When do feds hold em or fold em?

By DAVID MOON, Moon Capital Management, LLC
September 21, 2008

When I was a child growing up in Alabama, there was only one activity in the fall that rivaled football: cotton-picking season.

When the giant pickers would return from the fields to deposit their bounty, we would climb the sides of the wagons and jump into the mounds of the soft bolls. It was like a low-tech version of those huge blow-up bouncy things parents rent for their kids' birthday parties today.

Little did we realize that we were taking part in Alabama's role in the history of Wall Street ' a lineage that appears to have ended this past week.

In the mid-1800s, three German brothers moved to Montgomery, Alabama where, in 1844, they started a little cotton-brokerage business. In an attempt to hedge their bets that Alabama might not become the financial capital of the world, in 1858 they opened a second office in New York City.

A century and a half later, their little brokerage firm, Lehman Brothers, has filed for bankruptcy.

Trying to avoid the same fate, Merrill Lynch agreed to be acquired by the former North Carolina National Bank, currently known as Bank of America.

Although the feds passed on Lehman Brothers, they apparently felt frisky enough after wiping out the shareholders of Freddie Mac and Fannie Mae to try the same trick on insurance giant AIG.

How does the government decide which companies get saved and which are left to die?

Who gets to have their bad assets backstopped by taxpayers in a negotiated purchase?

When do the Feds wash their hands and walk away?

Treasury Secretary Henry Paulson has seemingly declared himself god and guru of the financial markets, with the responsibility for deciding when to use taxpayer money and government regulators to wipe out some shareholders to benefit others.

Despite apparently long discussions among the remaining large banks with strong balance sheets and the federal government, no one was willing to buy Lehman at a price that would save the stockholders and satisfy the management.

When a similar circumstance occurred at Bear Stearns six months ago, Paulson forced a sale of Bear to rival JP Morgan Chase at the bargain-basement price of $2 a share. The government also agreed to reimburse JP Morgan if certain of the Bear Stearns assets turned out to be worthless.

One day earlier, Bear shares had begun trading at $57. Predictably, the stockholders complained. The government relented and came up with a new price: $10 a share.

How in the world had the feds managed to miss the value of the remaining Bear Stearns assets by a factor of five? Had they just plucked $2 out of the air?

Even at $10 a share, the government allowed JP Morgan to buy the company for essentially nothing. The brand new Bear Stearns office building was, by itself, worth almost that amount.

Later the government decided to fully back the Freddie Mac and Fannie Mae bondholders, but it used recently and specifically appropriated Congressional authority to nationalize the equity interests.

Venezuelan strongman Hugo Chavez would have been proud.

In the case of Lehman, the Feds decided to let the market and existing legal system handle the situation. The bondholders will get that to which they are legally entitled. Same for the stockholders.

Now there's an interesting concept.

David Moon is president of Moon Capital Management, a Knoxville-based investment management firm. This article originally appeared in the News Sentinel (Knoxville, TN).

Add me to your commentary distribution list.

MCM website