period."

The German finance ministry said links between German banks and Lehman Brothers were "manageable".

Japan's financial watchdog ordered Lehman Brothers' Japan unit to retain certain assets within Japan, it said in a statement.

A consortium of 10 global commercial and investment banks announced plans to provide 70 billion dollars to help offset a credit squeeze.

Bank of America, Barclays, Citibank, Credit Suisse, Deutsche Bank, Goldman Sachs, JPMorgan Chase, Merrill Lynch, Morgan Stanley, and UBS, said in a joint statement they "initiated a series of actions to help enhance liquidity and mitigate the unprecedented volatility and other challenges affecting global equity and debt markets."

They also said they would work together "to help facilitate an orderly resolution" of the derivatives exposures between Lehman Brothers and its counterparties.

"These actions reflect the extraordinary market environment," the statement said.

Meanwhile, The New York Times reported that AIG was seeking a 40 billion-dollar bridge loan from the Federal Reserve in the face of a possible downgrade from credit ratings agencies that could spell its doom.

New Evidence on Taxes and Income

By ARTHUR B. LAFFER and STEPHEN MOORE

The new Census Bureau data on income and poverty reveal that many of the economic trends in this country are a lot more favorable than America's detractors seems to think. In 2007, overall real median family income increased to $50,233, up $600 from 2006. The real median income for intact families -- mother and father in the home -- rose to $78,000, an all-time high.

Although incomes fell sharply in the U.S. after the dot-com bubble burst in 2000 (and still haven't fully recovered), these latest statistics reflect a 25-year trend of upward economic mobility. More important, Barack Obama is wrong when he states on his campaign Web site that the economic policies started by Ronald Reagan have rewarded "wealth not work." Based on this false claim -- that the rich have benefited by economic growth while others have not -- he intends to raise tax rates on high-income individuals.

To be sure, there has been a massive amount of wealth created in America over the last 25 years. But tax rates were cut dramatically across the income spectrum, for rich and poor alike. The results?

When all sources of income are included -- wages, salaries, realized capital gains, dividends, business income and government benefits -- and taxes paid are deducted, households in the lowest income quintile saw a roughly 25% increase in their living standards from 1983 to 2005. (See chart nearby; the data is from the Congressional Budget Office's "Comprehensive Household Income.") This fact alone refutes the notion that the poor are getting poorer. They are not.

Looking at the last two business cycles (first year of recovery to first year of recovery), this low-income group experienced a 10% rise in their inflation-adjusted after-tax incomes from 1983 to 1992 and then another 11% rise from 1992 to 2002). Roughly speaking, the Reagan and Clinton presidencies were equally good for them. Income gains over the last 30 years have been systematically understated due to several factors. These include:

- Fall in people per household. The gains in household income undercount the actual gains per person, because the average number of people living in low-income households has been shrinking. On a per capita basis, the real income gain for low-income households was 44% from 1983 to 2005, about 22% from 1983 to 1992 and about 18% from 1992 to 2002. These are excellent numbers by any measure.

- Earned income tax credit effect. The Earned Income Tax Credit (EITC) is a government payment to low income people who work. It was instituted on a small scale in 1975. In 1986, 1990, 1993 and 2001, Congress expanded the program.

Over time the EITC has multiplied the number of poor households that fill out tax forms each year and are thus counted in government income statistics. That's because to be eligible to receive the refundable EITC, a tax return must be filed.

Official tax return data show that in 1983, 19% of returns had zero tax liability; that percentage has climbed steadily, reaching 33% in 2005. (The Tax Policy Center estimates that in 2008 nearly 40% of filers will have no income tax liability.) Thus, we are now statistically counting more poorer families today than we used to. This is a major reason that median and poor household income gains appear to be a lot smaller than they have been in reality.

- Income mobility. In the U.S., people who had low incomes in 1983 didn't necessarily have incomes as low a decade later. People in this country have long moved up over time, and this income mobility continues to be true. While some people do remain in the lowest income group, they are the exception.

One way to quantify income mobility is to examine how many people remain in the same tax bracket over time. We compared the returns of tax filers in the lowest tax rate bracket (zero) in 1987 with their returns in 1996. Only one third of the tax filers were still in the zero tax bracket, but 25% were now in the 10% bracket, 32% had moved up to the 15% bracket and 9% were in the 25%, 28%, 33% or 35% brackets. And that was following them for a decade, not a generation.

From 1996 to 2005, we have the income mobility data for income quintiles. Of those filers who were in the lowest 20% in 1996 and who also filed in 2005, 42.4% remained in the bottom 20%, 28.6% were in the next highest quintile, 13.9% were in the middle quintile, 9.9% were in the second highest quintile, and 5.3% were in the highest quintile.

What is also striking about the data is that the poor today are, in general, not the same people who were poor even a few years ago. For example, the new Census data find that only 3% of Americans are "chronically" poor, which the Census Bureau defines as being in poverty for three years or more. Many of the people in the bottom quintile of income earners in any one year are new entrants to the labor force or those who are leaving the labor force. Obviously, there is also a significant core of truly poor people in this group, but that core is drastically less than 100%.

The data also show downward mobility among the highest income earners. The top 1% in 1996 saw an average decline in their real, after-tax incomes by 52% in the next 10 years.

America is still an opportunity society where talent and hard work can (almost always) overcome one's position at birth or at any point in time. Perhaps the best piece of news in this regard is the reduction in gaps between earnings of men and women, and between blacks and whites over the last 25 years.

Census Bureau data of real income gains from 1980 to 2005 show the rise in incomes based on gender and race. White males have had the smallest gains in income (up 9%), while black females have had by far the largest increase in income (up 79%). White females were up 74% and black males were up 34%. Income gaps within groups are rising, but the gaps among groups are declining. People are being rewarded in today's economy based on what they know and what they can do, not on the basis of who their parents are or the color of their skin.

There are of course Americans who live in poverty, as there are very affluent Americans with $25 million yachts and $10 million homes who hold ostentatious $200,000 birthday parties. But the evidence is plain that all groups across the income distribution have made solid gains during the last generation.

Taking from the rich through much higher tax rates in order to help the poor and middle class makes no sense intellectually and has seldom worked in practice. Reducing rates, on the other hand, does increase the share of taxes paid by the highest income-earning group. For example, in 1981, when the highest tax rate on the rich was 70% and the top capital gains tax rate was close to 45%, the richest 1% of Americans paid 17% of total income taxes. In 2005, with a top income tax rate of 35% and capital gains at 15%, the richest 1% of Americans paid 39%.

We suspect that Mr. Obama will discover that when you put "tax fairness" ahead of economic progress, you produce neither.

Mr. Laffer is president of Laffer Associates. Mr. Moore is senior economics writer for The Wall Street Journal editorial board.

CUBAN MISSILE CRISIS REDUX

THE LIBERTARIAN

Monday, September 15, 2008

Wake-Up Call: Lehman's Mortgage Marks

Lehman bankruptcy shakes world financial system

New Evidence on Taxes and Income

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