Life Since The Lehman's Collapse

This is a bit moot by now, but the fact that Lehman Brothers was "allowed" to fail probably triggered the massive panic and risk aversion which clouded all assets for the following 4-5 months. Lehman basically closed shop on 9th September 2008. Bespoke had a look at how global markets have performed since then.

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Saturday, October 25, 2008

Lehman Brothers, The Rosetta Stone

The 'Rosetta Stone' is an Ancient Egyptian artifact (حجر رشيد in Arabic) which was instrumental in advancing modern understanding of hieroglyphic writing.

Lehman Brothers' demise probably caused the "banking crisis of confidence", which brought about the present state of financial markets. The massive deleveraging by funds of all kinds, the downgrading of emerging markets' debts and currencies, the flight to USD and yen, the numerous injection of liquidity into the system by central banks, the guaranteeing of deposits to prevent bank runs, the notion that nothing has real value anymore... may all be traced to Lehman Brothers' bankruptcy, or rather Paulson's refusal to save the company. Lehman Brothers may be the Rosetta Stone which helps us better understand why things are the way they are now.

Though Lehman was the smallest investment bank when it failed — and regulators decided it was not too big to fail — its demise set off tremors throughout the financial system that reverberate to this day. The uncertainty surrounding its billions of dollars of transactions with banks and hedge funds exacerbated a crisis of confidence. That contributed to the freezing of credit markets that has forced governments around the globe to take steps to try to calm panicked markets, including guaranteeing bank deposits.
The list of creditors with material exposure to Lehman Brothers is long. There will be dozens of holders of senior notes, sub debt and junior sub debt, so you can’t make too much of the fact that it looks as though the Japanese banks were laid out. We’d need to see the signatories to the Trust Indentures of the three sets of Notes to see just how many financial institutions and debt funds were exposed to Lehman’s various debt pieces:

• $138 billion of senior notes, which have Citibank and BONY listed as indenture trustees
• $12 billion of subordinated debt, with BONY listed as indenture trustee
• $5 billion of junior subordinated debt, also with BONY as indenture trustee
• $463 million of bank debt provided by Japan’s AOZORA
• $289 billion of bank debt provided by Japan’s Mizuho Corporate Bank
• $275 million of bank debt provided by Citibank N.A.’s Hong Kong Branch
• $250 million of bank debt provided by BNP Paribas
• $231 million of bank debt provided by Japan’s Shinsei Bank
• $185 million of bank debt provided by Japan’s UFJ Bank
• $177 million of bank debt provided by Japan’s Sumitomo Mitsubishi
• $140 million L/C provided by Svenska Handelsbanken
• $93 million of bank debt provided by Japan’s Mizuho
• $93 million of bank debt provided by Canada’s ScotiaBank branch in Singapore via NYC
• $75 million of bank debt provided by Lloyds Bank

Paulson obviously did not appreciate Lehman's involvement. Lehman is a leveraged brokerage shop that was the counterparty to trades sized in billions, including interest rate swaps, commodity futures, corporate bonds, international equities and real estate loans, currency swaps, and private equities. The counterparty risk created fear and triggered domino selling. Banks refused to lend to one another fearing the other end to be infested with Lehman's positions. Insiders claim that it could take over a decade to fully unwind Lehman's positions.The scary bit is that Citigroup and Bank of NY may not be out of the woods yet as things stand.

What's more, Lehman was one of the largest prime brokers to international hedge funds. Lehman's bankruptcy immediately caused wholesale panic within the hedge fund industry as funds tried to close/transfer/pull their money out of their Lehman custodian. Today over $60 billion is still locked up in Lehman's London brokerage unit. Given the leveraging nature of hedge funds, the effect on global equity markets was catastrophic as trillions of dollars were wiped off global equity markets. If you were to leverage the $60 billion twenty times (about right) it comes to $1,200 billion worth of positions that needed to be unwound.

Maybe now we can get a better grip on why so many injections of liquidity and bailouts still failed to calm the markets. The injection of capital is more than sufficient, its just that those with fresh capital are not really lending, except to very solid names. Maybe Paulson would be better off addressing the root, i.e. unwind those institutions and creditors affected by Lehman's failure. The escalating domino effect from Lehman's failure is already cascading across the globe. I hope its not too late for Paulson and the global financial leaders to stem the tide.
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What the table shows is that investors have been discriminating. During the height of the panic, everything got sold down massively, even markets in Malaysia, Venezuela, Vietnam, Taiwan, etc... which had very little exposure to the subprime debacle. Yes, these markets should be sold down as a major financial crisis such as the subprime thingy would drastically affect global trade, global demand in particular. Many were fretting that everything gets sold down in a major crisis, even when the "real effects" may be not as severe in some far flung or more disciplined economies. Many were shrugging and throwing their hands in the air, not know why the selldown had to be so "wholesale" in nature.

This table shows clearly that investors do differentiate, and will punish accordingly over time. The right rewards and punishments for the right markets. This table should give us all a lot of comfort in that in the event of a major crisis, the kneejerk reaction would be risk aversion and a wholese-type sell down. It is during the initial first few weeks that those with tough stomachs will benefit in the long run. Yes, investors do differentiate, yes investors do appreciate the differences, yes investors do know the real culprits, yes they know the real effects on each economy and the resilience of each smaller economy, yes they do know that the same crisis affects everyone differently, yes they appreciate the fact that some economies are better managed and are more disciplined in their fiscal and monetary policies ... This is an important point because if all markets get sold down in a major crisis, then its pointless to look at specific sectors, specific stocks, specific countries ... as all will get whacked anyway. The table showed us that doing your homework counts, it pays to know more, it pays to understand more regions ... because if not, we might as well sack all analysts and just hire the few strategists to monitor and anticipate major financial crisis.


p/s photo: Keiko Kitagawa