The Wall Street Meltdown and the Satellite Business

As this column is going to press, events unprecedented since the Great Depression — and perhaps in history — have rocked Wall Street and financial markets worldwide.

In a single September weekend, two of the four remaining independent American investment banks — Merrill Lynch and Lehman Brothers — failed. (These followed the spring demise of Bear Stearns). Merrill was swallowed up by Bank of America in an emergency purchase, while Lehman filed for bankruptcy and is heading to probable liquidation. The largest insurance group, AIG, required an $85 billion bailout loan by the U.S. government, which deemed it, unlike Lehman, "too big to fail" without causing a financial meltdown. The U.S. government also took over Fannie Mae and Freddie Mac, and Congress was debating a $700 billion bailout of the financial services industry.

All these institutions were victims of the subprime mortgage crisis and the creation of complex derivative securities — ones based on the value of other "underlying" securities which are hard to value, hard to assess risk against and hard to understand at all. The credit crisis will not end quickly.

Obviously, debt finance transactions will be extraordinarily difficult, including mergers and acquisitions financed with debt, a mainstay of sector activity, especially in the last five years. The final approval of the Sirius-XM merger and the acquisition of Intelsat by BC Partners are noteworthy events that have generated some buzz about other possible tie-ups, but both deals were committed before the crisis began.

Some of latest buzz involves DirecTV and EchoStar. The proposed merger denied by the U.S. Federal Communications Commission (FCC) in 1997 and revisited in 2006 is facially more possible in light of the Sirius-XM approval. But there is a more interesting overlay going on here that may influence the course of future deal making and for which we all need to be prepared.

In 2003, I spoke at a conference in San Francisco attended by several Brussels-based Eurocrats. They predicted that industry-specific regulation as practiced by the FCC was a dying paradigm, and the future would consist of purely competition-based regulation in which — as long as competitive markets were guaranteed by antitrust or competition rules — free market forces would obviate the need for all other regulatory structures. I took a contrary position and said that in the wake of the then-recent Enron, WorldCom and Arthur Andersen accounting standards issues, we were entering a re-regulatory period akin to that of the 1930s following the Great Depression. I attracted a great deal of disbelief and a certain amount of scorn, but I think I was right then, if a bit early.

We are entering a re-regulatory period of financial markets, in which the size, diversity and complexity of financial engineering will be heavily scrutinized, with the concept of institutions that are "too big to fail" and which want, need and expect government bailouts on the downside, but no regulation to limit their activities on the upside will be a particularly easy target for politicians and regulators.

Antitrust and competition concerns will be reinvigorated in other industries. The International Traffic in Arms Regulations, Export Administration Regulations and Committee on Foreign Investment in the United States regimes are not going anywhere. There is no meaningful constituency for eliminating them, and lost business attributable to those regimes is hard to prove and relatively small even when proved. No politician wants to be the one that relaxed those rules and then have a major homeland security catastrophe traced back to relaxed technology exports or foreign investment they permitted.

Communications regulatory scrutiny, both on a competition level and otherwise, also will be enhanced. The U.S. government also will look harder at whether given markets are losing choice in news and other media due to a proposed merger. The fact that Sirius and XM were able to convince regulatory bodies that satellite radio competed in a broader market, justifying their merger, does not mean that DirecTV and EchoStar will find it easy to convince officials they compete with cable and other entertainment devices.

All these hurdles — legal, regulatory and political — will become higher in an environment in which the government has repeatedly had to bail out institutions deemed too entwined in the economy to fail, which got that big in an largely deregulated environment, and one in which the regulations remaining in place were not vigorously enforced. Companies and institutions interested in getting their strategic and financial acquisitions and investments over these hurdles will need plenty of longsighted, clear-eyed, strategic thinking to succeed. Frankly, the industry is out of training for that.