Exhuming Lehman (and looking for Signs in the Entrails)

14 May

Ah Investment Banking. Such an image problem (warning: sweary). Just check out David Enrich’s two excellent recent stories for the WSJ about the antics of the interdealer brokers and their IB trader counterparties, complete with Lady Marmalade’s (do NOT Google “Lady Marmalade Party” at work) Orgasmic Love Swing and enough sordid details to keep a tabloid in business (they were also manipulating LIBOR at the time, but hey, SEX PARTIES are easier to explain). These people are basically the sort of adolescent pondlife who are most at home swigging alcopops at a busstop, left to babysit the global economy. With predictable results.

Still, outrage-friendly as it is, Investment Banking is no more than part of the story, and probably not the most important stuff. (Outraged lefties: Feel free not to read any further, or to read and misunderstand it. However, if you do by the end feel that this is a defence of Investment Banking As It Has Been Practiced, please write your concerns down on a piece of paper and put them somewhere safe for the day when I may be interested. Somewhere safe where the sun probably doesn’t shine).

As a starting point, let’s look at Lehman Brothers, if not the Westerplatte of the crisis, certainly the Operation Barbarossa. When Lehman filed for Chapter 11 in the US in September 2008, it unleashed chaos. Not the least of the chaos was the filing for bankruptcy of LBIE – Lehman Brothers International Europe – the firm’s main European operation, based in London. This was dead centre for all the firm’s hedge fund trades, but also for its derivatives and currency trading with insurance companies and mutual funds and the rest of what is known in the industry as “Real Money”. In Too Big To Fail, when Evan Handler (playing Lloyd Blankfein of Goldman) reports “people panicking because they can’t get their money out”, this is what he’s referring to (around 48s in the trailer below). LBIE was probably the purest bit of so-called “casino banking” within Lehman, attracted to the UK by the country’s disengaged, clueless regulators exciting pro-business climate.

When Lehman credit default swaps cleared a couple of months after the bankruptcy, Lehman debt was worth 8.7c on the dollar. Markets in the various bits of Lehman took a while to develop, but for most of the intervening time, LBIE debt has been one of the runts of the litter.

But that’s changed now. Not only has PWC already paid out 25p in the £ on unsecured claims , but the odds are that unsecured creditors will get all their money back, complete with penalty interest. This is after taking out over £600m in fees for their own services. Owners of securities custodied at LBIE as prime broker (Prime Brokers are to hedge funds what mafia bookmakers are to US gamblers) will fare a little, but probably not much, worse. More to the point, there’s a pretty strong correlation between how casino/investment bank a bit of Lehman was and how high the recovery values are. In the US, Lehman Financial Products has already paid out 100c/$ on claims. Claims on the Holding company – that owned the whole thing – have returned around 15c so far, and are changing hands in the mid-20s. Claims on LBI and LBCC – two broker-ish bits of the whole – come somewhere in between.

There’s a couple of conclusions here. The first, narrow, one, is that Lehman were actually pretty good bookies. Lehman positions were frozen Jurassic-Park-Mosquito style in mid-September 2008. Foreign exchange and derivative contracts were broken off and values fixed at the break date. Now there are qualifications here – not least six years of ultra-loose money and bank bailouts – but there’s at least a prima facie case that LBIE could have been a viable business had it been separated out, and the world could have been spared at least part of the intervening chaos. European regulators who appear intent on continuing with the “plucky amateur” approach to bank liquidation should maybe take a long hard look at the lessons here.

But the broader conclusion is that trader antics aside, the main role of Investment Banking in the crisis was less as a loss-producing force in itself, but in a) channeling funding to the wilder banks on the periphery and b) the produce-and-sell model of spreading the losses far and wide via structured products. For all the financial innovations of the last decades, we still have developed no surer way of losing money than lending to deadbeat debtors, usually against property. Structured Products and other IB innovations allowed one loss to be enjoyed time and again by a much wider group of creditors, but it was rubbish lending at the heart of the problem.

In Europe it’s noticeable that the crises come in two bags. In the periphery, ordinary, decent banks needed no assistance from investment bankers/casino capitalists in blowing up. AngloIrish and the Spanish Cajas generated their losses the old-fashioned way. The role of investment bankers here was confined to channeling money (especially from the core) to them. In the core however, the role of investment banking was more toxic. Essentially all of the Core European banks which have gotten into trouble did so with help from newfangled products as a vehicle to transfer losses from Nevada, Andalucia and Limerick to savers. ING, Depfa, Fortis, UBS all needed bailouts, but not for loans made in their home jurisdictions. The UK, unlucky country capable of catching smallpox in a chicken pox outbreak, was unusual in managing both. HBoS, Northern Rock and Bradford and Bingley were all bog-standard homegrown lending disasters. Only in RBS did structured products play a major role.

The role investment banks played was in funding the disastrous peripheral banks and helping those banks to pass the risks on to the savers of the Core. “Casino banking” seems to have regulated itself better than many realised. It’s the customers who needed looking after.


There’s a really interesting piece pretty tangental to the above here on Dealbreaker about the various games played with Lehman in bankruptcy.

15 Responses to “Exhuming Lehman (and looking for Signs in the Entrails)”

  1. ven bar May 14, 2013 at 10:23 pm #

    oh..you are all wrong…the problem is just NGDP started falling much before all this was happening..looks like you don’t read MMT /NGDP.

  2. Al Lang May 14, 2013 at 10:28 pm #

    Re: “disengaged, clueless regulators”. Might be interesting to compare, of the entities regulated by the FSA and SEC in, say, 2005, how many of each survived / didn’t survive the following few years?

    The regulation that is fashionable now is not the regulation that was fashionable then. Doesn’t mean they were, or are, stupid.

    • stefan May 17, 2013 at 8:46 am #

      Pawel actually did not say stupid, he said ‘disengaged’ – which was the official strategy of light-touch regulation and ‘clueless’ – meaning that they did not really know what was going on as evidenced eg by the FSA report into the NRBS disaster.

      So I think Pawels characterisation is actually spot-on: in order to generate a good business climate (and to lure away business from New York) regulators were under political orders to go lightly, and going lightly they did, which greatly contributed to the build up of the imbalances that eventually caused the crisis.

      Whether they should have known is a different question. Institutionally certainly – hence the change in regulatory tack – but on a personal level this is far from clear given the political steer they had

  3. willyrobinson May 15, 2013 at 10:15 am #

    There was maybe far more securitization in Ireland than you realise, partly because nobody was allowed to lose from it – the Irish Government paid out 100c in the euro when mortgages started to unravel:

    “In 2001 the [Irish Government] passed the Asset Covered Securities Act which allowed financial institutions to securitise commercial property loans. Anglo Irish Bank was an enthusiastic and dedicated issuer of commercial property securities. In 2006 Start Mortgages issued the first Irish sub-prime mortgage backed securities. The debt that was being pumped into the Irish economy created a profitable income stream for the financial sector. However, with no way for the Irish economy to absorb that debt through productive growth, the debt simply ended up as asset price inflation and speculative commercial and residential construction.

    In 2009 Irish Nationwide Building Society, while acting under the cover of the government bank guarantee, bundled over 8,000 residential mortgages with a face value of €1.5 billion into a special purpose vehicle it named Armoin Securities. It issued shares in Armoin – which had been given a AAA+ rating by Fitches – and then proceeded to buy the shares itself. By October 2010 over 8 per cent of the mortgages were in arrears and in April 2012 Armoin was shut down by its then owners, the IBRC.

    In June 2012 the minister for Finance, in a reply to a question on Armoin by the Socialist Party TD Clare Daly, said that Irish Nationwide set up Armoin in order “to access low cost funding from the ECB.” Irish Nationwide created collateral for inter-bank lending by using the government guarantee and close-to-arrears mortgages. The debt created by such procedures are now ours via the IBRC.

    Conor McCabe, Cork Evening Echo print edition, Thursday 26 July 2012

    • pawelmorski May 15, 2013 at 10:16 am #

      Really interesting. Where did the securitisations end up?

      • willyrobinson May 15, 2013 at 1:09 pm #

        They were not designed to be traded. More details here on Conor McCabe’s site:


      • willyrobinson May 15, 2013 at 1:11 pm #

        Maybe this is the better link:


      • stefan May 17, 2013 at 8:53 am #

        probably as collateral for LTRO’s and other refinancing operations at the ECB; I dont think the Irish taxpayer would have suffered any additional damage by those operations given that those were legacy loans of Irish Nationwide so they would have ended up in the IBRC either way

      • willyrobinson May 17, 2013 at 11:43 am #

        Not quite Stefan.

        In 2012 the notes were recalled and paid out at par with interest, but either (a) these weren’t legacy loans of Irish Nationwide, as Armion was an entirely separate entity, or (b) Armoin was a not-quite-separate entity casting doubt on the legality of the securitization and the motivation for setting it up. Either way, as an Irish taxpayer you’d have to be pretty upset. Quoting Conor McCabe again:

        ‘The prospectus for Armoin stated clearly that if Irish Nationwide was not in a position to pay then the investor will lose out – yet the Irish taxpayer paid out full value on an investment from a bankrupt bank, even though the contract itself clearly states that such a risk of non-payment was part of the deal…

        “There can be no assurance that Irish Nationwide will have the financial resources to honour its repurchase obligations under the Mortgage Sale Agreement. This may affect the quality of the Loans and their related security in the Portfolio and accordingly the ability of the Issuer to make payments on the Notes.” (p.17)’


    • dumdedumdum May 16, 2013 at 6:44 pm #

      Very interesting indeed.

  4. William Herschel May 16, 2013 at 9:02 am #

    “The role investment banks played was in funding the disastrous peripheral banks and helping those banks to pass the risks on to the savers of the Core.”

    Cause: brain-dead/criminal/unobservant lenders in small banks in the periphery, including the very far periphery, lending to people who with the least bit of checking would have been seen as unable to pay their bills.

    Effect: investment banks pour money into the hands of these brain-dead/etc. lenders in small peripheral banks, because a creditor never sleeps.

    In other words, a criminal class springs up in Ireland, Spain, and Nevada at a conveniently simultaneous moment, and the unsuspecting investment banks unwittingly support their criminal behavior.

    Don’t you have it backwards?

    I would add that “regulators” is another name for reach-around specialists selected by banks. Which banks? Of course, small banks in the periphery who need help lending to deadbeats. Sure. Obviously.

    If it looks like agitprop, smells like agitprop, tastes like agitprop, and reads like agitprop, it is agitprop.

  5. E.L. Wisty May 16, 2013 at 2:00 pm #

    Reblogged this on Pink Iguana.

  6. stefan May 17, 2013 at 9:11 am #

    Great article – and I do agree that the leading investment banks are pretty amazing organisations, and ‘in the long run’ they almost certainly knew what they were doing – which did not prevent from them being killed in the short run of course, as happened to Lehman, Bear, and Merrill to some extend, and as it might have happened to Goldman and Morgan Stanley as well had they not have had some helping hand.

    Where it gets slightly murkier is where the competitive advantage of an IB is not necessarily in the quality of its business decisions, but in its access to cheap funding and other cross subsidies that they get through the relationship with their financial infrastructure brothers, hence the ring-fencing discussion.

    Which to some extent also holds for Lehman of course: prime-brokerage is an important part of market infrastructure, and whilst hedgies might seem a less deserving bunch than grannies, this re-hypothecation mess where funds did not even know what their risk position was for a long time (because they werent sure whether or not they would eventually get their securities back) is something that should really be avoided in the future…


  1. 10 Wednesday PM Reads | The Big Picture - May 15, 2013

    […] of the Fed May Be Right (DealBook) • Exhuming Lehman (and looking for Signs in the Entrails) (It’s Not That Simple) • Holder Says Leak Required “Very Aggressive Action”… Bank Crimes, Not So Much […]

  2. 10 Wednesday PM Reads - Euro News Cloud - May 15, 2013

    […] of the Fed May Be Right (DealBook) • Exhuming Lehman (and looking for Signs in the Entrails) (It’s Not That Simple) • Holder Says Leak Required [...] Read […]

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