Perhaps I am unduly cynical, but I find it pretty odd that the general counsel at the New York Fed. Thomas Baxter, is making statements about the Lehman collapse now.
For those who are familiar with US jurisprudence, anything said to an attorney in confidence is privileged information (yes, there have been some attacks on that principle, but for the most part it still stands). That fact makes attorneys careful about how they handle information. Moreover, Fed officers are very circumspect. Fed presidents occasionally break ranks and offer personal views, but anything from the NY Fed general counsel had to be sanctioned
And this disclosure is a bit peculiar. Why did Lehman go under? Because the government wasn’t willing to offer a backstop. That has been the general view of the matter and no principal has stepped forth to dispute it. Indeed, former Lehman CEO Dick Fuld has repeatedly complained about what he perceived to be unfair treatment, that every other big player on the rocks got some sort of government support.
If you read the Bloomberg story, it does not disprove the broad outlines of that account, but nevertheless CLAIMS to do so:
“The facts are often that people conclude that we let Lehman fail, and that factual predicate is not accurate, that the government let Lehman fail,” Baxter said. “The problem we encountered on Sunday, Sept. 14, is Barclays wasn’t in a position to give a similar guarantee of the trading obligations of Lehman” as JPMorgan Chase & Co. gave to Bear.
Yves here, That little $29 billion backstop provided by the Fed to JP Morgan is somehow omitted in the comparison of the two situations (in addition, some have contended the support was a not permissible activity, and may have contributed to the Fed/Treasury refusal to pony up dough for Lehman). But let’s return to the legerdemain:
The group of bankers and officials was trying to repeat the Bear rescue on Lehman, except that this time officials told lenders that “unlike with Bear, you all are going to finance the assets that are taken to facilitate the acquisition. That was plan A,” Baxter said.
“The problem with plan A was not an absence of financing” because the bankers in the room did agree on a deal, Baxter said. “They had the money and they were willing to put it out.”
The hitch was “much more technical,” Baxter said.
“The problem for plan A relates to, what do you do in the period between the announcement of a merger and the actual closing of the merger?” Baxter said. He said plan A failed because Barclays couldn’t guarantee the trading obligations.
Barclays agreed to acquire Lehman after a syndicate of banks consented to backstop a new entity that would take over $55 billion to $60 billion of Lehman’s troubled assets, according to people familiar with the negotiations. The deal fell apart when the U.K.’s Financial Services Authority refused to sign off on the Barclays purchase that day and U.S. officials refused to take further steps to save the deal.
Yves again. Now this leaves opaque the question of whether the FSA simply needed more time, or whether there was concern that they would attach conditions that would require the deal to be renegotiated. And remember, this was a weekend special. Getting anything other than a simple waiver agreed by a consortium during the week would be well nigh impossible.
So why didn’t the officialdom find a way to bridge the deal till closing? Baxter diverts the listener from that question, and proceeds:
The New York Fed meeting then turned to discuss plan B, Baxter said.
“The best option was to put the parent of Lehman into bankruptcy, to continue an operation as broker-dealer at least in the U.S., and to continue a broker-dealer operation through Federal Reserve liquidity,” Baxter said. “That happened.”
In the week after the bankruptcy filing, the Fed loaned “big time” to keep the broker-dealer in business, with funds totaling as much as $50 billion, he said. Barclays then returned to the table and bought the division.
“If you go back and study the way we did Bear Stearns, you’ll see the importance of the guarantees,” Baxter said.
Following Lehman’s filing on Sept. 15, “there was a spiral of confidence disappearing,” Tony Lomas, a partner at PricewaterhouseCoopers who is administering Lehman’s U.K. bankruptcy, told the same conference today. He previously worked on the aftermath of Enron Corp.’s financial collapse.
Now this is a tad slippery. Thanks to all of the shenanigans of the Roaring Twenties, the securities laws created in 1933 and 1934 were very comprehensive and far sighted. John Hempton comments:
I am hardly a lawyer – so take the bush lawyer caveat – but the way it works is that the broker dealer may not borrow against your securities to finance their own business, only client business….
Moreover when you deposit a million dollars at the broker dealer and give them the right to repledge those securities they can only rehypothecate 140 percent of your outstanding balances.
If you have 1 million deposited and you have 100 thousand borrowed then only 140 thousand can be rehypothecated and the rest must sit in a segregated client account. [If your broker wants to steal from the segregated client account there are precious few defences – but…] You can not contract out of this requirement.
So (provided the broker is not acting criminally) you should get the bulk of your money back if the broker dealer fails. And provided the capital requirements are adequate (and they mostly are) the broker dealer won’t fail. Even the Drexel Burnham Broker Dealer did not fail…..Whilst Lehman brothers went bust Lehman US broker dealer did not. This pretty well saved the US hedge fund industry.
I welcome reader comment here, but ex fraud (and I am not under the impression any was alleged here) the US broker/dealer operations should have been a sound piece in the larger Lehman mess. The fact that Barclays scooped it up so quickly would seem to confirm that belief. Thus while the Fed lending may have been sizable, it should not have entailed much risk.
In fact, Hempton claims that the piece that all the regulators got wrong were the much more lightly regulated UK broker dealer ops (note the Fed did NOT lend to them). They were the black hole that lead to greater losses than most analysts anticipated:
Europe however was a different story. Lehman Europe failed – and the clients of the European broker dealer (read a good proportion of the London hedge fund community) are now queuing as unsecured creditors of Lehman. Many funds have folded. Far more have been nicked. Whilst the US hedge fund business is currently looking dazed, confused and a little problematic the UK business is on life support….
This puts in a different light the 8 billion dollars that Lehman London transferred to the US when it was failing. I stand open to correction – but I would guess that the money was obtained from client accounts from the European/London broker dealer. It is certainly being investigated by Lehman clients. This is a scandal of the first order allowed by an insane lassis faire approach to financial regulation.
Now let’s go back to the main event. Here the wisdom of letting Lehman go has been pilloried in the press for months. The Fed and Treasury remain largely silent on the matter (yes, we get a few circling the wagons type statements, but no substantive detail).
Now we have a defense of sorts offered by a party clearly authorized to do so, while the Geithner confirmation is in play (but truth be told, still seems like a done deal). Is this a bit of image burnishing? The peculiar timing would certainly say so.