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Lehman Black Hole Update: It’s Gotten Bigger!

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The Financial Times provides an update on the Mess That Ate the Markets, circa September-October 2008. As we’ve harped on, Lehman’s bankruptcy advisors have been remarkably unhelpful in providing much insight on why the firm had such a big hole in its balance sheet. The previous estimate we had seen was $150+ billion (a swing of $26 billion in net worth as of the firm’s last financial reports, end of May 2008, versus the last loss tally of $130 billion).

Now if I read this correctly (and readers are encouraged to tell me if I have this wrong or there are other interpretations) the shortfall risen a lot. From the Financial Times (hat tip reader Hubert):

Bryan Marsal, a partner with restructuring firm Alvarez & Marsal and serving as Lehman’s chief executive, presented the bank’s “state of the estate” report in a Manhattan bankruptcy court on Wednesday.

Lehman said it had reached a final agreement with Bankhaus, a German depositary bank that was one of its most complex subsidiaries, to fix future claims between the estates.

Mr Marsal said a new plan is expected to be presented in the fourth quarter for creditors to vote upon.

He said working with foreign subsidiaries had been “a key priority” in recent months, but had been more difficult than expected.

In his report, Mr Marsal revealed that initial creditor claims of $1,162bn had been whittled down to between $250bn and $350bn, following eliminations of duplicates, negotiations and estimates based on A&M’s models. Lehman has added $2.2bn to its expected recovery total since April and the future recovery estimate is $57.5bn.

“The liquidation strategy supported by unsecured creditors focuses on creation of value instead of creation of immediate cash,” said Mr Marsal.

Under the proposed plan, some unsecured creditors would receive less than 20 cents in the dollar.

Mr Marsal said there was still outstanding litigation seeking at least $5bn.

Potentially, tens of billions more could come from suits against Barclays, JPMorgan Chase and Bank of America.

Yves here. Admittedly, this extract omits how the secured creditors did. They just took their collateral and ran. But it appears to confirm a line of thought I had heard earlier: a lot of commentators have focused on the shortfalls in value on the asset side, while ignoring the fact that liabilities (in particular derivative exposures) were understated.

Take the creditor claims of $250 to $350 billion. Against that we now have assets we will generously peg at $60 billion. So we now have a $190 to $290 billion shortfall. The midpoint is nearly double the lass loss estimate. When you add back the reported equity, you get $216 to $319 billion, or 1/3 to nearly 1/2 of the value of Lehman’s total assets ($660 billion). Now perhaps the lawsuits will bear some fruit, but even a $50 billion settlement, which would be an extraordinary recovery, wouldn’t change the overall picture all that much (amazing what numbers this large will do).

The explanation used to deter further inquiry is that the damage ballooned because Lehman suffered a “disorderly collapse.” But the problem with this tidy account is that the maximum amount attributed to the impact of market upheaval was $75 billion. So not only were Lehman’s books cooked, but Repo 105 and the disorderly fail are insufficient explanation. There’s a great deal of other accounting fraud that has not come to light.

Where are the investigations and prosecutions? Lehman is an obvious example of massive chicanery, yet no action is being taken. If that isn’t a green light for future crooks, I don’t know what is.

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19 comments

  1. erich nolan bertussi davies

    this just goes to show you capitalism is killing us.. there is no such thing as free markets..

    it’s a rigged gambling system and at the end of the day the working families in cities and on farms get the brunt of it.

    while the suburbs goes on stealing from the rest of society.

    if you don’t know of him go check out Umair Haque, he has a way of getting us all back on track to #Betterness..

    go look up his Manifesto…

    cheers

  2. nytjunkie

    Why doesn’t some enterprising person just compare the outstanding bankruptcy claims with the liabilities on Lehman’s balance sheet and see which claims were never properly disclosed?

    On the other side, why doesn’t someone compare the assets liquidated or to be received by creditors to how Lehman carried them on their balance sheets to see how mismarked they are?

    When management’s no longer cooking the books and everyone ought to be able to see these things in the cold hard light of a bankruptcy courtroom, you can get a scale of the fraud on investors and creditors through accounting chicanery that goes on all the time at financial institutions.

    1. Yves Smith Post author

      Lehman had 120,000 derivatives exposures. Some were presumably hedges of assets, others no doubt were customer trades. Those don’t tie to the reported financials.

    2. doom

      I miss the good old days when the Fed used to fantasize that immediate netting and closeout was going to contain little hiccups like this. What is the status of Lehman’s derivatives netting and closeout process anyway? Epic litigation to game netting and derail closeout, I presume.

  3. Glen

    Here’s the deal, even with the fact that the Lehman black hole seems to be growing.

    How much has all of this cost the taxpayer? NOTHING.

    And the banking system is still here.

    So it would seem that either the American taxpayer was taken to the cleaners with TARP et al, or every other TBTF bank out there is pretty much a Lehman style ticking time bomb that “they”* are working feverishly to defuse.

    *I’m not sure who “they” are, but I have this sinking feeling there’s massive amounts of toxic debt that the American taxpayer will get gift wrapped as a crappy economy for the next ten years or so.

    1. Steve Hamlin

      “How much has [Lehman] cost the taxpayer? NOTHING. And the banking system is still here.”

      The banking system is still here ONLY because Frannie had been effectively nationalized the week before, the Fed provided a $85 billion facility to AIG the day after Lehman filed BK, and the initial $700bn TARP plan was unveiled 3 days later.

      Without those actions, the entire financial system, not just banks, would have imploded. Without that government support, we would not have a banking system.

      Payrolls would have failed at the end of September 2008. Daily credit facilities critical to most businesses would have dried up. Letters of credit, the lifeblood of international trade, were already being denied.

      In the third week of September 2008, there was serious concern about ATMs working and grocery stores still receiving deliveries.

      So while I understand, and agree with, your passionate desire to see (shadow) bank stock/bondholders feel $1 trillion worth pain, it simply wasn’t feasible to do so in one month.

      Is it worth cratering the economy to teach banksters and bank owners a lesson they truly deserve? As disgusting as it sounds, perhaps not.

      1. Glen

        That’s a crap argument. Suppose (just a mental thought question ONLY) a bomb wipes Fanny off the face of the earth. Is YOUR ability to go get YOUR money gone? No. Banking system is functional.

        Besides, if you’ve been concentrating on Fanny which certainly is being used by the Fed as a place to buy toxic debt, yes, you’re correct, but 1) Fanny didn’t make the bad loans and 2) FEd should not buy bad debt at full value making US taxpayer the d&*b f&*ks in this whole deal.

        Bailout is WAY LARGER than Fanny/Freddy:

        http://www.ritholtz.com/blog/2009/06/bailout-costs-vs-big-historical-events/

        And they did not start/cause this mess:

        http://www.ritholtz.com/blog/2010/09/fannie-freddie-acquitted/

        There were alternatives, they were discarded to just whitewash (at best, worst makes me sound shrill and tin-foily, but who knows we never investigated/audited which is what is NORMALLY DONE) the whole mess and make the American people pay:

        http://www.ritholtz.com/blog/2010/09/gone-swedish/

        As for all this:

        “Payrolls would have failed at the end of September 2008. Daily credit facilities critical to most businesses would have dried up. Letters of credit, the lifeblood of international trade, were already being denied.

        In the third week of September 2008, there was serious concern about ATMs working and grocery stores still receiving deliveries.

        So while I understand, and agree with, your passionate desire to see (shadow) bank stock/bondholders feel $1 trillion worth pain, it simply wasn’t feasible to do so in one month.

        Is it worth cratering the economy to teach banksters and bank owners a lesson they truly deserve? As disgusting as it sounds, perhaps not.”

        You have the start of an excellent book which will make you a millionaire if you can prove any of it is true. As for me, it’s all starting to sound just like the weapons of mass destruction BS that put us in the WRONG war. I ask you, can you seriously trust the same people that lied a whole country into war to not lie to you about this?

      2. CingRed

        Steve, are you working for Hank? For far less than $700B the banks could have been nationalized with sufficient capitalization supplied to keep things going. The stock and bond holders of the institutions who gambled and lost could have been told to go pound sand depositors could have been kept whole. You might also want to look at why the Fed withdrew over $100B in liquidity from the system which helped put Lehman over the edge. It was readily apparent in the slosh reports that they just happened to quit publishing right after that little move was noticed by a few astute individuals.

  4. Siggy

    Repo105 is a key piece of information regarding the accuracy of Lehman’s published financials. The implication of repo105 is that there are other inaccuracies that have yet to be publicized.

    Yves last paragraph is cogent. What I worry about is the fact that I have this sense that while an investigation may be in progress, the longer the interval between investigation and prosecution is, the lower the probability of conviction. Now I appreciate that intent is difficult to establish, but is not the misrepresentation of repo105 an act of deceit on its face?

  5. readerOfTeaLeaves

    The explanation used to deter further inquiry is that the damage ballooned because Lehman suffered a “disorderly collapse.” But the problem with this tidy account is that the maximum amount attributed to the impact of market upheaval was $75 billion. So not only were Lehman’s books cooked, but Repo 105 and the disorderly fail are insufficient explanation. There’s a great deal of other accounting fraud that has not come to light.

    Indeed.
    When I look at American politics, I see a crisis of legitimacy playing out.
    When I look at American-global economics, it appears to be an economic version of a crisis of legitimacy.

    Capitalism is not being killed by communism.
    It’s having the life choked out of it by accounting fraud.

    Paging Prof. William Black…

  6. Ishmael

    Yves — Probably a large amount of this was due to “fair value accounting.” I have never agreed to any of this (I am a CPA who consults with mid-size to large public companies). This all involves fantasy numbers. Let’s look at one thing, I know Lehman was doing. It was marking its debt down to market and recognizing a gain on it which increased equity. Well as indicated above that debt was secured so there was no gain and the debt holders seized a bunch of assets. Companies always are over optimitic about asset values and what they will settle liabilities for. The Big 4 audit opinions have become worthless. I was recently hired by a PE firm to come up with a true picture of a portfolio company after one of the Big 4 finished its audit. At the time I left the client was still reconciling out a number of assets but it was looking that a large amount of the assets on the books were not there. In addition, the company had far too long of a depreciation policy of assets. The Big 4 firm did not even require the company to have an annual physical of the assets even though it was in the equipment rental business.

    The accounting profession really started coming apart in the 80′s when marketing became more important than doing audits. I see the problem every day. About 2 years ago I went to another public company after doing about one hour of due diligence on their financials. Inventory turns were one time a year. I discussed problems and the CEO denied and denied. Said one of the big 4 did their books. Everything was ok. I kind of went whatever and left. Six months later the Big 4 firm resigned and the problem was guess where — inventory. Ends up being enormous defalcation by the controller also. I have encountered this same problem with the same firm 4 times even though they are suppose to be experts in this area.

    We get hired for work because we are uncompromising. As my attorney said, I am not very charming because within 10 minutes in the room I am asking about problems. CEO’s think they are kings are not use to someone questioning them and unwilling to listen to their BS.

    One of the big things that happened in the country is that the audit firms, AICPA and FASB became unaccountable for their work and really butt kissers for the financial service industry. I guess the legal profession is alot to blame also for giving everyone a legal argument for cover.

    1. steelhead23

      Hey Ishmael, ever read Moby Dick? You seem to have much in common with protagonist in that book – a fellow by the name of Ishmael.

  7. Jerry

    Instead of pursuing justice thru an unjust judicial system, I think it is time that Americans begin to pursue the impeachment of President Obama……any one else see it the way I do and if so how do we move forward…..post it on each blog you and I follow to start??? (I’m no a sour grapes Republican just trying to get even….I’m an independent)….

    1. covered

      Great, Jerry. What are you gonna impeach Obama for? Specifically? If it’s not for prosecuting these bastards that actually stole our damn money in the biggest heist in history. I’d be up for that. But that implicates everyone. Get it?

  8. Tao Jonesing

    “Where are the investigations and prosecutions? Lehman is an obvious example of massive chicanery, yet no action is being taken. If that isn’t a green light for future crooks, I don’t know what is.”

    Future crooks? They’re here right now.

  9. steelhead23

    Shhh. Be vewy, vewy, quiet. We’re hunting wabbits.

    Don’t you get it yet, Yves? If they prosecuted the thieves at Lehman, tongues would wag and the thieves at other broker dealers might get implicated – then the whole darn Ponzi would get exposed and we’d be damn lucky to avoid insurrection. So, pipe down. Somebody might hear you.

    1. piggly

      This is the emperors new clothes – as long as there is no child crying out the charade continues – and we get screwed

  10. oldmanwi

    Throw all the bums out. We need a complete change in congress.
    Those of us, who are independents, can make a difference if we
    vote against the incumbents. And for those of you who are dems] or repubs, ask yourself, what has my CONgress person done for the good of the country in the last year? Vote for the country not the party.

  11. wwilson19

    I trade derivitive/swaptions and don’t understand why no one clearly says what happend> GOLDMAN SACHS AND CO bankrupted lehman to make Money. and when I say GS and Co. I mean the leaders of our country the people in the congress and on the boards of our biggest banks/companies that have roots back to our founding fathers. If lehman did not fall the swaps would have been extended, the US economy would have recoverd and lehman’s board and owners would have prosperd, thus sinking GOLDMAN, BOFA-COUNTRYWIDE- and the select few that belive in oppression raither than real sustainable growth through american enginuity, whether it be the assembly line or google, which allowed information into china and will help drive the next 40years of growth for us and the world. How can everyone forget this countrywide funding deal as soon as this deal was anounced the real money should have protected themselves but thier greed prevented this/ causing almost 1T dollars to be borrowed from our homes/land/assets without our consent.

    assets = american tax payer =future payment streams ______________________________________

    FED guarantees 1T in loans VIA TARP/TALF (very impot TALF) through FDIC (Shiela)
    GS/MORGAN/BOFA use talf money to forclose on trillions of assets including LEHMAN via AIG SWAPS/REPOS(supported by our collateral) thereby refinaning our lives to make money. until the next big invention, cure or war. if this was done by one company to another it would be a hostile takeover and the finance rate would be around 7-9% with a 1.75% Investment banking fee. oh ya goldman and co got that fee aswell. BILLIONS IN UNDER-PRICED SECURITIES FREE TALF MONEY AND UNTOLD FUTURE PROFITS ON OUR REAL ESTATE

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