Lehman stock tumble raises government rescue specter

By Karey Wutkowski - Analysis

WASHINGTON (Reuters) - A 45 percent slide in the shares of Lehman Brothers Holdings Inc LEH.N, on concern it was struggling to raise desperately needed capital, stirred speculation that a U.S. government-sponsored rescue was increasingly likely.

The forced-sale of the Bear Stearns brokerage in March and the pre-emptive seizure Sunday of mortgage finance giants Fannie Mae (FNM.N) and Freddie Mac (FRE.N) has set a template that U.S. financial authorities might find hard to avoid.

Lehman, left as the smallest major U.S. independent investment bank after Bear Stearns' takeover by JPMorgan Chase & Co (JPM.N), has a prominent role in many of the same markets that Bear Stearns had: interest rate swaps, credit default swaps and equity derivatives.

While the government would be very reluctant to intervene yet again, especially if it required taxpayers' money, several experts say there may be no alternative to avoid a systemic financial crisis.

Treasury Secretary Henry Paulson and Federal Reserve Chairman Ben Bernanke may be forced to act to preserve stability in the rest of the financial system.

"There is a risk that you could get the equivalent of a financial black hole and more people getting sucked in," said Robert Litan, a senior fellow in the economic studies program at the Brookings Institution in Washington.

Litan doubted Paulson or Bernanke wanted to go down in history books as an example of what not to do.

The tipping point of government intervention comes down to exactly how much counterparty risk exists with Lehman.

Several financial experts said Paulson, a former Goldman Sachs chairman, was likely calling friends on Wall Street asking what people know, who is exposed and how much loss they are willing to take.

"Clearly, as was the case with Bear Stearns, there's concern that there would be outstanding trades that would be problematic to unwind should a worse case scenario develop," said John Canavan, analyst at Stone & McCarthy Research Associates.

COUNTERPARTY RISK

The Fed already has a borrowing facility open to Lehman, a measure offered to investment banks after the Bear Stearns failure. But it is meant to ensure short-term liquidity and not prop up an insolvent firm.

Some experts said if the counterparty risk is deemed to be small enough, regulators could move away from the precedent they set with Bear Stearns and send a message that the investments are not too big to fail.

"It's a closer call," said New York University economics professor Lawrence White, who formerly served on the Federal Home Loan Bank Board. "I don't think there would be a big effect in the stock market... If (the counterparty risk is) relatively small, the Fed turns its back and says tough luck."

Concerns about the survival of Lehman have been circulating for months, causing its stock price to drop almost 90 percent this year. Lehman has complained that unfounded rumormongering by traders who profit from share price declines are behind the dramatic decline.