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More on audit, leverage, primary dealer, repo and securitization.



In August 2007, Lehman closed its subprime lender, BNC Mortgage, eliminating 1,200 positions in 23 locations, and took a $25-million after-tax charge and a $27-million reduction in goodwill. The firm said that poor market conditions in the mortgage space "necessitated a substantial reduction in its resources and capacity in the subprime space".[1]

In 2008, Lehman faced an unprecedented loss due to the continuing subprime mortgage crisis. Lehman's loss was apparently a result of having held on to large positions in subprime and other lower-rated mortgage tranches when securitizing the underlying mortgages. Whether Lehman did this because it was simply unable to sell the lower-rated bonds, or made a conscious decision to hold them, is unclear.

In any event, huge losses accrued in lower-rated mortgage-backed securities throughout 2008.

In the second fiscal quarter, Lehman reported losses of $2.8 billion and was forced to sell off $6 billion in assets.[2]

In the first half of 2008 alone, Lehman stock lost 73% of its value as the credit market continued to tighten.

In August 2008, Lehman reported that it intended to release 6% of its work force, 1,500 people, just ahead of its third-quarter-reporting deadline in September.

On August 22, 2008, shares in Lehman closed up 5% (16% for the week) on reports that the state-controlled Korea Development Bank was considering buying Lehman. Most of those gains were quickly eroded as news emerged that Korea Development Bank was "facing difficulties pleasing regulators and attracting partners for the deal."[3]

It culminated on September 9, 2008, when Lehman's shares plunged 45% to $7.79, after it was reported that the state-run South Korean firm had put talks on hold.[4]

Investor confidence continued to erode as Lehman's stock lost roughly half its value and pushed the S&P 500 down 3.4% on September 9, 2008. The Dow Jones lost nearly 300 points the same day on investors' concerns about the security of the bank.[5]

The U.S. government did not announce any plans to assist with any possible financial crisis that emerged at Lehman.[6]

On September 10, 2008, Lehman announced a loss of $3.9 billion and their intent to sell off a majority stake in their investment-management business, which includes Neuberger Berman.[7]

The stock slid 7% that day.[8][9]

On September 13, 2008, Timothy Geithner, then president of the Federal Reserve Bank of New York called a meeting on the future of Lehman, which included the possibility of an emergency liquidation of its assets.[10]

Lehman reported that it had been in talks with Bank of America and Barclays for the company's possible sale.

The New York Times reported on September 14, 2008, that Barclays had ended its bid to purchase all or part of Lehman and a deal to rescue the bank from liquidation collapsed.[11]

It emerged subsequently that a deal had been vetoed by the Bank of England and the UK's Financial Services Authority.[12]

Leaders of major Wall Street banks continued to meet late that day to prevent the bank's rapid failure. Bank of America's rumored involvement also appeared to end as federal regulators resisted its request for government involvement in Lehman's sale.

Congressional oversight

House panel to hold hearing on Lehman oversight April 20


  • The Honorable Anna Eshoo, Member of Congress
  • The Honorable Ed Perlmutter, Member of Congress
  • The Honorable Timothy F. Geithner, Secretary, U.S. Department of the Treasury Testimony
  • The Honorable Ben S. Bernanke, Chairman, Board of Governors of the Federal Reserve System Testimony
  • The Honorable Mary L. Schapiro, Chairman, U.S. Securities and Exchange Commission Testimony
  • Mr. Anton R. Valukas, Partner, Jenner & Block LLP, Court Appointed Examiner Testimony
  • Mr. Richard S. Fuld, Jr., former Chairman and Chief Executive Officer, Lehman Brothers Testimony
  • Mr. Thomas Cruikshank, former member of the Board of Directors and chair of Audit Committee Testimony
  • Mr. William K. Black, Associate Professor, University of Missouri-Kansas City School of Law Testimony
  • Mr. Matthew Lee, former Senior Vice President, Lehman Brothers Testimony

Securities and Exchange Commission Chairman Mary Schapiro said her agency’s oversight of Lehman Brothers Holdings Inc. was “terribly flawed,” days after a bankruptcy examiner found the SEC didn’t try to stop the firm’s exaggeration of liquid assets.

“It was so terribly flawed in design and execution,” Schapiro testified to a Congressional committee today, referring to SEC examinations aimed at monitoring the soundness of Wall Street’s biggest investment banks. “We were ill-suited because of our enforcement and disclosure mentality.”

Eighteen months after Lehman’s collapse, the 2,200-page report by Anton Valukas has reignited the debate over what regulators should have known and done before Lehman’s collapse triggered a global financial crisis. The House Financial Services Committee said today it will hold a hearing so that lawmakers can question U.S. watchdogs at the time.

“Either the SEC and the New York Federal Reserve failed to discover the ongoing accounting fraud at Lehman, or they turned a blind eye,” said Representative Spencer Bachus, an Alabama Republican on the House panel. “In either case, the actions of these two regulators represent a grave failure and should be explored at a public hearing.”

Bachus wants to summon former SEC Chairman Christopher Cox, then-Lehman Chief Executive Officer Richard Fuld and ex-New York Fed President Timothy F. Geithner, who is now U.S. Treasury Secretary. Schapiro, Cox’s successor, took her post in January 2009.

Five Days vs. 24 Hours

Valukas’s March 11 report describes a gap between how Lehman and the SEC viewed the firm’s so-called liquidity pool, used to pay bills in a pinch, in the firm’s final months. Behind the scenes, the SEC questioned how quickly some assets could really be tapped. Still, Lehman didn’t tell investors that a growing share of the pool was being pledged as collateral to clearing firms, the report found.

The SEC deemed assets to be liquid only if they were convertible to cash within 24 hours. Lehman afforded itself five days. The SEC told Lehman it preferred the shorter limit and never enforced it, according to the report.

In another instance, the SEC didn’t take action after determining in June 2008 that Lehman had counted a $2 billion deposit at Citigroup Inc. among cash-like assets available in an emergency, according to the report. SEC analysts deemed the deposit’s designation as “problematic,” because withdrawing the money could have impaired Lehman’s trading.

Silence as Defense

In prior years, the SEC’s periodic objections to some assets prompted the firm to remove them. In 2008, though, the agency didn’t challenge the Citigroup deposit.

The silence of examiners, who focused more on stability than honesty with investors, was invoked as a defense as Valukas quizzed more than 100 executives and other witnesses about the financial health and reporting at Lehman, based in New York.

“A recurrent theme in their responses was that Lehman gave full and complete financial information to government agencies,” Valukas wrote. They told him that “the government never raised significant objections or directed that Lehman take any corrective action.” Valukas also found that Lehman kept regulators and credit rating firms in the dark when it “reverse-engineered” a key measure of stability through transactions known as Repo 105s. Lehman temporarily moved as much as $50 billion in assets off its balance sheet before reporting quarterly results.

Not Disclosure Specialists

The SEC’s examiners at Lehman didn’t belong to the agency’s ranks of investigators and disclosure specialists. Instead, they were part of the Consolidated Supervised Entities program, set up in 2004 to guard against the collapse of systemically important investment banks.

A week after Lehman’s collapse, Cox told Congress that no law authorized the voluntary program to prescribe a companywide liquidity level or enforce SEC leverage requirements. The SEC announced Sept. 26, 2008, the program was ending.

Valukas didn’t draw conclusions in the report about whether the SEC’s interactions with Lehman were appropriate. The SEC allows firms to determine how they disclose liquid assets, so long as they don’t deceive investors. Schapiro has replaced most of the agency’s top officials.

“We are looking closely at the examiner’s findings as part of our ongoing review of the accounting and disclosures of major financial institutions and their role in the financial crisis,” SEC spokesman John Nester said.

The House Financial Services Committee will hold a hearing into recent revelations that Lehman Brothers, the failed investment bank, hid billions of dollars in debt from the public.

Rep. Mary Jo Kilroy (D-Ohio) requested a hearing into allegations contained in a 2,200-page report from a court-appointed bankruptcy examiner in the Lehman case. Rep. Spencer Bachus (R-Ala.), ranking member on the committee, also had requested a hearing about Lehman.

Senator Dodd requests DOJ inquiry of Lehman

WASHINGTON – Today, Senate Banking Committee Chairman Chris Dodd (D-CT) sent a letter to Attorney General Eric Holder asking that he commission a task force to investigate activities at Lehman Brothers and other companies that may have engaged in similar accounting manipulation with a view to prosecution of those who broke of the law.

Below is the text of the letter:

Dear Attorney General Holder:

I am deeply concerned about the facts that have come to light regarding the demise of Lehman Brothers and the accounting manipulation that contributed to it. I respectfully ask you to commission a task force to investigate the Lehman situation as well as other companies that may have engaged in similar accounting manipulation with a view to prosecution of employees or agents who contributed to any violations of the law.

According to the Report of the U.S. Trustee-appointed Examiner Anton R. Valukas, Lehman presented a misleading picture of its financial condition to the public by using extensive repurchase agreements known as Repo 105 transactions. The Examiner found that “Lehman did not disclose its use – or the significant magnitude of its use – of Repo 105 to the Government, to the rating agencies, to its investors, or to its own Board of Directors.” The result was to conceal its holdings of bad assets and to temporarily remove approximately $50 billion of assets from its balance sheet at the end of the first and second quarters of 2008. The Examiner found that Lehman used Repo 105 transactions for no other articulated purpose than to shrink its balance sheet at the quarter-end, in a manner that deceived investors and creditors about its true financial state and misleading others.

We must work tirelessly to reduce the incidence of financial fraud in order to restore trust and confidence in the financial markets. A task force investigation and taking appropriate Federal actions in these matters will contribute to these goals.

Bankruptcy Examiner's report

Repo 105 and Lehman's collapse

"Repo 105" is about to enter the lexicon of shameful accounting and financial techniques employed to hide risk from the markets.

According to Anton Valukas, the examiner appointed to investigate the collapse of Lehman Bros by a New York bankruptcy court, Lehman used Repo 105 to hide from creditors, markets, ratings agencies, regulators and even members of its own board quite how much it had borrowed relative to its capital.

Or to put it another way, the firm used Repo 105 to exaggerate its financial strength in 2008, which was when this really mattered because of widespread concerns about the robustness of many banks.

The ruse worked like this.

Lehman was highly and dangerously dependent on raising hundreds of billions of dollars of short-term finance every day, in what's known as the repo market.

This is a market used by US investment banks in which assets can be swapped for short-term loans.

But because the finance raised in this way has to be repaid within days, the assets - in an accounting sense - are never deemed in an accounting sense to have left the repo-ing banks' balance sheets.

Except that Lehman found a ruse to use the repo market to make it look as though the assets had been removed in a permanent way.

Apparently (and this is quite difficult to believe) the accounting rules allowed Lehman to report a reduction in assets if it exchanged those assets for funds at a conversion rate of 105 to 100: so if Lehman exchange assets with a value of $105 for loans at a value of $100, that $105 of assets could be removed from the balance sheet when reporting group financial results.


Now according to Valukas, this ruse allowed Lehman to report that its assets were $38.6bn lower than was really the case at the end of the 2007 financial year. And the reduction increased to $49.1bn at the end of the first quarter of 2008 and $50.4bn by the middle of 2008.

Why did this matter?

Well, one of the most important measures of an investment bank's financial strength is its leverage ratio, or the ratio of its reported assets to its reported capital. The lower the ratio, the stronger a firm will appear to be: the bank will appear to have more capital relative to its loans and investments to absorb any losses on those loans and investments.

So by removing $50.4bn of assets from its reported balance sheet using Repo 105, Lehman reduced its reported leverage ratio from 13.9 to 12.1.

That may not sound a lot, but in the context of the fraught market conditions of 2008 - after Bear Stearns imploded - it could have been the difference between life and death for Lehman.

In particular, it was hugely dependent - as I've said - on raising short-term finance from the conventional repo market. And if its creditors in that market had known the true state of its leverage, they might have ceased lending to it even earlier than they did - which would have brought forward the date of Lehman's demise.

I'm slightly under the cosh now. But when time permits later in the day, I'll also look at why Valukas believes there is a case to claim damages from Lehman's chairman, Dick Fuld, three chief financial officers - Christopher O'Meara, Erin Callan and Ian Lowitt - and the firm's auditor, Ernst & Young.

For different reasons, he believes there may also be claims on JP Morgan and Citibank, for the way they demanded collateral from Lehman in its final days, and from Barclays, for the alleged improper transfer of certain assets to Barclays as part of its purchase of the rump of Lehman.

Reduced oversight in 2006 condoned repo 105 like actions

Regulators like the Fed and SEC have said they didn't know about Lehman's use of Repo 105s to hide its mountain of debt.

But in a must-read New York Times Op-Ed, law school professors Susan P. Koniak, George M. Cohen, David A. Dana, and Thomas Ross point out:

Our bank regulators were not, as they would like us to believe, outside the disco, deaf and blind to the revelry going on within. They were bouncing to the same beat. In 2006, the agencies jointly published something called the “Interagency Statement on Sound Practices Concerning Elevated Risk Complex Structured Finance Activities.” It became official policy the following year.

What are “complex structured finance” transactions? As defined by the regulators, these include deals that “lack economic or business purpose” and are “designed or used primarily for questionable accounting, regulatory or tax objectives, particularly when the transactions are executed at year end or at the end of a reporting period.”

How does one propose “sound practices” for practices that are inherently unsound? Yet that is what our regulatory guardians did. The statement is powerful evidence of the permissive approach bank regulators took toward the debt-dissolving financial products that our banks had been developing, hawking and using themselves for years. And it’s good reason for Americans to be outraged by the “who me, what, where?” reaction of Mr. Bernanke and the S.E.C. to the revelation of Lehman’s Repo 105 scam.

The interagency statement on “sound practices” of 2006 ... was greeted with effusive praise from bankers, their lawyers and accountants. Gone was the requirement [proposed by the law professors and others] to ensure that customers understood these instruments and that the banks document that they would not be used to phony-up a company’s books.

The focus on complexity was also gone, as was the concern over transactions “with significant leverage” — that is, deals with little real cash underneath, another unfortunate deletion because attending to excessive leverage would have served us well.

Instead, the only products that the banks were asked to handle with special care were so narrowly defined and so obviously fraudulent that suggesting that they could be sold at all was outrageous. These included “circular transfers of risk ... that lack economic substance” and transactions that “involve oral or undocumented agreements that ... would have a material impact on regulatory, tax or accounting treatment.” [and these weren't banned, but apparently only required special disclosures by the banks]

Just as troubling, at least in retrospect, the new statement specifically exempted C.D.O.’s from the need for any special care..."

JPMorgan, Citigroup helped cause Lehman’s collapse

JPMorgan Chase & Co. and Citigroup Inc. helped cause the collapse of Lehman Brothers Holding Inc. by demanding more collateral and changing guarantee agreements, a bankruptcy examiner said today in a report.

“The demands for collateral by Lehman’s lenders had direct impact on Lehman’s liquidity pool,” said Anton Valukas, the U.S. Trustee-appointed examiner, in a 2,200-page report filed in Manhattan federal court. “Lehman’s available liquidity is central to the question of why Lehman failed.”

Former Lehman Chief Executive Officer Richard Fuld, former Chief Financial Officer Erin Callan, former executive vice president Ian Lowitt and former managing director Christopher O’Meara certified misleading statements, the report said. Fuld was “at least grossly negligent,” the report said. Lehman collapsed in September 2008 with $639 billion in assets, the biggest bankruptcy in U.S. history.

Commenting on Barclays Plc’s purchase of Lehman’s North American brokerage, Valukas said a “limited amount of assets” belonging to Lehman were “improperly transferred to Barclays.”

Kerrie Cohen, a Barclays spokeswoman in New York, and JPMorgan spokesman Brian Marchiony declined to comment. Citigroup spokeswoman Danielle Romero-Apsilos didn’t have an immediate comment. Lowitt, who is now at Barclays, didn’t immediately repond to an e-mail seeking comment. Barclays is Britain’s second-biggest bank. Citigroup is the third biggest U.S. bank, and JPMorgan is second.

Fuld Warning

Fuld was warned months before the bankruptcy by Treasury Secretary Henry Paulson that Lehman might fail if it continued to report losses without finding a buyer or putting in place a survival plan, according to the report.

Lehman’s chief was “at least grossly negligent in causing Lehman to file misleading periodic reports” while its risks were rising because of long-term assets financed with short-term debt, Valukas said in the report.

Lehman’s executives engaged in conduct ranging from “non- culpable errors of business judgment” to “actionable balance sheet manipulation,” as they used “accounting gimmicks” to move assets off the balance sheet without disclosing that to the government, rating agencies, investors or Lehman’s board.

Fuld’s lawyer, Patricia Hynes, disputed the examiner’s claim that the Lehman estate has a colorable claim against him relating to transactions called “Repo 105 transactions.”

Didn’t Know

“Mr. Fuld did not know what those transactions were -- he didn’t structure or negotiate them, nor was he aware of their accounting treatment,” Hynes said in a statement. Hynes also said none of Lehman’s senior financial officers, lawyers or outside auditors raised concerns about the transactions with Fuld.

Valukas said in his report that Ernst & Young, Lehman’s auditing firm, failed to question inadequate disclosures by the Lehman executives.

Valukas said that Lehman’s directors are “immunized from personal liability” concerning the way the company handled risk because management hadn’t presented any “red flags” to them.

Valukas, 66, spent a year and $38 million producing the report on whether banks triggered Lehman’s bankruptcy or if Barclays improperly benefitted from it and what role was played by the U.S. Federal Reserve System. Valukas interviewed more than 100 people including U.S. Treasury Secretary Timothy Geithner, Federal Reserve Chairman Ben Bernanke and former Securities and Exchange Commission Chairman Christopher Cox, and scrutinized more than 10 million documents, plus 20 million pages of e-mails from Lehman, according to filings in U.S. Bankruptcy Court in New York.

Colorable Claims

“The Examiner has determined that there are a limited number of colorable claims for avoidance actions against JPMorgan and Citibank,” Valukas said in the report. Valukas defined a colorable claim in the report as sufficient credible evidence to persuade a jury to award damages at trial.

Barclays bought Lehman’s brokerage for $1.54 billion. Lehman has sued Barclays for $5 billion or more, saying it made a “windfall” on the purchase, and Barclays responded that it is owed $3 billion. A bankruptcy-court trial is scheduled for April 26.

JPMorgan and Citigroup were two of New York-based Lehman’s main short-term lenders. On Feb. 24, Lehman said it settled with JPMorgan over the last of $29 billion in claims the bank filed against Lehman.

New Guarantee

Citigroup, which handled currency trades for Lehman, received a new guarantee from Lehman when Lehman was already insolvent and didn’t give enough value in return, the report said.

“The Examiner concludes that a colorable claim exists to avoid the Amended Guaranty as constructively fraudulent,” Valukas’s report says.

Lehman Chief Executive Officer Bryan Marsal said in an e- mail the bankrupt investment bank would “carefully evaluate” Valukas’s report to assess how it might help “ongoing efforts to advance creditor interests.”

The case is In re Lehman Brothers Holdings Inc., 08-13555, U.S. Bankruptcy Court, Southern District of New York (Manhattan).

Regulators were on site prior to Lehman's collapse

"Almost two years ago to the day, a team of officials from the Securities and Exchange Commissionand the Federal Reserve Bank of New York quietly moved into the headquarters of Lehman Brothers. They were provided desks, phones, computers — and access to all of Lehman’s books and records. At any given moment, there were as many as a dozen government officials buzzing around Lehman’s offices.

These officials, whose work was kept under wraps at the time, were assigned by Timothy Geithner, then president of the New York Fed, and Christopher Cox, then the S.E.C. chairman, to monitor Lehman in light of the near collapse of Bear Stearns.

Similar teams from the S.E.C. and the Fed moved into the offices of Goldman Sachs, Morgan Stanley, Merrill Lynch and others.

There were plenty of reasons to send in these SWAT teams. With investors on edge about the veracity of valuations on Wall Street — and with hedge fund managers like David Einhorn publicly questioning Lehman’s numbers — the government examiners rifled through Lehman’s accounts. They also interviewed executives about various decisions, and previewed the quarterly earnings reports.

Yet now, two years later, we learn through a 2,200-page report from Lehman’s bankruptcy examiner, Anton R. Valukas, that the firm was taking a creative approach with its valuations and accounting.

One crucial move was to shift assets off its books at the end of each quarter in exchange for cash through a clever accounting maneuver, called Repo 105, to make its leverage levels look lower than they were. Then they would bring the assets back onto its balance sheet days after issuing its earnings report.

And where was the government while all this “materially misleading” accounting was going on? In the vernacular of teenage instant messaging, let’s just say they had a vantage point as good as POS (parent over shoulder).

The new mystery is why it took this long for anyone to raise a red flag. “Even though Lehman dressed up its accounts for the great unwashed public, it did not try to fool the authorities,” Yves Smith, the author of “ECONned: How Unenlightened Self Interest Undermined Democracy and Corrupted Capitalism,” wrote on her blog last week. “Its game-playing was in full view.”

Indeed, it now appears that the federal government itself either didn’t appreciate the significance of what it saw (we’ve seen that movie before with regulators waving off tips about Bernard L. Madoff). Or perhaps they did appreciate the significance and blessed the now-suspect accounting anyway.

Oddly, when the bankruptcy examiner asked Matthew Eichner of the S.E.C., who was involved with supervising firms like Lehman, whether the agency focused on leverage levels, he answered that “knowledge of the volumes of Repo 105 transactions would not have signaled to them ‘that something was terribly wrong,’ ” according to the examiner’s report.

There’s a lot riding on the government’s oversight of these accounting shenanigans. If Lehman Brothers executives are sued civilly or prosecuted criminally, they may actually have a powerful defense: a raft of government officials from the S.E.C. and Fed vetted virtually everything they did.

On top of that, Lehman’s outside auditor, Ernst & Young, and a law firm, Linklaters, signed off on the transactions.

The problems at Lehman raise even larger questions about the vigilance of the S.E.C. and Fed in overseeing the other Wall Street banks as well.

“I’m concerned that the revelations about Lehman Brothers are just the tip of the iceberg,” Senator Ted Kaufman wrote in a speech he was preparing to give Tuesday on the Senate floor. “We have no reason to believe that the conduct detailed last week is somehow isolated or unique. Indeed, this sort of behavior is hardly novel.”

Reserve Bank of Australia queried Lehman on repo 105

"MONTHS before the Lehman Brothers collapse brought the world's financial markets to a halt, the bank's minions were facing Reserve Bank of Australia questions about suspect transactions Lehman's was using to mask billions of dollars in debt.

A report into the Lehman Brothers bankruptcy released yesterday includes emails in which Lehman employees contemplate whether they should give the RBA a vague reason for accounting practices being used to hide the bank's troubles, or whether a deeper explanation should be provided. An internal email written on on May 22, 2008 by Anthony Jawad, of Lehman Brothers International (Europe) to his colleague Kieran Higgins, says: if they want a deeper explanation then we may have to get down to the nitty gritty of the truth. Do you want us to go down this line or want us to just give it a miss? … [T]he more people that know the truth, the more dodgy it can be".

Others told him the practice was legal.

The anecdote, on page 859 of the 2200-page document, is just one example in the Wall Street equivalent of a coroner's report.

The report, compiled by an examiner for the now-bankrupt bank, lays out, in new and startling detail, how Lehman Brothers used accounting sleight of hand to conceal bad investments that led to its undoing..."

Valukus concludes "transfers at issue maybe fraudulent transfers"

"...Earlier on Wednesday, Barclays Bank, Goldman Sachs, Morgan Stanley, JPMorgan Chase, and Chicago-based trading firms Citadel LP and DRW Trading were identified as the firms asked to participate in an emergency auction of Lehman's futures positions as firm lurched toward bankruptcy in September 2008.

That disclosure was the final part of the examiner's report to be made public as exchange operator CME Group lost a bid in bankruptcy court to keep the identities of the companies secret. The report concluded "that an argument can be made that the transfers at issue were fraudulent transfers," noting that Lehman lost $1.2 billion in the sale of a $2 billion portfolio to Barclays, Goldman and DRW.

CME Group, with the support of the futures industry, had sought to withhold the names of buyers of Lehman's former futures and options positions in a special auction conducted by CME in the midst of Lehman's 2008 collapse..."

Matters related to the collapse

Collateral, liquidity, clearing banks, disclosure and collapse

The day before Lehman Brothers Holdings Inc. filed for bankruptcy, almost all of its $41 billion cash pool was tied up at bank lenders including JPMorgan Chase & Co., Citigroup Inc. and Bank of America Corp., according to a court-appointed examiner’s report.

After Bear Stearns Cos. failed in 2008, Lehman began to count obligatory deposits and collateral pledged to banks as cash, and to use those larger amounts in discussions with regulators and analysts and in public disclosures, examiner Anton Valukas said in his report on firm’s collapse.

Based on such representations, a memo from Buckingham Research Group analysts two days before Lehman’s Sept. 15, 2008, bankruptcy concluded: “Lehman remains well positioned in a ‘run on the bank scenario’” because of a $42 billion liquidity pool that would enable it to meet demands for cash.

Less than $2 billion of those assets were “readily monetizable,” Valukas said in his March 11 report.

Liquidity is absolutely critical to the broker-dealer and investment bank holding company business model due to the fact that these financial entities are dependent on short-term secured financing to fund their daily operations,” Valukas said in the 2,200-page report. “Lehman knew that liquidity played a crucial role in its business model.”

He said there may be grounds for suing Lehman executives for “causing” the company to file misleading financial reports while its risks were rising.

Accounting Methods

Valukas’s report details other Lehman accounting methods that may have misled investors, including transactions that made $50 billion disappear from its balance sheet in a half year, and a way of valuing real estate investments that avoided writedowns by focusing on a project’s future prospects.

After Bear Stearns collapsed, Lehman was “widely regarded” as the investment bank second-most dependent on short-term financing for its daily operations, making it vulnerable if lenders pulled back, Valukas said, citing a June 2008 Morgan Stanley research report. At the time the fourth- largest investment bank, Lehman had estimated liabilities of $613 billion, including short-term repos, or agreements to repurchase assets, of $159 billion, or almost 26 percent of those obligations, according to the Morgan Stanley report.

Valukas cited a 2007 regulatory filing by Lehman that acknowledged “failures in our industry are typically the result of insufficient liquidity.” Bear Stearns was bought by JPMorgan for less than a tenth of its value after its money ran out.

“We are reading and analyzing the examiner’s report,” said Kimberly Macleod, a Lehman spokeswoman, declining to comment on specifics.

Encumbered Assets

Lehman’s use of encumbered assets to bolster cash began in June 2008, when Citigroup asked for a $2 billion deposit against trades it was settling and clearing for Lehman, and continued a week later when JPMorgan, Lehman’s main U.S. clearing bank, requested $5 billion in securities to meet revised margin requirements.

Lehman continued to count those amounts as liquid assets, taking the position that it was appropriate, even though the collateral was pledged to JPMorgan and it “understood” that a withdrawal of the deposit from Citigroup “would have an impact on Citi’s willingness to clear and settle trades for Lehman,” Valukas said.

In August, Lehman posted $500 million in collateral with Bank of America to secure its daytime exposures on trades for the investment bank, counting the amount in its liquidity pool “despite the fact that the collateral was subject to a security interest, was returnable to Lehman only on three days’ notice and was placed to ensure that Bank of America would continue its clearing operations,” Valukas said.

Security Deposit

As security for similar risks, Lehman deposited more than $800 million with HSBC Holdings Plc and an unspecified amount with JPMorgan in two accounts, according to Valukas. Again, Lehman counted these amounts as its own readily available cash, “even though JPMorgan required almost all of the funds in those accounts each morning to unwind the previous day’s tri-party repo trades,” the examiner said.

In September, JPMorgan sought and received more than $8 billion in cash as security for risks it was taking as Lehman’s bank, and the pledged money also was counted in Lehman’s cash, the examiner said.

At the end of the third quarter, Lehman reported that its liquidity totaled $42 billion compared with $48 billion in the second quarter, Valukas said. Those numbers didn’t fully reflect the drop in assets that could easily be converted to cash, according to Valukas’s findings.

SEC Unaware

Lehman’s primary regulator, the U.S. Securities and Exchange Commission, was unaware of the extent to which Lehman was counting clearing-bank collateral in its liquidity pool until the day before Lehman’s bankruptcy filing, Valukas said.

New York-based Lehman collapsed that day with $639 billion in assets as lenders pulled back, making it the largest U.S. bankruptcy ever.

In a March 14 presentation to the SEC, Lehman described its liquidity pool as “primarily cash and cash equivalents and unencumbered, liquid, investment grade collateral,” according to the report.

Valukas said Lehman never told rating services or its shareholders and lenders that it was including so many deposits and pledges in its liquidity. In a July 2008 quarterly filing, it said its liquidity pool was intended to cover expected cash outflows for 12 months “in a stressed liquidity environment.” Those outflows included debt coming due, collateral calls related to Lehman’s derivatives contracts, and a “loss of repo capacity,” it said.

The bankruptcy case is In re Lehman Brothers Holdings Inc., 08-13555, U.S. Bankruptcy Court, Southern District of New York (Manhattan).

Fed refused collateral and Lehman collapsed

"...Onaran: How about liquidity risk? That wasn’t incorporated into the rest of the risk-management function, was it?

Williams: Exactly. Liquidity is a big risk especially if you’re relying very heavily on overnight borrowing. Lehman was borrowing $180 billion a day on the repo market. Bear Stearns Cos. was knocking on the repo door for about $50 billion every day, assuming it was going to be open for them.

Discount Window

Onaran: Why did the Fed decide not to lend to Lehman from its discount window when its overnight lenders balked? Wouldn’t opening the window to investment banks have prevented such a liquidity crisis? Did the Fed decide Lehman was insolvent and not just illiquid?

Williams: The Fed had more insights into Lehman’s collateral and refused to lend against it. Then a few days later, when Barclays Plc came in and bought Lehman’s U.S. businesses, the Fed accepted that same collateral to lend to Barclays. It wasn’t good enough collateral for Lehman, but it was for Barclays.

The Fed decided Barclays was going to be around, but Lehman wasn’t. So it looks like they decided it was insolvent."

Systemic disruption from Lehman failure

"The Lehman case illustrates how a disorderly bankruptcy can lead to uncertainty and contagious disruption in financial markets. Uncertainty over the size of exposures and the eventual recovery rates on these exposures led global bank equity prices to fall sharply and interbank spreads to rise to record highs. At the same time, runs developed on U.S. money market funds that were—or were believed to be—invested in Lehman Brothers’ commercial paper. Pressure on these funds soon led to fire sales of all U.S. commercial paper, reducing the flow of funds to corporate borrowers.

The Lehman case also highlights how disorderly bankruptcy can lead to a loss of access to key services, such as payment and settlement services, and may cause a disruption in these systems. Lehman Brothers did not take deposits and did not play a critical role in the U.S large value payment system. However, since Lehman Brothers had offered prime brokerage services for a number of hedge funds, these funds lost access to credit lines they relied on to fund their positions. Moreover, hedge funds lost access to collateral that Lehman Brothers kept as their custodian, acting as the funds’ intermediary in accessing the major central securities depository systems."

Lehman foresees outcome of their collapse

The confidential document provided by Lehman Brothers with their predictions of effects on the financial markets if they entered bankruptcy:

  • Repos default: Financial institutions liquidate Lehman repo collateral
  • Repo defaults trigger default of a significant amount of holding company debt and causes the liquidation of hundreds of billions of dollars of securities
  • Lehman swap agreements include cross default terms allowing counterparties to liquidate billions of dollars of trades and collateral at the time of their choosing. Failed trades escalate exponentially
  • Lehman trading, middle office and operations inundated by massive numbers of transactions

Lehman loses all control of its financial position

  • Massive global wealth destruction
  • Impacts all corporations and financial institutions
  • Retail investors/retirees assets are devastated
  • Enormous flight to quality causes flight from risk assets and financial institution capital
  • Liquidity evaporates for virtually all asset classes
  • Global economy deterioration at unprecedented levels

Events at the NY Federal Reserve

A week earlier, the Treasury had engineered the rescue of government-sponsored mortgage-finance companies Fannie Mae and Freddie Mac. Six months before that, Paulson had arranged for the Fed to guarantee $29 billion of Bear Stearns toxic assets to facilitate the firm’s sale to JPMorgan Chase.

“If you look back at what was being said on TV and in Congress, the constant refrain was, ‘No, not another Bear Stearns, not another bailout,’” said Michele Davis, assistant Treasury secretary for public affairs under Paulson.

If Lehman was going to be saved, Paulson said, it would have to be by those sitting around the table, all of whom knew that without a buyer or a bailout in place by the time markets opened Monday morning the 158-year-old firm would be history.

Some participants said the bankruptcy filing took them by surprise because they were betting Paulson and Geithner would pull off a last-minute rescue.

“There was always a tiny thought in my mind that the government would flinch at the last minute,” said Gary D. Cohn, president and chief operating officer of New York-based Goldman Sachs, who attended the meetings.

Geithner ‘Homework’

Geithner divided the bankers on Friday evening into three teams to do what one participant called “homework.”

The first group, which included Cohn of Goldman Sachs and Credit Suisse’s Calello, was assigned to evaluate Lehman’s real estate and private equity holdings to determine how much of a capital deficiency the firm faced. The second team, with Mack and Thain, tried to cobble together a funding mechanism for the company’s bad assets in the event Lehman could woo a white knight, participants said.

“The No. 1 priority was to find a buyer,” said Davis, now a partner at Brunswick Group LLP, a public relations firm based in Washington.

Lehman executives, who had watched the share price tumble 94 percent since the beginning of the year, were talking to two: Bank of America and Barclays Plc.

Selling Merrill

The third team of bankers -- including Robert P. Kelly, CEO of Bank of New York Mellon Corp., the world’s biggest custody bank, which keeps records, tracks performance and lends securities to institutional investors -- was asked to look at the risks of a possible bankruptcy.

Every few hours, the teams would regroup at the conference table and report back. The bankers discussed which firms might follow Lehman down the drain, according to Thain, 54. There was little doubt Merrill would be next, he said.

By Saturday, Thain had snatched one of Lehman’s suitors and was in talks to sell Merrill, the third-biggest U.S. investment bank, to Charlotte, North Carolina-based Bank of America for about $50 billion. At one point, Paulson looked at the Merrill Lynch chief and said, “John, you know what to do,” according to another executive who attended the meetings.

The marriage, approved by the banks’ boards before Lehman declared bankruptcy, took less than two days to consummate.

Barclays Talks

That left only Barclays. While the London-based bank was interested in Lehman, it didn’t want to touch the firm’s real estate holdings, especially after the team responsible for scrutinizing the books estimated that Lehman had overvalued them by as much as $30 billion, three participants said. One said Barclays kept coming back with less attractive offers, leaving more of the business’s worst assets behind.

By Saturday evening, the bankers -- many of whom stood to gain business after Lehman’s demise -- were still discussing how to come up with the $30 billion needed for a rescue. Barclays sought a temporary guarantee from the U.K. government to cover Lehman’s commitments until its shareholders could approve the deal. When Paulson phoned Chancellor of the Exchequer Alistair Darling, his counterpart in London, Darling told him he didn’t want to import the U.S. cancer, according to two people who said Paulson mentioned the remark later.

Darling, through a spokesman, denied using the word “cancer.”

“At no point were the British authorities asked to approve or reject a deal for the purchase of Lehman Brothers,” said Jason Knauf, senior press officer for the U.K. Treasury.

1 Million Bets

On Sunday morning, shortly before noon, Paulson announced that Barclays wouldn’t be buying Lehman on any terms, participants said. By then, the bankers had turned their attention to their own survival. Cohn of Goldman Sachs said he led the charge to make sure the banks didn’t lose money on derivatives trades either with Lehman or on Lehman.

Derivatives are contracts whose value is derived from stocks, bonds, loans, currencies, commodities or linked to specific events such as changes in interest rates. Lehman had made about 1 million such bets in the over-the-counter market, according to a person with access to that information.

The unregulated $592 trillion market for over-the-counter derivatives, 41 times the size of the U.S. economy, contributed more than half of some banks’ trading revenue and had never been tested by the bankruptcy of a major Wall Street firm.

Unwinding Trades

The Fed had already begun trying to untangle Lehman’s credit-default swaps on Saturday morning, calling in a group of experts in derivatives operations from Wall Street firms and asset-management companies. They were given one hour to show up at the New York Fed.

Swaps are a way for investors to gamble on whether companies will continue making debt payments or for lenders to buy insurance against borrowers who stop paying. If the company defaults, one side in the bet pays the buyer face value of the debt in exchange for the underlying securities or the cash equivalent.

In order to unwind the trades, the team would need to do so-called portfolio compression, reducing the number of outstanding swaps by eliminating duplication and combining similar bets made by the same counterparties. The process involves sending the trades to an outside vendor, running them through a software program, reviewing the results and deciding which ones to settle.

It couldn’t be done, at least not before trading began in Asia on Monday morning, the person said.

Repo Market

On Sunday, the banks called in their own traders to see if they could minimize any losses from dealings with Lehman. That also proved impossible. One snag was that some corporations involved in the trades couldn’t get their representatives to the New York Fed in time, said one participant. Another was that many of the banks couldn’t determine what bets they’d made on or with Lehman.

A last-ditch attempt on Sunday to try to resolve some outstanding derivatives contracts between Lehman and the other banks at the Fed had little success, according to two people who were in the room. One reason: The banks were only interested in resolving the contracts in which Lehman owed them money and not those where the banks owed Lehman money, said one of the people at the meeting.

The bankers acknowledged that one of their favorite avenues for borrowing would be disrupted by Lehman’s collapse. Making sure the market wouldn’t freeze for short-term loans called bank repurchase agreements, or repos, was where the participants had their biggest success -- and their bitterest disagreements.

‘Default Scenario’

In a repo arrangement, a lender sends cash to a borrower in return for collateral, often Treasury bills or notes, which the borrower agrees to repurchase as soon as the next day for the face value of the securities plus interest. When lenders perceived that Lehman might not pay repo loans or be able to post adequate collateral, they required more and higher quality assets from the firm.

The presentation prepared by Lehman employees, titled “Default Scenario: Liquidation Framework,” predicted, among other things, that a bankruptcy would trigger a freeze in the broader repo market.

“Repos default,” they wrote. “Financial institutions liquidate Lehman repo collateral. Repo defaults trigger default of a significant amount of holding company debt and cause the liquidation of hundreds of billions of dollars of securities.”

Repo collateral caused what might have been the tensest moment of the weekend, according to two participants.

Rule 23(a)

While poring over Lehman’s mortgage portfolio on Saturday, former Goldman Sachs partner Peter S. Kraus, a Merrill Lynch vice president and now CEO of New York-based AllianceBernstein Holding LP, accused JPMorgan’s Dimon of being too aggressive in demanding more collateral and margin from other banks to cover declining values, according to two people who were there.

JPMorgan, as a so-called clearing bank, holds collateral for other banks in what are known as tri-party repo transactions. When the value of the collateral declines, JPMorgan can require a borrower bank to post more or higher quality assets so the lending bank is protected.

Dimon didn’t respond to Kraus, the participants said, and the confrontation died down. Both declined to comment.

The Fed was sufficiently anxious about a standstill in repo funding that on Sunday, Sept. 14, it temporarily modified Rule 23(a) of the Federal Reserve Act to allow banks to use customer deposits to fund securities they couldn’t finance in the repo market. That change, scheduled to expire in January, has since been extended through Oct. 30.

NY Fed declines to guarantee Lehman liabilities, FSA requirement

A series of intense transatlantic phone calls between US and UK regulators made during the frantic weekend that ended with the collapse of Lehman Brothers are detailed in the Financial Services Authority's first documented account of the bank's demise. The account is based on confidential information it would normally not have been able to disclose.

While the FSA chief executive Hector Sants refused to give evidence in person to a court-appointed US bankruptcy examiner, the regulator submitted written evidence which shows the US authorities made repeated attempts to convince the UK to change its rules to make it easier for Barclays to take over the ailing US bank.

The FSA said under UK law it would not have been able to make its submission public but that Barclays had consented to the release of conversations it held with the UK regulator that weekend.

The documents show the concerns held by the FSA about the ability of Barclays to maintain a big enough capital cushion if it proceeded with the ambitious takeover and the worry that even if the bank could satisfy the capital requirements "the aggregate level of risk might still be unacceptable".

But they lso show Barclays decided not to make a formal bid as Lehman's long-term liquidity position was uncertain and the US authorities could not provide a guarantee to support Lehman's trading positions beyond the change of US president in January 2009.

The dilemma of how to deal with Lehman's burgeoning liabilities before Barclays could formally complete the takeover - which, under UK listing rules, requires a shareholder vote, which can take months to organise - is at the heart of the calls made that weekend, before Lehman collapsed on Monday 15 September 2008.

The series of calls - which began on Thurday 11 September 2008 - culminated in an exchange at 3pm on Sunday 14 September - just hours before Lehman collapsed - between the FSA's then chairman Sir Callum McCarthy and Christopher Cox, the chairman of the US Securities and Exchange Commission. In the call, Cox urged McCarthy to waive the listing rule which required Barclays to hold a shareholder vote on the deal and which would have taken weeks and left Lehman in limbo unless the US authorities were prepared to guarantee its trading positions.

McCarthy made it clear that there was no precedent for such a waiver and that Barclays had not asked the regulator to consider such a move.

Just two hours earlier, at 1pm, McCarthy had told Timothy Geithner - now the US Treasury secretary but then the president of the Federal Reserve Bank of New York - that without a guarantee from the Federal Reserve Bank of New York Barclays was faced with providing an unlimited guarantee of prior and future exposures of Lehman.

The documents show that on the Sunday lunchtime the "FSA remained concerned about whether Barclays could structure a transaction which would enable it to maintain the necessary core tier one capital ratio" but that the Barclays chief executive John Varley had telephoned Hector Sants, his counterpart at the FSA, at 4pm on the Sunday to admit that Barclays had decided the deal could not be done.

Varley had told Sants of his bank's ambition to buy Lehman on the previous Wednesday and had made it clear that the bank had three main criteria before proceeding with a bid:

  • a high level of certainty of completion with the necessary support of the Federal Reserve to ensure this
  • liquidity support from the Federal Reserve
  • a discount on Lehman's net asset values.

Sants stipulated that the FSA would need to know what impact the deal would have on Barclays' liquidity and capital and that the regulator would "not countenance a drop in the Barclays core tier one capital" below the minimum set out by the regulator.

Mix-up between London and Washington

"The book, published today, describes in detail what happened on September 13 and 14 last year, when Hank Paulson, the US Treasury Secretary, his successor Tim Geithner — then president of the New York Federal Reserve — and Christopher Cox, chairman of the Securities and Exchange Commission, were battling to prevent the fall of Lehmans. Their plan was for other banks to underwrite its most toxic assets. The investment banking division, the most attractive remaining asset, would then be sold — and Barclays quickly emerged as the leading candidate to buy the business, but, as this exclusive extract reveals, the Financial Services Authority and Alistair Darling had other ideas."

"A breakdown in communications at the highest level between the US and the UK led to the shock collapse of the investment bank Lehman Brothers in September last year, a Guardian/Observer investigation has revealed.

The downfall of Lehman, which triggered the biggest banking crisis since the Great Depression, came after a rescue bid by the high street bank Barclays failed to materialise.

In London, the Treasury, the Bank of England and the Financial Services Authority all believed that the US government would step in with a financial guarantee for the troubled Wall Street bank. The tripartite authorities insist that they always made it clear to the Americans that a possible bid from Barclays could go ahead only if sweetened by US money.

But in Washington, the former Treasury secretary Hank Paulson has blamed Lehman's demise on Alistair Darling's failure to let Washington know of his misgivings until it was too late. Paulson has told journalists that during a transatlantic phone call the chancellor said he was not prepared to import the American "cancer" into Britain – something Darling strongly denies.

With finance ministers and central bank governors from the G20 countries meeting in London on Saturday, the first-hand accounts of those handling last year's events underline a rift between London and Washington over who was to blame for the demise of Lehman, which triggered a month of mayhem on the financial markets.

Lehman's demise sent shock waves around an already fragile financial system and raised fears that any bank, anywhere in the world was vulnerable to collapse. Within three days, HBOS had been rescued by Lloyds TSB. A month later RBS, HBOS and Lloyds were propped up with an unprecedented £37bn of taxpayer funds.

Hector Sants, the chief executive of the Financial Services Authority, said: "I have sympathy for the US authorities given the complexity of the problems they faced that weekend but I do believe it was a mistake to let Lehman's fail." As well trying to find a solution for Lehman, the US authorities were also aware that Merrill Lynch was on the brink and that weekend it was taken over by Bank of America.

While admitting the UK authorities had botched Northern Rock a year earlier, Sants said the collapse of Lehman had more dire consequences. "Without the future market shock created by Lehman Brothers' collapse, RBS may not have failed," said Sants.

"Was Lehman the cause or was it the manifestation? It was our view that if Lehman had been supported you would not have seen such a dramatic reduction in liquidity."

Sir John Gieve, deputy governor of the Bank of England last September, said: "It was a catastrophic error. It caused a loss of confidence in the [US] authorities' ability to handle the financial crisis which really did change things and proved hugely costly."

The UK tripartite authorities – the FSA, the Bank of England and the Treasury – had expected the US government to stand behind Lehman in the way that it had backed two crucial mortgage lenders the previous week and helped to orchestrate the bailout for Bear Stearns in March.

No explanation has ever been given for the lack of government funds offered in the final weeks of the Bush administration, which had to step in to prop up the insurance company AIG days after Lehman's demise.

The UK tripartite authorities were concerned about the financial system in the spring of 2007 and asked their American counterparts to participate in a "war game" to prepare for the collapse of a major US bank and develop a response to a financial crisis. However, the war game, which was to have included the UK, Switzerland, the Netherlands and the US, never took place because of a lack of willingness to participate by the US regulatory bodies.

Timeline of events related to collapse

One year on we look at how the shockwaves from the Wall Street bank's collapse spread around the world

Lehman's whistleblower's letter to management

In May 2008, former Lehman Senior Vice President Matthew Lee wrote a letter to senior management warning that the New York securities firm may have been masking the true risks on its balance sheet. A month later, he had been ousted.

His warning was revealed for the first time in a report by a U.S. bankruptcy-court examiner and showed that Lehman’s auditors knew of potential accounting irregularities and allegedly failed to raise the issue with Lehman’s board. Here is the letter that placed the little-known Lehman executive at the center of allegations that Lehman manipulated its numbers and misled investors.

(See link for full text of letter)

Participants views of the collapse

"My new book, A Colossal Failure of Common Sense, moves to a stark and irrevocable conclusion, that Henry Merritt Paulson, the former U.S. Treasury Secretary, made a fateful decision that within two weeks brought the world's economy to its knees.

He decided to let Lehman Brothers, the 158-year-old Wall Street institution, go bankrupt. He need not have done so. But on that fateful weekend, Sept. 13-15, 2008, he made the decision with which he must live for the rest of his life. He would not save Lehman Brothers. As one senior Lehman managing director told me, "They put Lehman's head underwater and watched for the bubbles." And that did it, globally, as first the U.S. and then the rest of the world swooned.

Since last winter, I have had many hundreds of hours to ponder Paulson's history-making decision, and while I cannot revise the truth, nor in any way let him off the hook, I am drawn to the conclusion that the Treasury boss did not lose the war on that final weekend. He lost it the previous March when he stepped forward and saved the much smaller Bear Stearns, which was in the same leaking boat as Lehman with far worse debt and no hope. Hank Paulson could have let them go, but he did not. He practically frog-marched JPMorgan Chase (JPM) into the arena and ordered it first to loan Bear Stearns a large amount of cash, and then five days later to buy the 86-year-old Wall Street bank.

When Paulson gave the lifeboat to Bear Stearns, it gave Lehman's CEO Richard S. Fuld a deadly, false sense of confidence.

JPMorgan's Behavior Change

Even today, the most clever Lehman minds tell me about a form of schizophrenia that JPMorgan displayed in its dealings with Bear Stearns and later Lehman. Bear was an investment bank almost half the size of Lehman. Yet the Fed and Treasury commissioned JPMorgan and its CEO Jamie Dimon to provide cash infusions to Bear the week before the bank's bailout. JPMorgan became a new tool in Hank Paulson's chest of creative innovations.

Fast-forward to September 2008—and oh how things had changed. Most senior traders and bankers I spoke to from Lehman were shocked at the new demeanor of JPMorgan, the split personality that Lehman was now experiencing like a bayonet in the back. JPMorgan was in a foul mood of sorts. Injecting aid, a cash infusion for Lehman? No, JPMorgan was now demanding weekly increases in the collateral that Lehman would have to put up in order to secure short-term loans to run its businesses. This suffocated the 158-year-old investment bank. It put her to sleep.

But what, I ask, would have happened if Paulson had simply stepped aside and let Bear Stearns collapse into bankruptcy back in March? I'll tell you the first thing: Dick Fuld would probably have had a heart attack. "If he can let Bear Stearns go, he can let us go."

And what would have been the natural progression? Fuld would have had no options. Mired in debt, holding billions and billions of unsellable assets, already entering its death throes, Lehman would then have had only one way out: to accept the offer about to be made by the Korea Development Bank, which when it materialized was around $23 a share. Fuld might have been way out of his depth in 21st century finance. But he was nobody's fool, and he had a sense of self-preservation second to none. He would have accepted the Korean money in seven seconds, particularly since Paulson himself never stopped urging him to do so right until the men from the Far East withdrew as Labor Day arrived...

...Hank Paulson and then New York Fed chief Timothy Geithner have argued that Bear Stearns had to be saved because systemic defense mechanisms protecting the markets had not been set up yet. Well, a fool could tell you the adequate mechanisms were not set up when Lehman failed, either. If Hank had let Bear go, the world would have looked very different.

Bankruptcy filing

Lehman Brothers filed for Chapter 11 bankruptcy protection on September 15, 2008. According to Bloomberg, reports filed with the U.S. Bankruptcy Court, Southern District of New York (Manhattan) on September 16th indicated that J.P. Morgan provided Lehman Brothers with a total of $138 billion dollars in "Federal Reserve-backed advances." The cash-advances by JPMorgan Chase were repaid by the Federal Reserve Bank of New York for $87 billion on September 15th and $51 billion on September 16th.[13]

The Guardian's economics editor sets out the five things you need to know about the current economic crisis in the light of Lehman Brothers' liquidation

Lehman sale details weren’t approved, judge says

  • Source: [Lehman Brokerage Unit Sale Details Weren’t Approved, Judge Says] Bloomberg, October 22, 2010

Final details of the distribution of billions of dollars of assets as part of Barclays Plc’s purchase of Lehman Brothers Holdings Inc.’s brokerage unit were never approved, the judge in the bankruptcy case said.

“Let me be clear about one thing, Mr. Boies,” U.S. Bankruptcy Judge James Peck told Barclays’ lawyer David Boies yesterday. “I never approved the clarification letter,” one of about 12,000 documents filed in the case.

Peck had interrupted Boies as he began closing arguments in the $11 billion trial in Manhattan. The lawyer said the judge had no legal basis for reopening his own sale order because all details of the deal were known at the time. That included a so- called clarification letter allocating extra assets to Barclays.

Lehman, which accuses Barclays of making an $11 billion “windfall” when it bought the brokerage in the 2008 financial crisis, is trying to convince Peck that he has grounds for overturning his own order approving the sale. Peck didn’t indicate what effect his statement would have on the details of the brokerage sale

Lehman settles JPM’s $7.68bn claim

Failed financial firm Lehman Brothers is to pay JPMorgan $557 million and allow the bank to retain $7.1 billion in collateral as part of a settlement for a bankruptcy filing.

According to court documents, JPMorgan is planning on transferring illiquid securities worth several billion dollars back to the collapsed bank.

The filing relates to the period before the bankruptcy of Lehman Brothers when JPMorgan worked as the clearing bank on behalf of the struggling institution’s brokerage unit.

JPMorgan required the banking offshoot to pledge collateral to act as a guarantee for borrowed funds.

A claim for over $29 billion was filed against Lehman Brothers in September 2008 after the collapse - the amount was reduced over time by JPMorgan drawing on the collateral.

The new financial agreement is expected to settle the outstanding balance of the filing.

Kimberly Macleod, Lehman Brothers spokeswoman, was quoted by Bloomberg as saying: “The settlement allows Lehman to more efficiently manage billions of dollars worth of its illiquid assets thereby maximizing the return on those assets for the benefit of its creditors.

“The parties to the settlement have reserved all rights with respect to claims they have against each other.”

Both sides have retained the right to dispute claims in the future while the arrangement is yet to receive approval from the court.

Weil, Gotshal & Manges account of bankruptcy filing

Exactly a year ago, banking behemoth Lehman Brothers Holdings Inc. crumbled, its Chapter 11 filing sending shockwaves across the world economy. A select few lawyers were at Ground Zero of the implosion. Among them was Lori Fife, a business finance and restructuring partner at Weil, Gotshal & Manges, Lehman's bankruptcy counsel. Along with Weil bankruptcy legend Harvey Miller, Fife has been on the case for the past year.

To mark the one-year anniversary of the bankruptcy filing, The Am Law Daily spoke with Fife about the events surrounding Lehman's fall, and about what could have been done to stop it.

Hi Lori. To start, can you tell us how you first got involved in the Lehman case?

I was actually in the office that Saturday [September 13]. . . . I was in to prepare for a speech I was going to give. And I got an email from Harvey Miller. All the partners in the department did. He asked if anyone could help, that there was an emergency.

Did he say what type of emergency?

No, he didn't. I had an idea that it related to Lehman, ... [but] I wasn't positive. The email asked for volunteers, I volunteered. I had absolutely no idea what I was getting myself into.

Did you have any idea that Lehman might be filing for bankruptcy?

Absolutely not. I never worked on a Lehman matter. Lehman was always a very large client of the firm's, but I never had any dealings with them before. So I went to Harvey's office. Inside Harvey's office were senior partners. And they told me that the situation with Lehman was getting more serious and that they needed additional partners [on the case].

You said you already had an idea that something was going on with Lehman?

I was aware generally from the newspapers that Lehman was in crisis and that there were discussions with other institutions about potential mergers. I certainly did not expect Lehman to file for bankruptcy two days afterwards.

So at that point, the conversation with Harvey Miller wasn't necessarily, "Lehman is filing for bankruptcy," it was more like, "this situation is getting very serious."

Very serious...I was told, "We don't know what's going to happen with the merger discussions, with the government. We do need to prepare for some sort of potential Chapter 11 filing." But we are often retained by clients to prepare for a potential Chapter 11--which often doesn't happen. . . . So it was just sort of a prudent thing to do, given the circumstances.

What was your level of preparation for a possible bankruptcy? What was Lehman's?

Lehman didn't expect to fail. So they weren't spending weeks preparing for a Chapter 11 case. They were focusing on trying to save themselves in so many other ways. And when I got involved, I learned that we really weren't prepared to file for Chapter 11, if in fact we needed to.

What do you mean when you say that Weil, Gotshal wasn't prepared to file at that point?

We didn't have sufficient information to actually file Chapter 11 in a sort of controlled way.

Sufficient financial information?

Usually a company the size of Lehman has financing lined up before it files for Chapter 11, and this company certainly didn't have that. It didn't have any sort of plans in place. We normally take weeks, if not months, to actually plan a controlled Chapter 11 case... But putting aside planning, we didn't have any facts...Nobody at Lehman was spending the time that was necessary to give us information.

What happened on Saturday was, we had a short meeting with the SEC...And they wanted to get a sense as to what our plans were and where we were in the planning stages for Chapter 11. And we told them that we were nowhere. That Lehman had no plans to file for Chapter 11. That we fully expected that there would be some other bow-out or merger. Or something else. At that point, Barclays was still very much a real possibility and Bank of America was still a possibility, too. And still there was a spin-off possibility.

What happened the Sunday before you filed?

We came back very early [Sunday] morning to prepare for what was going to be a Lehman board of directors meeting at noon. I think the board was originally scheduled to discuss the various alternatives [for the company].We learned at that point that Barclays was no longer an alternative. So now things were getting more serious. Things at Lehman were getting very tight. We were in frequent conversations with governmental agencies. People in our offices started to kind of gear up.

Gear up in what way?

You have to understand that Lehman is actually thousands of entities across hundreds of countries. And one of the key decisions that, as attorneys, you have to work on is what entities to file [for bankruptcy]? Is it Lehman Brothers Holdings Inc., which is the parent entity? Or Lehman Brothers Inc., which, as a broker-dealer, cannot file for Chapter 11? You have hundreds of different affiliates in different countries. So we were getting calls from England and France...Things were getting very, very crazy. Were you in contact, at this point, with higher-level officials at the Treasury Department and at the Federal Reserve?

It started to get more high-level. And then a decision was made that we should all meet in person. So Harvey Miller, [Weil Gotshal corporate department cochair] Thomas Roberts, [Weil, Gotshal Chief Executive] Stephen Dannhauser, and myself went down to the Fed. And that was sort of like the first time I kind of started to say, "Well, this is kind of momentous."...And we walked in and [Citigroup CEO Vikram] Pandit walked out. And we knew a lot was going on.

Who did you meet with at the Fed?

People from SIPIC [the Securities Investor Protection Corporation] and people from the FTC and people from the Fed. . . . [SEC chair] Chris Cox [was there]. And the Lehman people, who I had never met before. We had a meeting with them and we basically tried to convince them to sell the company. The Lehman people tried to show [the government officials] that [there was] sufficient collateral in order for them to provide Lehman with funds to support the company.

So you were essentially pleading with the government not to let Lehman fail?

Yeah, totally.

At what point did you realize that the government felt Lehman should just be allowed to go under?

It became pretty clear in that meeting that they weren't interested in providing any funding for Lehman.

The government can't instruct you to file for bankruptcy. But they essentially came in and told you that that's what they strongly suggested, right?

Pretty much. And [after that meeting] we left [the Fed], and we went to Lehman [headquarters] and to the Lehman board meeting, and the business people reported on what had happened during the day. And in the middle of the meeting, Chris Cox interrupted the meeting--well, [Lehman CEO] Dick Fuld got a message through his secretary that the government wanted to interrupt our board meeting. And they did. And somebody [in the meeting] said, "Are you telling us to file [for bankruptcy]?" And [Chris Cox] took a break, and I think he spoke to his lawyer. And I think his lawyer probably told him, "You can't do that." He got back on and he said, "No, but..." It was a very, very strong suggestion.

Then we got back to the office and we began to basically prepare the papers to file. And by that point we had made a decision that if we had to file we would just file the holding company. And we basically filed a very, very skinny petition. You know, it was very minimal paperwork. And so we got back, and we ended up filing at maybe 2 or 3 o'clock in the morning that Monday [September 15].

Did it start to feel at all surreal at this point?

The whole thing was very surreal...Really from the moment we got to the Fed and after that. And particularly coming back after the Fed to Lehman for the board meeting.

What do you think, now that you've had a full year to look back on it all?

It's very unfortunate that the government didn't help Lehman. And I think that we've all witnessed the effects of it. And I think in retrospect, it's clear that they made a mistake.

During this period, did you have a sense that the Lehman bankruptcy would have major ramifications for other financial institutions?

I didn't anticipate that it would lead to a global financial crisis, but we certainly did recognize that it would have very broad implications and we tried to tell that to the governmental agencies. And we did say that, and they just didn't listen. They just didn't pay attention. I mean, we understood the complexity of the [financial] transactions that Lehman was involved in prior to the commencement of the case.

The government must have known the same thing you did.

Sure they did. And I don't understand why they didn't understand how difficult it would be to unwind all of these transactions.

So you were looking at this potential bankruptcy and thinking that the government's plan to let Lehman fail could have major implications.

Exactly. And we kept saying "this could be done in a much better way." I mean, if the government could have at least loaned us the money to do [the bankruptcy] in a planned way--like a soft landing into Chapter 11--we could have avoided so many of the issues that the whole world faced...We could have done so many different things in Chapter 11. Like sales of assets in a planned way, as opposed to this rushed [proposed] Barclays sale. Or splitting up the company, or creating a good company and a bad company. There were a lot of different strategies they could have pursued.

Any number of things the government has done with much smaller companies...

Exactly, but why not with Lehman?

Breakup process

On September 20, 2008, a revised proposal to sell the brokerage part of Lehman Brothers holdings of the deal, was put before the bankruptcy court, with a $1.35 billion (£700 million) plan for Barclays to acquire the core business of Lehman Brothers (mainly Lehman's $960 million midtown Manhattan office skyscraper), was approved. Manhattan court bankruptcy Judge James Peck, after a 7 hour hearing, ruled: "I have to approve this transaction because it is the only available transaction. Lehman Brothers became a victim, in effect the only true icon to fall in a tsunami that has befallen the credit markets. This is the most momentous bankruptcy hearing I've ever sat through. It can never be deemed precedent for future cases. It's hard for me to imagine a similar emergency."[14]

Luc Despins, the creditors committee counsel, said: "The reason we're not objecting is really based on the lack of a viable alternative. We did not support the transaction because there had not been enough time to properly review it."

In the amended agreement, Barclays would absorb $ 47.4 billion in securities and assume $ 45.5 billion in trading liabilities.

Lehman's attorney Harvey R. Miller of Weil, Gotshal & Manges, said "the purchase price for the real estate components of the deal would be $ 1.29 billion, including $960 million for Lehman's New York headquarters and $ 330 million for two New Jersey data centers. Lehman's original estimate valued its headquarters at $ 1.02 billion but an appraisal from CB Richard Ellis this week valued it at $900 million." Further, Barclays will not acquire Lehman's Eagle Energy unit, but will have entities known as Lehman Brothers Canada Inc, Lehman Brothers Sudamerica, Lehman Brothers Uruguay and its Private Investment Management business for high net-worth individuals. Finally, Lehman will retain $20 billion of securities assets in Lehman Brothers Inc that are not being transferred to Barclays.[15]

Barclays had a potential liability of $ 2.5 billion to be paid as severance, if it chooses not to retain some Lehman employees beyond the guaranteed 90 days.ap.google.com[16]

On September 22, 2008, Nomura Holdings, Inc. announced it agreed to acquire Lehman Brothers' franchise in the Asia Pacific region including Japan, Hong Kong and Australia.[17]

The following day, Nomura announced its intentions to acquire Lehman Brothers' investment banking and equities businesses in Europe and the Middle East. A few weeks later it was announced that conditions to the deal had been met, and the deal became legally effective on Monday, 13 October.[18]

In 2007, non-US subsidiaries of Lehman Brothers were responsible for over 50% of global revenue produced.[19]

Cross-border Bank Resolution Group recommendations (Lehman)

4. Lehman Brothers

Regulation and Business Structure

49. The Lehman Brothers group consisted of 2,985 legal entities that operated in some 50 countries. Many of these entities were subject to host country national regulation as well as supervision by the Securities and Exchange Commission (SEC), through the Consolidated Supervised Entities (CSE) programme in the United States. Under this programme, the SEC monitored the ultimate holding company of the group, Lehman Brothers Holdings, Inc (LBHI). The CSE programme met the provisions of the EU’s Financial Conglomerates Directive and allowed the US investment banks to operate in Europe subject to SEC supervision. The CSE programme also included the requirement that LBHI maintain regulatory capital in accordance with a capital adequacy measure computed under the Basel II Framework and addressed liquidity risk.

50. The Lehman structure was designed to optimise the economic return to the group whilst achieving compliance with legal, regulatory and tax requirements throughout the world and enabling the firm to manage risk effectively. It consisted of a complicated mix of both regulated and unregulated entities. The flexibility of the organisation was such that a trade performed in one company could be booked in another. The lines of business did not necessarily map to the legal entity lines of the companies. The group was organised so that some essential functions, including the management of liquidity, were centralised in LBHI. Structures of this complexity are common in large international financial institutions.

Resolution of a large cross-border financial institution - liquidity

51. An effective and orderly resolution of a large cross-border financial institution, while maintaining its key operations, requires a source of liquidity so that the firm can meet its ongoing trading and other commitments while it winds itself down or seeks an acquirer. This is demonstrated by the contrasting fates of the US broker-dealer (LBI), which did not immediately file for bankruptcy, and the London investment firm (LBIE). The Federal Reserve Bank of New York agreed to provide liquidity to LBI in order to effect an orderly wind-down outside of bankruptcy which ultimately resulted in the purchase of certain assets and assumption of certain liabilities by Barclays Capital. LBIE, however, relied on LBHI (the holding company) for liquidity, which ceased to be available when LBHI filed for bankruptcy. The ultimate outcome was that LBHI, the remainder of LBI not acquired by Barclays Capital, and LBIE are being wound down by insolvency officials who are experiencing a myriad of challenges. LBHI subsidiaries in jurisdictions such as Switzerland, Japan, Singapore, Hong Kong, Germany, Luxembourg, Australia, the Netherlands and Bermuda are also undergoing some type of insolvency wind-down proceedings in their respective jurisdictions. Coordination among these proceedings has been limited, at best.

Based on the Lehman experience, the following factors are particularly relevant to effective crisis resolution:

  •  If an acquirer for the entire firm can be found in an appropriate timescale, trading counterparties and other parties providing short-term funding will expect some sort of guarantee in the interim for them to continue to do business with the firm until the transaction closes – this can be challenging to achieve in a tight timeframe;
  •  As the amounts of liquidity needed are likely to be sizable, governmental resources may be required;
  •  For international firms and groups of this degree of complexity, a prepared, orderly resolution plan would be of great assistance to the authorities;
  •  Monitoring by regulators and the interplay of insolvency regimes are important;
  •  Group structures create interdependencies within the organisation that responsible regulators need to understand and monitor for both going concern and gone concern purposes;
  •  In the event of the failure of a cross-border financial institution, once the relevant component entities enter into insolvency proceedings the insolvency regimes applicable to the major entities are likely to be separate proceedings, serving different policies, with different priorities and objectives; and
  •  These differences continue to make coordination and cooperation among insolvency officials difficult as such coordination and cooperation may conflict with the duties of the officials to an entity’s creditors. To do their job effectively, insolvency officials may need access to information and records that are part of an insolvency proceeding in another jurisdiction.

Problems with returning client assets and monies

52. Even where the legal regime protects client assets and client monies held by a financial institution, the ability of those clients to quickly access their assets once insolvency proceedings begin is affected by a number of factors including:

  •  The institution’s record-keeping;
  •  Other claims the institution or its affiliates may have against the client;
  •  Sub-custody or other arrangements with affiliates that are also in insolvency proceedings; and
  •  The duties of insolvency officials to creditors generally.


53. For a large, complex financial institution there are multiple “home” and “host” regulators. Considering the speed at which a crisis can evolve it can be difficult for all interested authorities to communicate effectively and have access to information and actions taken in other jurisdictions which are relevant for their markets.

Settlement of credit default swaps

On October 22, 2008, those creditors of Lehman Brothers who bought credit default swaps to hedge them against Lehman bankruptcy settled those accounts. The net payments were $5.2 billion[20] even though initial estimates of the amount of the settlement were between $100 billion and $400 billion. [21]

Lehman seeks $10bn clawback in Barclays suit

"Attorneys representing the estate of Lehman Brothers filed a lawsuit on Monday against Barclays Capital, seeking to claw back as much as $10bn (£5.9bn) that it claims was transferred to the UK bank last year in the frenzied days following Lehman’s bankruptcy.

The suit is the culmination of a one-year quest by Alvarez and Marsal, the consultancy hired by Lehman following its sudden bankruptcy filing in September 2008, to determine whether billions of dollars worth of assets were improperly transferred to Barclays when it negotiated a deal to acquire the remains of Lehman.

Less than a week after Lehman filed for bankruptcy protection on September 15, 2008, Barclays received approval from the bankruptcy judge overseeing Lehman’s case to acquire the investment bank’s North American assets and its Manhattan headquarters for $1.75bn.

Alvarez and Marsal claims in the lawsuit that amendments to the preliminary contract approved by the bankruptcy judge created loopholes that ultimately facilitated the transfer of several billion in assets.

In approving the original contract, they claim, the court would have not been aware that the revised contract would allow for several billion dollars in additional assets to be transferred. To support their claim, Lehman’s executors state that Barclays transferred $45bn in cash to Lehman after the bankruptcy in return for $50bn in securities, with the understanding that Lehman would be able to reverse the transaction at a future date.

Barclays’ acquisition of Lehman’s assets has been widely regarded as a coup for the London bank. This year, Barclays reported a net gain of $4.2bn on the value of the assets it acquired through Lehman.

Barclays has not commented on the matter. Following previous legal actions by Alvarez and Marsal, the UK bank has maintained that the entire transaction was lawfully approved by the judge.

Barclays alleged to 'profit from Lehman assets'

"For those interested in the implications of our observations of the Barclays-Lehman transaction as they pertain to the Federal Reserve's discount window, we recommend skipping to Part 2.

Part 1: The Lehman "Blue Light Special"

It is becoming increasingly likely that Barclays will have to pay a cool $5 billion (at least) in additional consideration to the Lehman estate, after the Official Committee of Unsecured Creditors came out yesterday with a hefty joinder piece to the debtor's motion that Barclays materially misrepresented and, in essence, stole $5 billion or more from under the noses of both Lehman Brothers Holdings and its Creditors...

...A filing by the OCC provides a very good summary of the five purported axes of scammery that the Barclays' pickpockets were hoping to effectuate under the "End is Nigh" guise of systemic collapse, and the need for a quick transaction closing, no matter what the cost to Lehman:

  • Implied $5 Billion Discount. Unbeknownst to the Court or the Committee, early in the negotiations, Barclays and the Lehman Sellers agreed to give Barclays a $5 billion discount from the transferred assets' book value. Indeed, evidence suggests the $70 billion figure contained in the Asset Purchase Agreement ("APA") was not the value on the Lehman Sellers' books at all. Instead, it was a "negotiated" number with an embedded $5 billion discount. This discount was not disclosed in any of the transaction documents given to the Court.
  • Significant Structural Changes To Sale Transaction. The APA contemplated Barclays would acquire the North American broker dealer operations by purchasing certain of its assets and the liabilities relating to those assets. However, on September 17, 2008, the Federal Reserve Bank of New York (the "Fed") insisted that Barclays assume the Fed's obligations to provide financing to LBI. The Fed had financed LBI through a repurchase agreement (the "Fed Repurchase Agreement"). Barclays agreed to step into the Fed's position and entered into its own repurchase agreement with LBI (the "Barclays-LBI Repurchase Agreement"), which replaced the
  • Fed Repurchase Agreement. As is common in financings of this type, the Fed Repurchase Agreement contained an approximately $4.4 to $5 billion cushion or haircut in valuing the assets in relation to the liabilities. Barclays agreed to provide $45.0 billion in funding, which LBI would secure with assets worth at least $50 billion. After executing and filing the APA, the parties ultimately decided to transform the Barclays-LBI Repurchase Agreement into an asset sale, with Barclays keeping all of the collateral pledged under the Fed Repurchase Agreement (the "Fed Portfolio") — which contained not less than $5 billion additional collateral beyond the $45.0 billion that Barclays was required to advance, i.e., the haircut.
  • Mad Dash For Unencumbered Assets. Not satisfied with the $5 billion cushion, beginning on Friday September 19, 2008, Barclays demanded that the Lehman Sellers transfer billions of dollars more additional assets. The search for these assets continued after the Sale Hearing, and included (a) no less than $1.9 billion of unencumbered securities in the "non-actionable" box, (b) 15c3 Securities valued at between $750 million and $800 million and (c) an undisclosed amount of collateral supporting the OCC Accounts and other exchange-traded accounts (valued at approximately 2.3 billion).
  • Overstated Liabilities. The evidence also reveals that Lehman and Barclays intentionally overstated the Cure and Compensation Liabilities to foster the impression that Barclays was assuming greater liabilities. The APA Scheduled these amounts at $2.25 billion and $2.0 billion respectively. In reality, the estimates of the liabilities were only approximately $1.3-$1.7 billion.
  • Conflicts Of Interest In Negotiations. The Lehman Sellers' teams negotiating on behalf of the estates were steeped in personal conflicts of interest. Several of the negotiators for the Lehman Sellers either negotiated their employment agreements in the midst of the Sale Transaction negotiations or at least knew that they would be transferred to Barclays.

Barclays Capital received an $8.2 billion "windfall profit" when it took control of excess Lehman Brothers assets a year ago, it has emerged.

Court papers submitted on Tuesday by Lehman Brothers Holdings argue that Barclays gained assets it was not supposed to receive during the deal, due to the fact that "critical changes" to the agreement were made between the sale order being signed and the transaction being concluded.

Lehman executives agreed to give Barclays a $5 billion discount on the book value of the securities that the bank was acquiring, the document said, with the rest of the money being handed over at a later date at Barclays's request.

"The deal was actually structured to give Barclays an immediate and enormous profit windfall," Lehman stated.

"Lehman Brothers Holdings Inc. executives who negotiated the sale of the bank’s North American brokerage business to Barclays Plc knew they were giving the U.K.-based bank a $5 billion discount, Lehman said in court.

Executives including Ian Lowitt, Paolo Tonucci and Bart McDade knew that Barclays was getting securities valued at about $50 billion for $45 billion in cash, according to a September motion unsealed Oct. 15 in U.S. Bankruptcy Court in New York in which Lehman asked for the return of some assets.

Some executives negotiating the deal knew they would receive offers to work at Barclays after the sale, Lehman said, citing e-mails and deposition testimony. The salaries offered were blacked out.

“I was aware that the -- that Barclays was going to purchase a substantial block of assets for less than the amount that we had on our books to reflect a sort of bid offer that reflected both the size of the purchase, as well as inherent volatility in the market, which was significant that week,” Lowitt, Lehman’s chief financial officer at the time, testified, according to the documents.

A Barclays Capital spokeswoman, Kerrie-Ann Cohen, and Kimberly Macleod, a Lehman spokeswoman, declined to comment. Lowitt declined to comment through a spokesman. Tonucci, then Lehman’s global treasurer, didn’t respond to messages seeking comment. McDade, then the bank’s president, couldn’t be reached.

Lehman’s assets were under the control of the bankruptcy court when Barclays paid $1.54 billion for them in a sale that closed Sept. 22.

Facts Held Back

“Material components” of the deal were kept from U.S. Bankruptcy Judge James Peck, who approved the sale, Lehman said, giving Barclays an “immediate and enormous windfall profit” that may have exceeded $8.2 billion when liabilities Barclays assumed are taken into account.

Lehman filed the largest bankruptcy in U.S. history on Sept. 15, 2008, with assets of $639 billion.

The collapsed bank asked to revise the deal and be allowed to pursue claims for breach of contract, breach of fiduciary duty and unauthorized transfer of assets. The request is supported by Lehman’s unsecured creditors and James Giddens, the trustee liquidating Lehman’s brokerage on behalf of the U.S. Securities Investor Protection Corp.

The fight between Barclays and Lehman’s creditors over the value of assets transferred is set to last well into next year. Peck said Oct. 15 he wanted to hear live testimony rather than rely completely on depositions. He advised parties to discuss May trial dates.

Regulators’ Support

Government regulators supported the speedy sale to Barclays at the time in an effort to calm global securities markets. Some Lehman creditors fought it, saying the deal was moving too quickly and London-based Barclays was underpaying.

Lehman and Barclays held talks about an acquisition by the U.K. bank in the days before Lehman’s bankruptcy, without agreeing on a deal. Within hours of the court filing, Barclays approached Lehman and negotiated an agreement “very quickly” as the value of Lehman’s assets tumbled, according to court papers.

During a hearing on the deal before Peck, negotiators changed some terms without disclosing them to the court, according to Lehman’s filing by attorneys at Jones Day.

Lehman asked in May for permission to investigate whether Barclays got too good a deal after the U.K. bank’s financial results for 2008 showed a gain of 2.26 billion pounds ($3.72 billion) from the acquisition of Lehman’s North American operations.

The case is In re Lehman Brothers Holdings Inc., 08-13555, U.S. Bankruptcy Court, Southern District of New York (Manhattan)

Most creditors to receive 15 cents on $

Mission unaccomplished] The Economist, September 9, 2010

AS THE second anniversary of Lehman Brothers’ bankruptcy approaches, economists continue to debate whether the bank could or should have been saved. Its creditors and former clients are focused on the more practical question of what can be salvaged from the wreckage.

With over $600 billion of assets, Lehman was America’s largest and most complex corporate failure. Since then, Alvarez & Marsal (A&M), a restructuring firm, has been winding down Lehman’s holding company, untangling derivatives contracts and assessing more than 65,000 claims from clients, counterparties and other creditors. It has 200 people working on the derivatives book alone. PricewaterhouseCoopers (PWC) is leading a similar effort at Lehman’s main European arm.

One of the biggest tasks is to weed out the weakest claims, some of which are “very aggressive”, says Bryan Marsal, co-head of A&M and chief executive of Lehman Brothers Holdings. Its plan envisages approval of $260 billion of claims, a mere quarter of the total filed. Adding to the confusion, the 20 or so Lehman entities around the world have put in vast claims against each other. A big slice of this is “guarantee claims”, or debts that affiliates argue the holding company had backstopped (see chart).

Lehman units are also chasing third parties. The holding company is seeking up to $11 billion to compensate for the windfall allegedly made by Barclays when it snapped up Lehman’s American operations just after it went bust. A suit against JPMorgan Chase, over collateral calls the bank made on Lehman in the weeks before its demise, is due to go to trial in 2012...

... Ultimately, Lehman creditors can expect to retrieve as little as 15 cents on the dollar. Some fear that lawyers and other professionals are milking their misery. Their fees could reach $1.5 billion, double the take in the Enron case. The professionals say that creditors should not look at absolute numbers. As of March, administrators’ costs for Lehman’s London arm amounted to 0.65% of assets recovered. That sounds more palatable than $315m.

Lehman, Synthetic CDOs and bankruptcy

The Lehman bankruptcy court is out with a new decision that has the financial community somewhat miffed, since it removes one more piece of their mistaken belief that they don't have to understand or deal with the Bankruptcy Code. The decision will also lead to some interesting discussions with members of the English bench, who reached a contrary decision with regard to the same issue and parties. I'm extending an open invitation to all the judges to join me for coffee and bagels at my apartment on the UES to sort things out.

I've represented the transaction in question, which involved the issuance of synthetic CDOs, in this simplified diagram. The key thing to understand is that under the terms of the deal, which contains an English choice of law clause, the priority rights to the collateral switch if there is a Lehman default under the CDS contract. And Lehman Brothers Holding's chapter 11 filing in September 2008 constituted a default, since Holdings was a "credit support provider" under the terms of the CDS contract. The CDS buyer, LBSF, also filed a chapter 11 case of its own in October 2008, resulting in another default.

The other thing to understand is that there are reportedly about 1,000 similar Lehman transactions waiting in the wings.

The US bankruptcy court held that the collateral priority switch was an unenforceable ipso facto (bankruptcy termination) clause, and that the derivative "safe harbor" provisions in the Code did not apply.

The UK Court of Appeal, affirming a decision of the High Court of Justice, reached the exact opposite conclusion, holding that the deal did not violate the "anti-deprivation rule," which is essentially their rule against ipso facto clauses, based on a case from 1818.

(How we ended up with the pseudo Latin, when their rule is from 1818 and ours is from 1978, I don't know.)

My thoughts on the bankruptcy court decision, and the conflict with the prior decision from the UK, after the jump.

To my mind, the central part of the bankruptcy court's opinion comes at page 16, where the court begins to discuss the debtor's (LBSF) estate. Noting that the priority "flip" was not automatic, but rather turned on several administrative steps not completed in the time between Holding's chapter 11 filing and the LBSF petition date, the court held that the debtor had not yet lost its rights in the collateral upon bankruptcy. And for those readers who are thinking that the answer is to automate the collateral flip in the next deal, the court also notes that neither §365(e)(1) nor §541(c)(1)(B) -- the Code provisions invalidating bankruptcy terminations clauses -- require that a clause be triggered by the debtor's bankruptcy. Rather a clause triggered by any bankruptcy filing would seem to be invalidated by these provisions -- of course, the party seeking to invoke either statutory provision would have to find themselves in bankruptcy at some point to assert such an argument.

However, there is one obvious transactional lessen from the opinion. Namely, the court refused to apply the safe harbors, particularly §560, to the agreements in question because the collateral documents, including the priority flipping provision, were not even referenced in the CDS documentation. That is, the collateral agreements were not protected contracts. This suggests the need for a more "bespoke" CDS contract in future CDO deals, although that response supports the notion that the safe harbors are overbroad and in need of repeal.

What of the conflict between the High Court, the Court of Appeal and the New York bankruptcy court? The Court of Appeal's decision seems to place a lot of weight on the notion that the priority flip provision was somehow different from typical bankruptcy termination clauses, because it had been in place since inception of the deal, and thus Lehman's rights in the collateral were always contingent. The lead opinion also ascribes some import to the notion that it was the noteholder's funds that purchased the collateral in the first instance.

The first argument seems rather slippery, and would, if adopted in the U.S., convert the rule against bankruptcy termination clauses into a rule against subsequent acquisition of a bankruptcy termination clause -- which largely duplicates the work of the rules against preferences and fraudulent transfers. The collective nature of an insolvency proceeding would seem to argue against such a wide-open grant of contractual autonomy.

The second argument, based on the source of funds for the collateral, in some sense cuts the other way. That is, it gives special rights to a purchase money provider, even if they failed to exercise the special rights that such providers are already provided under debtor-creditor law (at least under US state laws like UCC article 9).

The courts also disagree on the significance of the gap between Holdings' chapter 11 filing and LBSF filing. Apparently the English courts have tended toward ease of administration in their anti-deprivation rule, eschewing the American court's notion that a contract might be incompletely terminated before bankruptcy. Under the English approach, it appears that a contract is either terminated before bankruptcy or it's not -- there is no middle.

Fundamentally, the problem is that contract law is state law, while bankruptcy in the United States is federal and thus subject to the Supremacy Clause of the Constitution. An important thing to think about whenever one uses an English choice of law clause in a deal where a default is likely to result in a U.S. chapter 11 case. In this case, the choice of law clause served to override New York contract law, but it did nothing to trump federal bankruptcy law, which rather routinely rides over contractual provisions.

Leaving the English courts to wonder why they even bothered, I suppose.

JP Morgan and Lehman collateral calls

A COURT-APPOINTED investigator is this week expected to shine fresh light on the role of JP Morgan and other financial institutions in the events running up to the collapse of Lehman Brothers, the American investment house.

Anton Valukas, a whitecollar crime specialist who played a leading role in the Conrad Black fraud investigation, was recruited by a New York bankruptcy court. His long-awaited report, which is understood to run to more than 1,000 pages, should be published this week.

It will focus on whether JP Morgan, Lehman’s main short-term lender, dealt a fatal blow to the bank by increasing collateral demands on loans in the days immediately before its demise.

Valukas’s findings will be pored over by all those who lost money in Lehman’s collapse, and by the Lehman estate, which holds the bank’s residual assets and is charged with recovering money for creditors. According to one source, the estate, which represents the interests of all the bank’s creditors, is planning to launch a $17 billion (£11 billion) claim against JP Morgan.

That would mirror a complaint lodged with the court by the bank’s creditor committee in the immediate aftermath of the bankruptcy filing. This claim, made in October 2008, cites the $17 billion figure as the amount of Lehman cash and securities that JP Morgan “froze” in its final days, precipitating the largest collapse in corporate history.

JP Morgan has emerged as one of the strongest survivors of the credit crunch. Last week it paid its boss, Jamie Dimon, a $17m bonus. If it is singled out in the report, it could trigger multi-billion-dollar claims from Lehman’s creditors and bondholders. One bondholder said: “This is just the first move. We will be going after JP Morgan for a long time.”

The investigation will also look at whether the Federal Reserve got preferential treatment as a creditor. Before Lehman filed for bankruptcy, the Fed lent it $46 billion in cash and securities. This was repaid promptly while other debts running into tens of billions of dollars have been left to be resolved in court.

Lehman UK arm to sue for $100bn

"Administrators of the London arm of Lehman Brothers, the Wall Street bank that collapsed a year ago, are preparing a $100 billion (£61.5 billion) claim against its former parent company in America.

The demand, which is being finalised by Price Waterhouse Coopers (PWC), Lehman’s UK administrator, will be lodged in the next few weeks. It will mark an acrimonious new stage in the international battles by creditors to recover billions still tied up in the largest corporate collapse in history.

Lehman owed $613 billion when it imploded last September. Liquidators in New York have since been sorting through the wreckage to set up a system to repay creditors and collect money from debtors. The US bankruptcy court has set a September 22 deadline for all creditors to file their claims.

John Suckow, president of Lehman Brothers Holdings — the remains of the US parent company — and a managing director at liquidator Alvarez & Marsal, is braced for a deluge of claims. The one from the London arm, which was the largest operation outside America, is likely to be the biggest.

Tony Lomas, one of the partners at PWC leading the case, said he will file on behalf of “more than 100” Lehman units that fall under the London umbrella. “On the face of it guaranteed most of the obligations of other subsidiaries so we’re going to be filing claims in the many tens of billions. It will be close to $100 billion,” he said.

The London claim will add to tensions between American and British administrators. Earlier this month, Alvarez & Marsal brokered an agreement with 13 other Lehman liquidators around the world.

The deal sets a protocol to share information on claims and assets with the hope of speeding up the reconciliation process and avoiding litigation. PWC declined to participate.

“Why you’d enter into an agreement with a bunch of other parties that you’ll probably end up litigating against is beyond conception,” said Steve Pearson, another PWC partner working on the case.

“We’re talking about billions of dollars. To sit in a room and say, ‘we’re all going to be nice to each other’, is almost certainly the wrong thing to do.”

Alvarez & Marsal’s Suckow added: “A lot of this case will come down to resolving claims made by other Lehman entities. We’re expecting a lot of duplicates. There’s a good chance that the parts will be greater than the whole.”

When the US parent filed for bankruptcy protection, it in effect severed relations with its businesses outside America.

Subsidiaries of the group famous for its “One Firm” ethos were transformed into creditors and debtors that were hit with claims running in the billions — there are 76 different court proceedings taking place around the world.

As the ultimate guarantor of the deals they did, including billions on inter-company loans and share trades, the former Lehman businesses will argue that the US parent should pay.

At the time of its collapse, Lehman had $639 billion in assets on its books. These included everything from real estate to office equipment. The most tangled element is the more than 1.7m “hung trades” to which Lehman was a party — transactions in shares or instruments such as derivatives that were frozen when the company collapsed.

The process of establishing the aggregate claim of any one entity, which may have had thousands of trades, some in the money, some showing a loss, is monumentally involved. Creditors have until November 2 to file more complex derivatives claims.

“We’re an asset management company now,” said Suckow. “Come September 22, it will be a question of sorting the good claims from the bad.”

Bebchuk et alia on executive compensation at Bear and Lehman

The Wages of Failure: Executive Compensation at Bear Stearns and Lehman 2000-2008, by Lucian A. Bebchuk, Harvard University - Harvard Law School; National Bureau of Economic Research (NBER); European Corporate Governance Institute (ECGI); Alma Cohen, Tel Aviv University - Eitan Berglas School of Economics; Harvard Law School; National Bureau of Economic Research (NBER); and Holger Spamann, Harvard University - Harvard Law School, was recently posted on SSRN. Here is the abstract:

The standard narrative of the meltdown of Bear Stearns and Lehman Brothers assumes that the wealth of the top executives of these firms was largely wiped out along with their firms. In the ongoing debate about regulatory responses to the financial crisis, commentators have used this assumed fact as a basis for dismissing both the role of compensation structures in inducing risk-taking and the potential value of reforming such structures. This paper provides a case study of compensation at Bear Stearns and Lehman during 2000-2008 and concludes that this assumed fact is incorrect.

We find that the top-five executive teams of these firms cashed out large amounts of performance-based compensation during the 2000-2008 period. During this period, they were able to cash out large amounts of bonus compensation that was not clawed back when the firms collapsed, as well as to pocket large amounts from selling shares. Overall, we estimate that the top executive teams of Bear Stearns and Lehman Brothers derived cash flows of about $1.4 billion and $1 billion respectively from cash bonuses and equity sales during 2000-2008. These cash flows substantially exceeded the value of the executives’ initial holdings in the beginning of the period, and the executives’ net payoffs for the period were thus decidedly positive. The divergence between how the top executives and their shareholders fared implies that it is not possible to rule out, as standard narratives suggest, that the executives’ pay arrangements provided them with excessive risk-taking incentives. We discuss the implications of our analysis for understanding the possible role that pay arrangements have played in the run-up to the financial crisis and how they should be reformed going forward.

Six Lehman bankers seek $122m in lost wages and bonuses

"Six European bankers at Lehman Brothers are claiming £70 million ($122 million) for lost pay and bonuses from the administrators of the collapsed bank.

The claims are contained in filings related to Lehman Brothers Holdings's chapter 11 administration in the United States.

The document shows the Italian banker Riccardo Banchetti, former joint chief executive of Lehman in Europe and the Middle East, is claiming $US26 million ($29 million) even though he had held the job for only a few weeks before Lehman went into bankruptcy last year.

Mr Banchetti is claiming for bonus awards and share options going back five years.

Others who have filed claims are Kieran Higgins and Georges Assi, former co-heads of the fixed-income business. Mr Assi, who lives in London, has claimed $US18.6 million for awards and share options he says he is owed.

They are joined by David Bizer, co-head of equity sales, who is seeking $US21.3 million in deferred compensation. Also named in the document are Harsh Shah and Giancarlo Saronne, both of whom live in Britain. Mr Shah is demanding compensation of more than $US10 million and Mr Saronne is seeking $US12.9 million.

The size of the claims from the six bankers adds insult to injury for the thousands of Lehman staff who lost their jobs when the bank collapsed in the world's largest bankruptcy.

While the European bankers' claims are huge, they are dwarfed by that of Joseph Gregory, Lehman's former second-in-command, who has filed a claim for $US233 million.

Other European claimants include Jeremy Isaacs, the former chief executive for Europe and Asia, and Rachid Bouzouba, the former head of equity sales. They, along with others on the bank's executive board, are filing schedule G claims which keep the details confidential.

Individuals make up just a fraction of the avalanche of claimants against Lehman's holding company.

Tony Lomas, chairman of business recovery services at PricewaterhouseCoopers, Lehman's European administrator, said he expected claims from separate Lehman units against the holding company to top $US200 billion.

More than $US150 billion of claims will be made against Lehman Brothers's US parent and subsidiaries, in addition to more than $US50 billion from other Lehman units across the world.

More claims may have been filed and not yet posted, and claims related to certain Lehman securities are not due until November 2, according to court papers. Many of the claims are also duplicates, filed for the same amount against several different Lehman units.

French banks sue over Lehman collapse

France's top banks are demanding billions of dollars from the administrator of failed Wall Street investment bank Lehman Brothers, official documents show.

BNP Paribas is claiming around $US1.3 billion ($A1.5 billion), Societe Generale $US800 million ($A924.21 million) and Dexia $US400 million ($A462.11 million), according to AFP's calculations based on documents for the administrator published on the site Epiq Systems on Friday.

Other French banks and insurers are claiming hundreds of millions of dollars more. The deadline for claims set by the US bankruptcy court was September 22, more than a year after the shock failure of Lehman Brothers.

Lehman's collapse on September 15, 2008 sowed panic in boardrooms, government offices and households around the world and has come to symbolise the beginning of a steep slump that plunged the global economy into recession."

Australian local councils win against Lehman

Local councils seeking to recoup losses from the Lehman Brothers collapse have had a win in the High Court, which has dismissed an appeal from the failed bank.

The ruling could spark a class action from 70 aggrieved councils and charities that bought complex debt products from Lehman before the financial crisis struck. These investments have since plunged in value.

In Canberra this morning, the High Court quashed appeals from the Australian and Asian arms of Lehman, upholding a previous Federal Court ruling.

Lehman sold the councils and charities $1.2 billion worth of complex debt securities which have led to hefty paper losses, but the councils said these were not being recognised by Lehman Australia's administrator, PPB.

Backed by litigation funders IMF, the councils challenged a deed of company arrangement that offered them between 2c to 13c in the dollar on their Lehman investments.

The Federal Court last year scrapped the deed because it attempted to shield overseas arms of Lehman from potential creditor law suits.

Today's decision confirms the deed will remain void, and sets the scene for a possible class action from 70 councils and charities.

The managing director of IMF, John Walker, said that unless the councils and charities could reach an acceptable deal with Lehman, they would proceed with a class action.

In the last 18 months since Lehman Brothers Inc. fell over, companies in the Lehman group have sought to stop claims being made on the holding company through insolvency regimes in countries outside America. This has been unsuccessful in Australia, Mr Walker said.

As a result Australian companies are now able to proceed with their claims in the Chapter 11 administration of Lehman Inc. This is a fair outcome.

Meanwhile, overnight reports from overseas have said Lehman Brothers Inc's total claims could be worth US$605 billion. Previous estimates had put claims at US$1 trillion.

Lehman-backed structured products

FSA regulatory actions

Structured products are essentially investment vehicles which are linked to an index or an asset class for a fixed period of time (typically three to six years) and which use derivatives to provide a return based on the performance of the asset/index over the period, usually with a full or partial guarantee of a return of capital at maturity. In the UK, they may take many different forms and structures, each of which will have different regulatory implications under the FSA's regime. Over recent years the market for these products in the UK and globally has grown considerably.

With guaranteed versions, these products offer a floor to any downside investment risk along with capped participation in stockmarket returns. The guaranteed element is generally provided by a third party and the risk of that third party not meeting its obligations is the credit risk.

At the time of the Lehman Brothers collapse in September 2008, it transpired that a considerable number of UK investors had taken out plans where either a full or partial guarantee had been provided by Lehman's.

The FSA’s response has been to conduct a review of the marketing literature for Lehman-backed structured products. This is now complete and the FSA is in the process of evaluating the findings. A further priority, which it aims to conclude as quickly as possible, is to prepare for an assessment of the quality of advice for these products. Thirdly, it is conducting an analysis of the wider market for structured products in the UK which will feed into the overall review.

In the aftermath of the Lehman's default, the Financial Ombudsman Service has received a number of complaints from investors and other parties involved in the sale of linked products. It has been investigating some cases, but the number of these is comparatively small in relation to the total numbers affected.

In the course of the regular liaison between the FSA and the ombudsman service, we agreed that implementing the Wider Implications process may have greater potential to remedy any consumer detriment, as well as potentially being able to deal with the concerns of more consumers than those who have referred cases to the ombudsman service.

Accordingly, the FSA wrote to the ombudsman service on 6 May 2009 asking it to consider deferring issuing any adjudicator views or ombudsman decisions in these cases. The FSA said it believed that this would allow it to explore all options to achieve the best outcome for consumers even though this might give rise to some delays in individual cases.

The ombudsman service responded on 7 May 2009, welcoming the prospect of a regulatory solution to these issues. It agreed to defer issuing any adjudicator views or ombudsman decisions in these cases for the time being, and to notify affected complainants and financial firms accordingly. The ombudsman service said that it would review the position in three months – in the light of progress by the FSA towards a regulatory solution.

On 13 August 2009 the FSA asked the ombudsman service to consider a further deferral, to give the FSA more time to progress its work with the aim of reaching the best possible outcome for all affected consumers. On the basis of the information available to it, the FSA believed that it would not be in the interests of affected consumers for the ombudsman service to press ahead with individual decisions. The ombudsman service responded that, in the light of this, it would defer issuing decisions - and would review the position in three months."

On 11 September 2009 the FSA told the ombudsman service that FSA had now completed enough of its work to conclude that regulatory action could take place alongside case-by-case adjudications without prejudicing consumers, and it now had no objection to the ombudsman service proceeding towards issuing decisions in the individual cases that had been referred to it. The ombudsman service is proceeding accordingly.

Hong Kong securities workers arrested over Lehman minibond sales

Two employees of Bank of China Ltd.’s Hong Kong unit were arrested over the lender’s sales of securities linked to failed Lehman Brothers Holdings Inc., the South China Morning Post reported, citing unidentified police.

The two workers at BOC Hong Kong Holdings Ltd. were released on bail, the report said. “We don’t comment on media reports regarding the enforcement actions of the police,” BOC spokeswoman Clarina Man said in a telephone interview today, declining to elaborate.

Banks in Hong Kong sold more than $1.8 billion of so- called Lehman minibonds before the company’s 2008 collapse triggered a slump in the value of the notes and sparked almost daily protests by buyers who said they had been misled. The Commercial Crime Bureau yesterday arrested two women on suspicion they fraudulently or recklessly induced others to invest money.

“The duo were believed to have separately misled and induced eight customers on various occasions to purchase structured products between 2005 and 2008,” the police said in a statement yesterday, without disclosing the identities of the suspects or their employer.

About HK$3.5 million ($450,000) was involved, police said.

The arrests may revive questions about whether banks properly supervised staff involved in selling the minibonds. Lawmakers last year scolded the heads of the city’s central bank and securities watchdog in public for not more closely supervising bank sales of complex financial instruments.

Lehman failure was the cause of the financial collapse

"For anyone who was engaged in the financial markets during the week of September 15, 2008, Lehman changed everything. It was obvious.

So what could be more tempting to finance professors than to overturn this conventional wisdom? Descartes described the man of letters who takes more pride in his speculations “the more they are removed from common sense,” and so showing that the Lehman collapse was inconsequential has spawned a minor literature.

The latest contribution by John Cochrane and Luigi Zingales, like others before them, rests partly on misunderstanding of the data. The authors deduce that Lehman wasn’t the main cause of last autumn’s turmoil by inspecting the daily movements in the spread between Overnight Interest Rate Swaps and three-month Libor, which they define as “the rate at which banks can borrow unsecured for three months.”

But a better definition of Libor under the circumstances was “the rate at which banks said they can borrow”. Libor is the result of a survey, not a measure of actual transactions. In the week of September 15 last year, big banks refused to settle foreign exchange with each other. They were not lending interbank for three month terms, so Libor during that week tells us little.

We could say the same thing for OIS. Volume was light to nonexistent in the week of September 15 last year. What we do know is that three-month T-bills traded at 0.04 per cent on September 17, down from 1.47 per cent on Friday September 12. These are real data that ought to impress the professors that the market was breaking down as fast as it knows how.

John Taylor, the father of the Lehman-was-no-big-deal thesis, wrote in a Wall Street Journal op-ed last year that spreads between T-bills and Libor “remained in that range [of the previous year] through the rest of the week” after Lehman’s demise. In fact, in the year prior to Lehman’s collapse, the peak spread was 2.05 per cent; on September 17, 2009 it reached 3.00 per cent. (Of course, any conclusions based on Libor that week are equally unreliable.)

The other principal mistake of the Lehman deniers is their assumption that the incident unfolded entirely on September 15, 2008 and any effect had to be observable by that morning. But during the final two weeks of September, the market still had to absorb the news that the Securities and Exchange Commission had no plan for an orderly transfer of client assets in the US, while Lehman Brothers International Europe would be handed over to an administration process designed for liquidating grocery stores.

Getting the story right on Lehman matters for two reasons. The first is that, if we convince ourselves that no damage results when the government plants the belief that it will rescue a huge financial firm, and then suddenly lets it fail, it is more likely this will happen again.

The second reason is the Lehman estate itself. Lehman affiliates are locked in legal combat across borders with no obvious way for existing laws to resolve the problem for many years to come. For example, at the time of its administration, Lehman Brothers International Europe had about $26bn of client securities deposited. So far, $13bn has been returned, but almost all of this was from Chinalco’s stake in Rio Tinto.

There is plenty of room to debate the larger counterfactual: if the government had never bailed out Bear Stearns and other too-big-to-fail firms that followed, would Lehman have mattered? If the government had never bailed out anyone at all, would we be better off? But given the bailouts that preceded the Lehman failure, the Lehman failure did in fact change everything. Sometimes things that are obvious turn out to be true.

Richard Robb is chief executive of Christofferson, Robb & Co., the investment management firm, and professor of professional practice at Columbia’s School of International and Public Affairs.

Lehman failure was not the cause of the financial collapse

Many people say that letting Lehman fail was the mistake that caused the financial crisis. To them, the lesson is that the government should never allow any "systemically important" financial institution to fail. If only Lehman had been bailed out, the story goes, we could have avoided much of a 45% drop in the S&P 500, a 4% drop in output, the rise in unemployment to 9.7% from 6.2%, and the $784 billion "stimulus" to top off a $1.59 trillion deficit.

This story is false.

The Lehman failure was not an isolated event. It was a movement in a dramatic crescendo of failures.

Two weeks prior, on Sept. 7, the government took over Fannie Mae and Freddie Mac, wiping out much of their shareholder equity. On Sept. 16, the government bailed out AIG, lending it $85 billion. On Sept. 25, Washington Mutual, the nation's sixth-largest bank, was seized by the FDIC. On Sept. 29, Wachovia, the nation's seventh-largest bank, was sold to avoid a similar fate. All this would have happened without Lehman. Meanwhile, the Federal Reserve and the Treasury Department went to Congress to ask for $700 billion for the Troubled Asset Relief Program (TARP).

Which of these events set off the financial and economic crisis by freezing lending to commercial banks? The nearby chart shows that the main risk indicators only took off after Treasury Secretary Henry Paulson and Fed Chairman Ben Bernanke's TARP speeches to Congress on Sept. 23 and 24—not after the Lehman failure...

...More deeply, Lehman's lesson cannot be that the government must always bail out every large financial institution. From the 1984 failure of Continental Illinois bank to the S&L crisis of the late 1980s, the Latin American bond defaults of the 1990s, the 1997 Asian crashes, the 1998 collapse of the Long-Term Capital Management hedge fund and now this mess, financial institutions are taking more and more risks, but their bondholders keep getting rescued.

This crisis pushed our government close to its fiscal limits. The next one will be beyond what even our government can contain.

The big banks know the government will bail them out, and they are already bigger, more global, more integrated and "systemic" than ever. They are making huge trading profits—profits that must someday turn to losses. If brokerage and banking are "systemically important," they cannot be married to proprietary trading. Yet the financial-reform plans do not even talk about breaking up this marriage—they hope simply to regulate the behemoths instead.

The blame-it-on-Lehman story leads to a dangerous complacency. If we can persuade ourselves that the fault was just one policy mistake, forced on the feds by silly legal restrictions and not enough bailout power, everything can go back to the cozy way it was before.

This is a convenient story for large banks that dominate the lobbying and communication effort. And it absolves the Fed and Treasury of facing up to their long string of policy mistakes.

We don't pretend that we could have done any better. That's the point: A system with so much power vested in so few people, with so few rules, in which crises are managed with 2 a.m. conference calls, cannot possibly do better no matter how good the people at the top. Repeating the Lehman story lets us all ignore the fact that this system cannot go on.

No charges filed in Lehman collapse

It is so widely accepted that Lehman Brothers Holdings Inc.’s balance sheet was bogus that even former Treasury Secretary Hank Paulson can say it in his new memoir. And still, the government hasn’t found anyone who did anything wrong at the failed investment bank.

How could that be, 17 months after Lehman collapsed and sent the global credit crisis into overdrive? While Congress and the White House dither about reforming the U.S. financial system, the wheels of justice are grinding so slowly, if at all, that it seems there’s no appetite in Washington for holding Wall Street executives accountable for anything.

In his new book, “On the Brink,” Paulson doesn’t point fingers at specific Lehman executives for violating any rules. He displays amazing candor, though, in describing how Lehman’s asset values were a gross distortion of the truth. It doesn’t take much imagination to figure out they didn’t get that way all by themselves.

For instance, why couldn’t the Federal Reserve arrange a government-assisted bailout for Lehman in September 2008, as it had done for Bear Stearns Cos.? Paulson tells us that Tim Geithner, then head of the New York Fed, “made clear that the Fed could not lend against Lehman’s dubious assets.” Meanwhile, Paulson said Lehman’s chief executive officer, Dick Fuld, “was still clinging to his belief in the value of his assets, but he was alone there.”

Math Class

Other banks, Paulson wrote, balked at an industry-backed rescue because “they knew that to make the math work, they would have to make a loan secured by assets worth much less than their stated value.” In describing one pile of bad investments, Paulson said these “had been carried by Lehman at $52 billion, but after their analyses the firms estimated their value at closer to $27 billion to $30 billion.”

In short, Paulson said, “the investment bank had been loaded with toxic assets worth far less than the value at which they were carried, creating a capital hole.”

Paulson’s account is as lucid an explanation of why Lehman blew up as anyone has written. It does leave you wondering, though, if it ever occurred to him to tell anyone at the Securities and Exchange Commission or the Justice Department that Lehman’s accounting might need to be investigated. His book provides no indication that he did.

Quite the opposite, Paulson said he felt terrible for Fuld and other Lehman executives: “It was impossible not to sympathize with him. After all, I had run a financial institution; he had been one of my peers.” Maybe a Treasury secretary who hadn’t been the CEO of Goldman Sachs Group Inc. would have viewed their plight less charitably. Paulson declined to comment for this column.


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