The Collapse of Lehman Brothers

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Why did Lehman Brothers collapse so quickly when their reported financial condition a week before had actually been fairly decent? Answer: because they were lying about their financial condition. Economics of Contempt has now read the entire 4000+ page (!) report written by the court-appointed examiner after Lehman’s collapse, and it turns out that at the time they were reporting a $32.5 billion liquidity pool they actually had, at most, a $2.5 billion liquidity pool:

Earlier in 2008, Lehman’s two main clearing banks, JPMorgan and Citi, started requiring Lehman to collateralize its intraday exposures….Lehman reluctantly agreed, but requested that the banks release the collateral at the end of each day. Why did they care if the banks released the collateral every night if it just had to be posted again the next morning? Because Lehman calculated its reportable liquidity at the end of each day, and if the clearing-bank collateral was released at the end of each day, Lehman considered it part of the “liquidity pool.” By the end, roughly $19bn of the $32.5bn liquidity pool consisted of clearing-bank collateral.

In no functional sense was the clearing-bank collateral “unencumbered” — if Lehman requested the collateral back, JPMorgan and Citi would have at the very least required them to pre-fund their trades (which Lehman didn’t have the cash to do), and more likely would have just stopped clearing their trades. People at Lehman admitted as much to the Examiner. And once a broker-dealer’s clearing bank stops clearing its trades, the broker-dealer is finished. Including the clearing-bank collateral in its liquidity pool was not only inappropriate, but also aggressively deceptive.

Without liquidity — real liquidity, which means money that Lehman could get to within a day — Lehman was doomed. But they refused to report their true liquidity situation, and when their funders started dropping out they went bust almost instantly. This is one of the reasons why the obscure topic of the “net stable funding ratio,” which is part of the Basel III negotiations, is important. More on that here.

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DEMOCRACY DOES NOT EXIST...

without free and fair elections, a vigorous free press, and engaged citizens to reclaim power from those who abuse it.

In this election year unlike any other—against a backdrop of a pandemic, an economic crisis, racial reckoning, and so much daily crazy—Mother Jones' journalism is driven by one simple question: Will America will move closer to, or further from, justice and equity in the years to come?

If you're able to, please join us in this mission with a donation today. Our reporting right now is focused on voting rights and election security, corruption, disinformation, racial and gender equity, and the climate crisis. We can’t do it without the support of readers like you, and we need to give it everything we've got between now and November. Thank you.

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