This post was inspired by David Webb’s ‘The great Taking’, the interest shown by the public, and my reflections on the things I learned from the Lehman Bankruptcy. There are some basics to begin with, on property and on bankruptcy.
Magna Carta (39) (translated) “No free man shall be seized or imprisoned, or stripped of his rights or possessions, or outlawed or exiled, or deprived of his standing in any way, nor will we proceed with force against him, or send others to do so, except by the lawful judgment of his equals or by the law of the land.”
Supposedly, Company Directors ensure that their company remains solvent. That means that upon a declaration of closure or bankruptcy, the equity in the company is extinguished. Upon a closure, the assets are sold off, the creditors are fully paid, the Preference Shareholders get repaid to the extent that funds permit, and any remaining capital is paid to the Common Shareholders.
These concepts tend to fall apart when banking is the main function of the Company and when bank solvency is called into question. That’s the reason for “bankruptcy” being a thing. The financial crash of 2008 and the Lehman Bros bankruptcy provide a lesson, but not the relevant beginning.
The beginning was the “Irrational Exuberance” (Alan Greenspan) of 1999, the Dotcom Boom and bust of 2000-2001 following which the Federal Reserve Banks cut interest rates to keep the rest of the economy functioning. The low interest rates led to a boom in real estate, and to sales of Mortgage Backed Securities (MBS) and the expansion of other financial instruments.
In 2005 the process of increasing US interest rates from 1% to over 5% began, and this diminished the value of MBS significantly, especially sub-prime mortgages, commonly referred to then as ‘toxic debt’. Thus, not all debt or mortgages are created equal, some are more equal than others.
The fall in the market value of debt reduces the asset side of the balance sheet of any bank that holds it, hence at some point as concerns get raised, banking begins to look more like a game of musical chairs waiting for the music to stop. To further complicate matters, bets are taken on outcomes as those holding risk seek to lay off potential losses, and to sell the worst of their collateral to less sophisticated buyers. In particular, leverage in the shape of derivatives linked to interest rates becomes fashionable.
Here’s the problem. There’s only so much good collateral and once the debts exceed the value of the collateral, the game moves from one of musical chairs, to something closer to six men in a lifeboat with nothing to eat but each other. I’ll observe that the financial instruments that are supposed to provide protection here have to work in a situation where prima facie they cannot work. They cannot create good collateral out of toxic assets. Possibly the biggest banks were most at risk, but they managed to sell themselves as “Too Big To Fail”. Which brings me to the Lehman Bros of September 2008, as just one of many items of collateral damage.
J P Morgan Chase was both Custodian and Banker for Lehman Bros. In particular J P Morgan Chase provided clearing facilities to Lehman Bros for the trades they executed. On September 2008 Lehman Bros pre-announced their third quarter results commenting that things had improved since the second and third quarters and that Shareholders Equity had improved during the quarter to $28Bn.[2]
What was not said at that time was that J P Morgan Chase was pressuring Lehman Bros to, among
other things, provide additional collateral for monies loaned. A Court Case filed on 26th May 2012 has the following relevant quote : “J P Morgan forced LBHI to sign these agreements in the early hours of September 10, 2008, just minutes before the rest of the world would hear LBHI’s earnings report. J P Morgan coerced LBHI’s compliance with the threat that Lehman’s ability to clear trades would be cut off, which would have forced the immediate collapse of Lehman’s business. LBHI received nothing in return for incurring the obligations set forth in these agreements, and they were executed at a time when LBHI was insolvent and/or undercapitalised, and when, on information and belief, many of LBHI’s subsidiaries were also insolvent.”[3]
The ruling (September 28, 2012) from that case was that “Holding that previously transferred property is not property of a debtor's estate.”
The pressure from J P Morgan continued after September 10, 2008, with J P Morgan demanding and getting Lehman’s best assets and cash to the tune of over $8Bn, and on September 15th, 2008, Lehman Bros filed for bankruptcy, after J P Morgan made good on their threats.
Here’s how things looked in March 2012 : The numbers are horrendous: $637Bn in liabilities; claims totalling $1.8Tn; over $300Bn in allowed claims, and depending on which piece of paper you look at, between $65Bn and $105Bn available to be paid out. In July 2009, the administrators published a snapshot of the state of the Bank’s accounts, ending September 2008. Assets were $272Bn, Liabilities were $316Bn, and the administrators confidently expected to recover some $50Bn from LBHI’s affiliate companies, principally LBIE, the London headquarters for European operations. The shortfall, in excess of $44Bn, between assets and liabilities wiped out Equity, and would later approximate to the sums Lehman created by accounting trickery for their May 2008 filing. Also in the May 2008 filing, among Non-Current Assets, were $125Bn of mortgages and other items. These may have been among the items auctioned off at between eight and twelve cents on the dollar, suggesting a realised loss for the Creditors and Shareholders of some $100Bn.
Before getting into some details in Part 2, here’s a recap of the main points, and a link to Ben Bernanke’s big bailout.
* Lehman Bros went into bankruptcy because of J P Morgan’s actions, and not only because of their reliance on J P Morgan as a business partner.
* Losses were realised when Lehman’s Receiver auctioned off assets at ten cents on the dollar. I do wonder whether residential property changed hands at one tenth of it’s book value, and what the residents might have thought had they known.
* Not all debt is created equal.
* Increasing interest rates provided a systemic risk to all companies that lent long and borrowed short.
To the greatest extent the entire problem was created by the actions of the Federal Reserve, first by interest rate policy, and then by their funding via bailouts, of those Banks etc, deemed Systemically Important, not only in the USA, but Globally. This was and is, a huge moral hazard
“What is now unquestionable, and what will be made clear shortly, is that the dollar trade is precisely what the basis trade, or any other trade, would have ended up being for any and every Central Bank that had a funding mismatch in dollars after the Lehman bankruptcy (all of them), had the Federal Reserve not stepped in and become the lender of last resort to the entire world.”[4]
“It is time someone in Congress asks the Chairman all the pertinent questions that evolve from this analysis and how he is prepared to handle its next, much more vicious, and likely terminal, iteration.”[4]
Here is an open question : Was Lehman Bros bankrupt on 10th September 2008?
[1] https://www.nationalarchives.gov.uk/education/resources/magna-carta/british-library-magna-carta-1215-runnymede/
[2] http://web.archive.org/web/20231231152853/https://www.wsj.com/public/resources/documents/LehmanPreAnnounce
[3] https://casetext.com/case/lehman-bros-holdings-inc-v-jpmorgan-chase-bank
[4] https://www.zerohedge.com/article/how-federal-reserve-bailed-out-world
