Tuesday, September 09, 2008

Stocks Fall on Fears that U.S. Government May Not Continue Bailouts

New York Times - Wall Street's Fears on Lehman Bros. Batter Market
Telegraph (UK) - Lehman Brothers' Shares Plunge as Concern on Wall Street Grows
Bloomberg - U.S. Stocks Tumble as Lehman Brothers Rattles Banking Shares

The investment firm Lehman Brothers lost half its stock value in a day as investors' fears grew that the U.S. government would not bail out the company if it failed. The Dow Jones Industrial Average lost nearly 300 points because of the increased pessimism about Lehman Brothers. The downswing erased most of the gains from a day earlier, where news of the government bailout plan for Freddie Mac and Fannie Mae had caused stocks to gain the most in a month.

Lehman Brothers is one of the U.S.'s oldest and largest investment banks. The company has been losing value for over a year, and has lost 90 percent of its stock value since February 2007. Investors fear that after the U.S. government-initiated buyout of Bear Stearns earlier this summer and the recent government takeover of mortgage giants Fannie Mae and Freddie Mac, the government might decline to intervene in future corporate failings.

Lehman's price also dropped over fears of its inability to raise capital, with a Korean bank recently pulling out of negotiations with Lehman Brothers over a capital infusion. Standard & Poor's also downgraded Lehman Brothers to a negative rating.

The U.S. government has demonstrated its willingness to intervene in the U.S. markets in order to prevent corporate failure and further financial turmoil. However, because of the recent government action with Fannie and Freddie, investors are speculating that the government already has a high taxpayer burden and would not intervene to save more U.S. companies.

(1) How realistic is it for the U.S. government to continue to orchestrate bailouts and purchases of failing companies?
(2) How much would the failure of a single U.S. investment firm affect the entire financial system?

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