Lehman Shock Waves Hit European Bourses

Buying Lehman Brothers was a risk Barclays ultimately refused to take, adding to investor fears about the state of Europe's finance industry

by Stanley Reed

When U.S. Treasury Secretary Henry Paulson called Barclays President Bob Diamond on Sept. 12 and asked him to consider buying Lehman Brothers, both the U.S. government and Barclays (BARC.L) knew that the London-based bank could not consummate the deal over the weekend without U.S. government help.

Nevertheless, with much of the detail worked out, the deal fell apart on Sept. 14 because the American government refused to backstop Lehman's hundreds of billions in outstanding trades, according to a source close to Barclays. The London bank could not take on that risk without obtaining shareholder approval, Barclays says. As a result, Lehman (LEH) is going into bankruptcy.

That new tough-guy approach is not going down well in European markets. By midday on Sept. 15, the FTSE 100 index of the London market was down 5.08%. Paris' CAC 40 plummeted 5.57%, while Germany's DAX index took a 4.31% hit. Europe bore the brunt of the shock wave because most major Asian bourses were closed for a holiday.

In an indication of the fears sweeping the financial industry, $43 billion in liquidity auctioned off on Sept. 15 by the European Central Bank was three times oversubscribed. The Bank of England pumped in another $9 billion, and Switzerland's central bank added still more. The industry's powerful thirst for liquidity could lead to still more infusions from central banks, analysts say. "It doesn't look good. We are quite worried," says Jacques Cailloux, an economist at Royal Bank of Scotland (RBS.L).

Bank Stocks Battered

Bank and other financial stocks weigh heavily in the European indexes, and these shares are taking a severe pounding as credit jitters rule the day. Barclays didn't get much of a reward for its caution. Its stock was down 14.91%. Royal Bank of Scotland, which outbid Barclays for ABN Amro last year, also took a beating and was down 15.54%.

Even worse was HBOS (HBOS.L), the largest British mortgage lender, which fell nearly 30%. European banks also encountered extreme investor disfavor. Deutsche Bank (DBKGN.F), Germany's largest, was down 8.9%, while France's Société Générale (SOGN.PA) fell 13.35%. Insurers also took a pounding, with German giant Allianz (ALVG.F) down 7.72%.

The broad punishment meted out to bank stocks is not surprising, given the shock of one of the four largest U.S. investment banks folding and another venerable American institution, Merrill Lynch (MER), seeking refuge in the acquisitive arms of Bank of America (BAC) in a $50 billion deal. Over time, though, the market is likely to distinguish between different types of risk. Already HSBC (HSBA.L), which is managed more conservatively than most other banks and was early in recognizing and dealing with its U.S. real estate loan problems, appeared relatively unscathed with just a 3.85% decline on Sept. 15.