naked capitalism

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.