Lehman's fall and China's markets

Shannon Roxborough | Sep 18, 2008 6:20am EDT | Comment

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Lehman Brothers Holdings Inc.'s (NYSE:LEH) announcement early Monday of plans to file for Chapter 11 bankruptcy capped off a roller-coaster weekend on Wall Street that saw already shaken U.S. markets rattle further due to woes at other major financial firms and the federal government takeover of beleaguered mortgage financiers Fannie Mae and Freddie Mac.

Strangled by the subprime crisis and plunging real-estate values, the storied investment banking titan collapsed under the weight of $60 billion in bad debts on its property holdings. The fall of the venerable 158-year-old Wall Street institution marks the beginning of the largest corporate bankruptcy case in U.S. history, based on total assets before the filing ($639 billion as of May 31).

Much like the Enron bankruptcy in 2001, Lehman Brother's crash-and-burn not only permanently reshapes the American financial landscape, it is already causing a ripple effect that is sending shudders through global markets. In wake of the news, the Dow Jones Industrial Average tumbled over 500 points, Chinese share prices closed sharply lower, Hong Kong stocks nosedived to their lowest level since Oct. 27, 2006, and the Shanghai composite dipped below its psychologically important 2,000 level — amid fears that the bankruptcy would stoke further troubles in the United States financial sector.

Asian governments closed the doors of Lehman’s operations from Tokyo to Seoul in an effort to reassure investors that effects on regional companies with exposure to the bank would be limited. The Bank of Japan pumped 2.5 trillion yen, or $24 billion, into Japanese money markets, Taiwan's central bank infused the foreign-currency interbank market with $3.59 billion, and the chief of the Hong Kong Monetary Authority told the local media of plans to make a similar move to help give the island's banking system with much-needed cash.

The Industrial and Commercial Bank of China (ICBC) reported that its mainland and overseas branches hold $151.8 million worth of bonds related to Lehman, while Macao-based Seng Heng Bank Limited, an ICBC subsidiary, holds $12.81 million in bonds tied to a Lehman trust. Both banks said that while the bankruptcy won't have a significant impact on their businesses, they are evaluating the risks of the bond holdings and will continue to monitor global market changes.

The People's Bank of China announced the trimming of the benchmark one-year lending rate by 27 basis points to 7.20%, the first such cut in China's key interest rate since February 2002. The central bank also slashed the commercial bank reserve requirement by 100 basis points to 16.5% on Sept. 25. The move will hurt Chinese banks in the near term, but will ultimately stimulate the economy and help ease the effects of the global credit crunch. The Bank of China Ltd., the country’s second-largest lender, is carefully scrutinizing its holdings of unsecured Lehman Brother's credit, a figure topping $50 million.

Bankers in Shanghai and Hong Kong are fearful that the ongoing meltdown of American financial markets will continue to wreck havoc on Chinese banks. Analysts agree. The Swiss bank Credit Suisse called People's Bank of China's decision to cut lending rates a "clear negative" for the sector, warning it will cut margins and could result in zero growth for 2009.

Sam Chen, an analyst with JP Morgan, cut his rating on Chinese banking stocks to "neutral" citing reduced earnings visibility after the rate cuts. While he noted China's banks are well positioned to weather the global economic downturn, he warned of potential fallout from the Lehman Brothers tumble: "Apart from the risk of panic-selling, falling bond prices could lead to further impairment on U.S. securities exposures of Chinese banks."