Lehman Brothers in Bankruptcy Protection

A year ago, there was an unobtrusive item in the news about the Bear Sterns mortgage hedge fund crisis. I wrote about that when it first happened, because although it didn't make the major news at the time, it was something that conspiracy theorists quickly jumped upon as the "straw that would break the camel's back" and finally expose the underlying weaknesses of the US financial system. Little did I know just how right they were.

Last week, the US government intervened to prop up Freddie Mac and Fannie Mae, the two mortgage giants who hold almost half of the mortgages in the United States. Quite simply, the government could not allow them to fail.

A few hours ago, Lehman Brothers filed for Bankruptcy Protection in New York. The global financial implications of this are staggering. Lehman is a giant - a firm that is more than 150 years old, and an integral part of Wall Street. The company recently listed its assets as being worth almost $700 billion dollars. Yes, that's billion with a Big B, not million. Compare that to the assets of something like MicroSoft - about $72 billion. Yes, they are different types of companies and assets, but you get the picture. Lehman is/was Big League.

Then, shortly after that bombshell, another press release just notified the world that the Bank of America, after failing to come to a deal to rescue Lehman (as many had hoped), is going to buy Merrill Lynch (another Goliath) in a deal valued at $50 billion. There is little doubt that today, September 15th, is going to be one of the most gut-wrenching days in history for global financiers.

On a positive note, the Federal Reserve is taking extraordinary measures to try to calm markets. They have been wary of intervening too directly, after they got involved in the Bear Sterns mess and were highly criticized. But they are taking behind-the-scenes steps to steady the markets, through changes in debt collateralization rules. But even so, I doubt that they can have as much of an impact as they would like. Today is a holiday in Asia, so the Asian markets are closed, but Europe opens shortly, and when Wall Street opens, some financial analysts are predicting a bloodbath. A lot of people might shrug and say, "Who cares?" but the bottom line is that the fallout from this weekend's events will send ripples through the global economy for months and possibly years to come.

And don't think that this is the end of it. More American banks are going to fail in the next year. The economy will get worse. With the run-up to the American presidential election in November, chances are that the economy will enjoy a temporary two-month "grace period" where the shocks aren't as bad as they could have been, but 2009 looks like it could be a very ugly year. We'll see large jumps in businesses scaling back operations or folding, large jumps in unemployment, and rapidly rising food and gas prices at the same time to deal a double-blow to everyone. The worsening American debt crisis is reaching a global tipping point. It's not just mortgages and energy, it's the entire financial system that is not-so-slowly collapsing. As I've said before, America is an empire in steep decline. As Ernest Hemingway said in 1932, ""The first panacea for a mismanaged nation is inflation of the currency; the second is war. Both bring a temporary prosperity; both bring a permanent ruin. But both are the refuge of political and economic opportunists."

Sorry to be the bearer of bad news, but brace yourselves ...

ETA, 15 hours later: The Dow Jones dropped over 500 points today (biggest point drop since 9/11), the TSX dropped over 500 points today, and other markets around the world are also reeling. In the US, my bet is that Washington Mutual will be the next giant to fall.