Jeremy Warner's Outlook: Balance-sheet size slashed at Lehman's

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The Independent Online

As if on cue, along comes Lehman Brothers with another $6bn worth of capital raising to shore up reserves damaged by news of the first quarterly loss since the investment bank went public in 1994. Until a few months back, Lehman's appeared to be sailing through the credit crunch comparatively unscathed, but in recent weeks there has been intense speculation, much pooh-poohed by the company, that the bank might be forced to follow its smaller rival, Bear Stearns, into intensive care.

As it turns out, the speculation is only partially wrong, with loss-making hedging and proprietary trading positions adding to the sharp increase in mark-to-market adjustments. Richard Fuld, the chairman, described the resulting $2.8bn loss as "disappointing". He can say that again. Is there no end in sight to all this banking gloom?

Quite a lot of City bankers continue to delude themselves that the present crisis is only an aberration, or bad dream, from which they will eventually awake and resume normal money-making service. This is not an entirely illogical point of view. Markets always eventually recover, and, with each passing cycle, investment banks have tended to bounce back even stronger than before. Is this one going to be any different?

Unfortunately for the bankers, there is good reason for believing it will. Post the Bear Stearns meltdown, the Federal Reserve in a panic move to shore up Wall Street made the discount window available to investment banks on the same terms as commercial ones.

What this means is that inter-dealer brokers (the investment banks) can now borrow from the Fed to satisfy their funding needs in the same way as commercial banks. If this arrangement continues, then investment banks will have to be made subject to the same degree of oversight and capital requirements as others. The freedom to run amok will be removed.

Such is the political furore surrounding the central role investment banks played in the credit crunch that this may happen regardless of whether the discount window remains open to them.

Lehman's capital raising is not immediately linked with this debate. The purpose was more to draw a line under the chatter in the markets around the group's liquidity and capital position. Even so, by raising all that extra capital, Lehman's is repositioning itself as a less risky and therefore considerably more constrained organisation. Over the past quarter, around $130bn of assets have been sold, reducing net leverage down to below 10 times.

The hope at Lehman's is that the reduction in leverage – a process going on across the banking industry right now – will be compensated for by higher margins on what business remains. We'll see, yet whatever the outcome, it may be that the glory days of unrestrained investment banking are over for good. This time around, they pushed the envelope that little bit too far, and, in so doing, they have guaranteed a vicious regulatory backlash. The tide won't be flowing back again any time soon.

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