Fed has limited options if talks on Lehman bailout fail

Washington: If intense weekend talks fail to turn up a buyer for investment bank Lehman Brothers, the Federal Reserve's options for calming markets will be down to words, interest rates, or appeals to Congress to extend its powers.

One option is to do nothing at all and some analysts think that may be the best one, even if it proves to be the straw that breaks Lehman's burdened back.

"A reasonable argument can be made that a failure, while painful, would not cause systemic damage," said economist Mark Zandi of Economy.com in West Chester, Pennsylvania. "I think the Fed really can't do much in this case and probably shouldn't."

Since it orchestrated the sale of Bear Stearns to JPMorgan, complete with a $29 billion promise to absorb losses, the US central bank has faced criticism from among its own members and outside that it may have overstepped its bounds.

Letting Lehman fail could help the Fed restore some credibility among those who say its willingness to bail out Wall Street time and again has set a dangerous precedent, one that may be encouraging would-be Lehman buyers to wait and see whether more government cash is coming.

"It would reflect badly on the Fed if they have to bail out Lehman," said Anil Kashyap, an economics professor at the University of Chicago's Graduate School of Business.

Impact

"It's been six months since Bear Stearns. Everybody knew that Lehman was shaky. They've had six months to think about this and if their best answer is to throw more taxpayer money at them, there is going to be a lot of criticism."

US Treasury Secretary Henry Paulson let it be known on Friday that he "adamantly" opposed using taxpayer funds to help rescue Lehman and the Fed similarly signalled it didn't want to do so.

That has persuaded many analysts that Lehman may be the test-case, where officials decide a rescue stands or falls on its own merits and not rely upon guarantees of taxpayer help.

"The Fed will seriously consider letting Lehman find a buyer or file for bankruptcy protection," said Raghuram Rajan, former chief economist at the International Monetary Fund who teaches at University of Chicago's business school. "The Fed and the Treasury want to take a stand against the notion they stand behind all large financial firms. Lehman may be where they make the stand."

Since the credit crisis mushroomed in August 2007, the Fed has poured cash into frozen financial markets, created lending facilities to tide over firms in need of emergency funding, and lowered its federal funds rate by 3.25 percentage points.

None of that saved Lehman from its current predicament. The few remaining measures that are available to the Fed may not be very effective in settling markets either if Lehman cannot find a buyer.