Just a week after the government seizure of mortgage finance giants Fannie Mae and Freddie Mac, the financial system dropped another bomb today when 158-year-old investment bank Lehman Brothers undertook the largest bankruptcy filing in history, according to Bloomberg. The revelation came the same day the credit crisis, which first struck last summer and triggered Lehman's downfall, precipitated a hasty agreement to sell financial titan Merrill Lynch to Bank of America. While the moves rattled markets and stand to shake up the financial ecosystem, here's a look at what they'll mean for consumers.
Stock investors. The Lehman bankruptcy sent stocks down hard this morning as fears that the financial sector's problems would spread hit already nervous investors facing a weak economy and tight credit. Stocks plummeted in early trading with the Dow off more than 340 points or 2.8 percent in early trade to its lowest level since July 15. Stocks in the S&P 500 slumped 2.6 percent with declines across the index being led by energy shares. European stocks led the drop overnight, and Asian shares are expected to be weak when markets reopen after a holiday today.
It could be worse, however. Circuit breakers that stop markets from trading during huge drops haven't been triggered (that would be a drop of 1,200 points on the Dow). Investors now await the Federal Reserve's decision on whether it will issue an emergency rate cut tomorrow and continue to watch the fate of American International Group as it struggles to raise capital.
Mortgage rates. While unnerving to investors, the developments could translate into lower mortgage rates for consumers. As in most financial panics, the news is precipitating a flow of investor cash out of riskier investments, like stocks, into ultrasafe U.S. government debt, says Mike Larson, a real estate analyst at Weiss Research. That will push yields on 10-year treasuries lower. And since 30-year, fixed mortgage rates tend to track such treasury yields, interest rates on home loans should decline for borrowers with good credit, Larson says. "These bouts of panic that we have in the market sometimes, frankly, are actually good if you are looking for a lower mortgage rate," Larson says.
However, Larson notes that these panic-driven declines in mortgage rates don't tend to last long, so if "you have been floating your interest rate, this is the time to get on the phone and try to lock it in." The average rate on a 30-year, fixed mortgage stood at 5.93 percent last week, according to Freddie Mac. Larson says that could fall to 5.75 percent this week.
Brokerage clients. In the event of a brokerage failure, most investors will be able to recover their funds. That's because the Securities Investor Protection Corp., a nonprofit company that was chartered by Congress, backstops investors from losses linked to brokerage failures. The SIPC protects investment accounts—stocks and bonds—up to $500,000, including a maximum of $100,000 in cash.
Clients of Lehman Brothers. Stephen Harbeck, president of the SIPC, says that Lehman's brokerage clients are still able to access their accounts. "The SIPC protects customers in the event that there are missing assets in their brokerage accounts, and the SEC customer protection rules make it clear that brokerage firms must segregate brokerage firm assets from the firm's assets," Harbeck says. "That was properly done here."
Clients of Merrill Lynch. The firm's agreement to be acquired by Bank of America should have no practical effect on Merrill's brokerage clients, as accounts will simply be transferred from one company to another, says Ed Yardeni, president of Yardeni Research. "Operationally, it is as if nothing changed," he says.