September 8th and 9th, both Fannie Mae and Freddie Mac topple over, the Government steps in to secure the two mortgage giants, by the 10th, markets are in free-fall and liquidity is evaporating – money simply isn’t showing up. Lehman Brothers, in particular, stands out.

Pre 15th of September

Pre 15/09/08

One of the world’s largest broker dealers, a 1 trillion dollar a day turnover giant, suddenly faces shortfalls in managing its daily book. JP Morgan stands by its broker-dealer arm, going as far as ensuring intra-day funding requirements above and over ordinary requirements, but the parent company is still scrambling to match-off its cash requirements. Merrill Lynch, the charging bull, is taken over by BofA and Lehman is left with one less suitor in the mix. By September 15th, the game is over – Richard ‘Dick’ Fuld files for chapter 11 protection and the world changes – brutally so.

post 150908

post 15/09/08

By the next day, Reserve Primary, one of the largest money market funds in the US, ‘breaks the buck’ and equity markets suddenly implode.

The recent Financial Crisis Inquiry Commission hearings in the United States have sought to bring back some of the key actors to these events in the same room for a frank discussion over what went wrong and why. The discussion was hard to listen to live. Fuld believes the bank was solvent, the Fed believe they did everything they could, the JP Morgan risk experts believe they were already operating beyond their means prior to the event, and no-one can really say how to avoid this next time around. More worrying to hear were the small anecdotes behind the event.

Over the course of the weekend of the 14th and 15th, the markets were in deadlock, funding wasn’t there, this wasn’t a hypothetical run on a bank, this was the crisis run on all banks. By Friday the 13th, Lehman had already been in deep talks with both BofA and Barclays in terms of a detailed takeover, but this was now reduced to Barclays and Lehman alone. BofA choosing the more-manageable prize of Merrill Lynch.

Byron S Georgiou - Commissioner

Byron S Georgiou - Commissioner

Collateral suddenly became a key word on everyone’s mind, collateral and how to find it for institutions that represented billions of dollars in capitalised equity, for an industry designed to make calls on other people’s collateral, not one designed to front their own. Prior to the weekend, Lehman had some of its core unencumbered collateral locked into intra-day arrangements with J.P. Morgan under the terms of its broker dealer window financing, but according to Richard Fuld, there was still enough available elsewhere to support an external financing arrangement. Views differ on the actual ‘availability’ of this collateral. According to the hearing, this was a moot point, as no additional emergency funding windows were available on September 14th for this collateral to actually be posted towards.

Thomas C Baxter Jr - Federal Reserve NY

Thomas C Baxter Jr - Federal Reserve NY

Then came September 15th and the emergency expansion of the PDCF window, or primary dealer credit facility, aimed to support american primary dealers gain traction through the unprecedented market dislocation. Unfortunately for Lehman’s, the letter on the PDCF window had only arrived post the chapter 11 filing, in hindsight a slightly ‘unfortunate’ breakdown in the communication chain.

Byron Georgiou expressed the same concern during the FCIC hearings yesterday but also re-emphasised that nonetheless, Lehman would not have survived the week-end without external financing, and that the timing of the bailout was not the core issue to fix: the core problem was the lack of viable overnight available funding.

Richard Fuld remained stoic throughout most of the hearing, displaying an outstanding ability to recount his balance sheet in the days prior and immediately during the September 15th weekend.

Richard Fuld - Lehman CEO

Richard Fuld - Lehman CEO

He also remains of the opinion, that on an accounting basis, the tier-one capitalisation of the bank stayed at 11% (in excess of regulatory requirements) through-out the ordeal. I think Fuld deserves some recognition for the incredible pressure faced during the event. In the end, there is no changing the record of events, it is now history, however, it is hard to take too critical a view over the course of the events from a merely quantitative basis – indeed, an 11% Tier-one ratio is potentially better than what some banks may have today.

[Fuld to FCIC Commission] capitalism works within a finite range of standard volatility measures

Nonetheless, the bank did fall, and questions of course turned to how best one can prevent future events. The reality is that such a ‘perfect storm’ remains terrifying still to this day. Certainly, I wasn’t too enthused by some of Fuld’s comments on the state of capitalism at large, with one notable quote, unfortunately taken in the heat of the moment that: “capitalism works within a finite range of standard volatility measures”.

No, Richard Fuld, Capitalism is not limited nor defined by a finite range of standard volatility measures. Perhaps Lehman’s was, but not capitalism. Indeed, capitalism is designed specifically to facilitate absorption of risks and to give us a survival cushion in the event of unprecedented uncertainty, but it is not meant to cut-out volatility, it is meant to confront it – rationally. Schumpeter would go as far as stating that the volatility that shakes us is also that which defines us. Our ability in being creative through our cycles of destruction is what provides the richness and life to daily capitalism. Whether one agrees or disagrees with this is a matter of personal judgement and economic analysis, but to say that Lehman was exempt from the daily reality of volatile uncertainty is incorrect, in fact they were supposed to be the leaders at how best to confront it.

Well, the past is past, but certainly the FCIC hearings have been an eery reminder of how human the 2008 meltdown actually was. It wasn’t really just a breakdown of alphabet soup securities, scary fuzzy entropy risk quantifying metrics, and of bureaucratic giants slowing moving their reach across the corridors of power in an archaic and mechanical fashion. No, this was a crisis of humans, mostly, of professionals, leaders in the field perhaps, but mostly just people who had to take decisions. And this part of the crisis will still remain with us and will continue to be here for some time to come: that human side, the personal side, that person you crossed at work or on the street side – the part that makes us human in a way.

Background Links:
Financial Crisis Inquiry Commission
Richard Fuld’s Submission to the FCIC
Chronology of the Lehman Bankruptcy
The Valukas Examiner Report on the Lehman Bankruptcy – 9 volumes of detailed e-discovery

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