Wall Street crisis of confidence stoked by Lehman

Lehman Brothers may find itself on more secure ground, but its poor showing in the second quarter has undermined confidence in banks and brokerages and left investors wondering what to believe about the state of the credit crisis.

Lehman Chief Executive Richard Fuld, who just a few months ago declared "the worst is behind us," stoked fears that Wall Street's top bankers might not have a firm grasp of how deep their balance sheets are mired in risk. Global financial institutions have already taken nearly $300 billion in write-downs since last summer, and the fear is that they may not be done.

"It has reached a point where people can only focus on loan losses, inflation, and increases in interest rates, all of which are negative for financial companies," said Richard X. Bove, an analyst with Ladenburg Thalmann & Co. "Investors don't want to own anything associated with the industry. They simply don't believe these banks have the ability to deal with the current environment."

The market, still stunned by the near collapse of Bear Stearns Cos. in March, was swift to react when Lehman Brothers Holdings Inc. reported a second-quarter loss of almost $3 billion, far worse than the most bearish predictions.

Lehman shares have plunged nearly 20 percent in the past two sessions. Analysts lowered already pessimistic ratings and kept a wary eye on its rivals, most of whom have felt similar pain since last summer.

In an effort to offset the losses and give it fresh ammunition for risk-taking, Lehman also raised capital by selling $6 billion of common and preferred stock, a move that analysts said will dilute existing shares by about 30 percent. Lehman raised $4 billion in April on better terms, raising questions about why it would not have sought a larger investment then.

"The larger capital raise at meaningfully lower prices indicates that the company did not have, and potentially still does not have, a complete grasp of its exposures," said Douglas Sipkin, an analyst with Wachovia Capital Markets.

On the other hand, most analysts, like Bove, point out that "Lehman is definitely not a Bear Stearns." Lehman has more than twice as much cash as Bear Stearns did before the Federal Reserve engineered a sale of the company to JPMorgan Chase & Co. in March. And, Lehman's most recent fundraising has pushed its capital position to nearly triple what Bear Stearns had.

Yet Lehman is still the smallest of Wall Street's publicly traded investment banks, and analysts have said its balance sheet is the one that more closely resembles Bear Stearns - which had to be saved from collapse by a government-orchestrated sale. That's why it has been the target of rumors in the past few weeks about financial troubles, while rivals' Goldman Sachs Group Inc., Morgan Stanley and Merrill Lynch & Co. largely escaped such speculation.

Wall Street might not have long to wait before it gets some answers. The other two investment banks whose second quarters stretch through the three months ended May 31 are set to report earnings. Goldman Sachs posts results on Tuesday, and Morgan Stanley is expected to that week as well.

"What their executives have to say, especially with Bear Stearns and Lehman Brothers in mind, is going to be very carefully followed," said David Trone, an analyst with Fox-Pitt Cochran.

One comfort to investors is that investment banks, unlike Bear Stearns, now have the ability to borrow from the Fed if it faced a cash shortage. Citigroup Inc. CEO Vikram Pandit said Tuesday during a speech in London that the market is more comfortable that brokerages can now borrow from the Fed's discount window, a move that was previously restricted to retail banks.

Pandit said that "regardless of whether that window is officially opened or closed, the market now assumes that it will be opened if necessary on an ad hoc basis."