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So Lehman’s was illiquid, not insolvent

This is interesting:

Creditors to the estate of Lehman Brothers will finally recoup all the money owed to them when the defunct US investment bank collapsed six years ago after administrators said they were ready to pay a dividend that will finally make them hole.

Hedge funds, asset managers and other major banks will be among the unsecured creditors receiving a dividend from PricewaterhouseCoopers, the administrator of Lehman Brothers, that will mean they will take their repayment to 100p for every £1 they were owed.

PwC estimates that creditors could actually receive interest on their money and has discovered a surplus of about £5bn that could be used to pay further dividends.

Tony Lomas, lead administrator at PwC, said the repayment of creditors six years on from Lehman’s 2008 bankruptcy was a “remarkable feat”.

“The fact that we have been able to pay ordinary unsecured in full, including the return of their trust assets and client money, with a significant surplus remaining, highlights the importance of having a healthy level of capital within a firm’s balance sheet,” said Mr Lomas.

Lehman’s (in London at least, dunno about the US) was bust, certainly, but because it was illiquid, not because it was insolvent. Which brings us to two points.

One, given this, was it wise to let it go under? And second, it does rather disprove some of the wilder claims about the bust. At heart the problem was maturity transformation, borrowing short and lending long. Fractional reserve banking in other words.

Not, as some seem to think, wild behaviour, greed or bonuses. Which leads to the question of what we should do about it, if anything. Myself I think the bank levy, there to pay for the implicit guarantee that FRB shops get, is the right thing to be doing. Because the value of FRB itself is sufficient that we’ll just have to put up with the failures and distortions that happen.

Agreed, many differ. But it is still true that if Lehman’s was a matter of liquidity, not solvency, then the debate about what to do has rather changed.

27 thoughts on “So Lehman’s was illiquid, not insolvent”

  1. If it’s able to pay 100% dividend after 6 years of administrators fees, that’s quite something.

  2. Let’s not forget about the propping up asset price business that was carried out by the CB at the expense of the plebs for the last 6 years and is still ongoing.

  3. What’s the argument? That the Fed should have known that the problem was only illiquidity and therefore acted a la Bagehot and saved the business? But wouldn’t that require the Fed to be competent?

  4. Lehman was allowed to die out of spite cos Paulson hated Fuld, largely because Fuld failed to help in the LTCM bailout and because he was a nutjob. At Lehman the average IQ increased as you descended the org chart.

  5. The £5bn surplus could alternatively be used to fill any hole in the books of the US parent after all creditors are paid in full.
    Please note that the liquidators had to pay some of the staff to run the business down and £millions in lawsuits arguing with the US administrator about which bit of Lehman owed how much to whom, more £millions of rent on the offices used as well as tens of £millions in their own fees. The staff costs alone will approach £0.5 billion.
    Barclays bought the best chunk of Lehman’s New York operation at a snip $250m, but it earned Barclays $billions per annum – a competent Central Bank would have sold it for more than $10 billion before dumping the rest.
    So know we know that “the biggest bankruptcy in history” wasn’t a bankruptcy at all. Remember that guys next time someone uses that silly phrase.
    The truth is a combination of what dearieme and Frederick said, though more dearieme as it is difficult to believe that Paulson would have engineered the crash just because he hated Fuld.

  6. One of the definitions of insolvency is the inability to pay debts as they fall due, which you are calling ‘illiquidity’. You are thereby creating a distinction without a difference.

  7. @john77

    I never meant to say that he engineered the crisis. I think Paulson was of the mind that “Dick got what he deserved” and at that time the political capital needed to get the $10bn needed to bail out LB was more than Paulson wanted to spend. And I can understand his attitude. I have been in the room with Fuld many times and he is no genius, he comes across more like a thug.

    It was only after LB blew and then AGI blew that Paulson realised that his baby GS was next in line and decided to act,literally getting down on his knees to plead for a massive bailout.

  8. @ Frederick
    Sorry, I phrased it badly: “crash” means “Lehman crashing”, not “a major crisis in the USA which had significant effects in other countries”.

  9. @ H
    Bankruptcy is inability to repay debts. Insolvency covers more than just bankruptcy. The latest stats from The Insolvency Agency shows that bankruptcy comprised only 24% of individual insolvencies in England & Wales in 2013 (although a fairer comparison would be Bankruptcies plus Debt Relief Orders which jointly comprised 52%); the comparable numbers in Scotland were 31% and 50%.
    Lehman Brothers was but because it was illiquid, not because it was bankrupt.
    Happy now?

  10. Frederick: Lehmans did contribute to the LTCM bailout. It was Bear which declined to join in and later found the Fed unsympathetic to its difficulties.

  11. @PaulB – you are right. Although they gave less than the others (but then they were smaller).

    In any case my point was that there was a bad relationship between Paulson and Fuld.

  12. The fact that the Lehmans’ creditors can be repaid in full now doesn’t prove that its liabilities didn’t exceed its assets in 2008. Rather, the market price of its assets increased subsequent to its failure.

    Unless Tim is telling us that sub-prime mortgage tranches had some intrinsic value, quite different from what the market perceived…

  13. @ PaulB
    ” Rather, the market price of its assets increased subsequent to its failure.”
    You *are* joking aren’t you? The market price of its assets slumped as a direct consequence of its failure. “Fire sale” with an immediate cut in the price of all the stocks where Lehman was known to be long, let alone. Barclays paying $250m for a business earning $billions.
    Actually sub-prime mortgages did have some value unless *virtually all* the borrowers defaulted and the aggregate sale price of the houses fell short of the aggregate cost of repossessing and then selling them. The lower tranches of split-CDOs were worth total less value of top tranches but, except in the cases of outright fraud where the mortgage was a a multiple of the value of the house, they did have some value and most had more value than ascribed to them by the market.

  14. Indeed – The same was true of Enron in the UK, but that still didn’t stop it from being brought down by the collapse of Enron US.

    I know Enron UK’s former Risk Manager and he was as conservative as they come and ran Enron UK as well as any of their Integrated Supply and Trading counterparts, yet still gets tarnished by the same brush.

  15. Well, it was solvent given current ZIRP interest rates and market levels, not given interest rates at the time.

    The Madoff ‘investors’ got about 59% of their money back too, doesn’t mean Madoff was that solvent, just means later developments permitted them to recover more than seemed likely at the time.

  16. Noo, not quite. The administrator went after those who had received payouts from Madoff. That money was recouped to pay the later investors. Which is te right way of dealing with a Ponzi scheme.

  17. John77: If Lehmans’ assets had been worth what they needed to be, the bank would have been resolving its problems by selling them or borrowing money against them, or it could have sold itself intact. None of those things happened.

    It’s quite true, and generally acknowledged at the time, that sub-prime mortgages in the aggregate were worth more than market prices seemed to suggest. The problem was that no one could tell the real quality of any particular tranche being offered.

  18. @ PaulB
    It is not always possible to find a willing buyer with $10 billion in cash if someone claims that you have triggered an instant repayment clause on a bank loan. So you are incorrect in claiming that Lehman could have sold all its assets in a hurry if they were worth what they needed to be. We know that Barclays got a “deal of the century” buying a chunk from the liquidator. It could not have sold itself intact because the DoJ would have banned any purchase by either competitor big enough to afford to buy Lehman (Goldman Sachs and Merrill Lynch) or by JP Morgan, because it had bought Bear Sterns: who else had that kind of money apart from the Arabs – who had been blocked from owning the US businesses of P&O – or China?
    You also overlook the margin call cash held by JP Morgan, among others, as a provision in case the security lodged by Lehman fell in value relative to the stocks that it had borrowed. Lehman could not retrieve that until it had repaid all the stock borrowed (much of which was not speculative but simply due to some Lehman clients taking time to deliver stock that they had sold through Lehman – NYSE settlement does not allow for the time that the US postal service takes to deliver certificates sent by post from the client to the broker). If Lehman tried to borrow against the stocks it held the amount it could have raised would have been lower than the value by a substantial safety margin.
    Life just isn’t as simple as we should like it to be.

  19. John77: I don’t believe the DoJ would have blocked any western bank from taking over Lehmans. Reports at the time were that both BoA and Barclays considered taking over Lehmans and decided against unless the Fed paid them to do it (BoA bought Merrills instead, which did have a positive value). The obvious conclusion is that Lehmans at the time was worth less than nothing.

    Meanwhile, the Fed was running a massive operation to provide liquidity to the banks. Lehmans certainly did not fail just because it was short of a few billion dollars of ready cash.

  20. @ PaulB
    ” Lehmans certainly did not fail just because it was short of a few billion dollars of ready cash.”
    Actually that is *precisely* why it failed.
    That is precisely the reason for any bank failure. Which is why the BoE was “the lender of last resort” to the English banking system and we didn’t have a bank run for more than a century until Gordon Brown thought he knew better.
    As a result of it being short of ready cash, it was faced with the option of making a fire sale.
    If you read Caldwell’s report on Northern Rock you will see that it had net assets of £1.5 billion when Darling expropriated it – the retrospective excuse for non-payment of compensation was that if the BoE decided not to support it then it would have to sell assets in a fire sale at a massive discount to open market value which would wipe out its surplus of assets over liabilities.

  21. The Fed had its TAF and Repo programmes to stop banks failing through illiquidity alone. If Lehmans had been sound it could have got the cash.

    The Fed could have saved Lehmans by pumping money into it, but it is not the Fed’s job (nor the BoE’s) to substitute its judgment for the market’s on the question of whether an individual bank is sound. And unquestionably the market had no confidence in Lehmans solvency. The market was not willing to buy Lehmans at any non-negative price.

    The value of a financial security is what the highest bidder is willing to pay for it at the time, not what it realises years later. I’m surprised to read arguments on this forum assuming some value arrived at with the benefit of hindsight.

  22. What is this form of retardation forcing you people to call this firm “Lehmans”. It is Lehman Brothers.

  23. @ PaulB
    I am not suggesting that Lehman Brothers was sound, just questioning whether it was actually bankrupt.
    “The value of a financial security is what the highest bidder is willing to pay for it at the time, not what it realises years later.”
    I am sure Warren Buffet will be fascinated to learn that 90% of his investments have no value 99% of the time. If you have an unquoted security with a fixed maturity date its value is the discounted present value of maturity proceeds using a discount rate that exceeds the nominally risk-free rate (Gilts or US Treasuries) by a margin for risk and another margin for illiquidity.

  24. Lehman Brothers as a bank had capital to absorb loses, so how much capital is left after the creditors get their 100%, that money should go to shareholders, although a fair chuck will have been burned through by the insolvency practitioners involved. Still I suspect that from a prudential perspective that Lehman Brothers was probably bust and almost certainly breached its capital requirements.

    I also echo comment above that on a mark to market basis is was definitley insolvent as its assets were worth far less than its liabilities at the height of the GFC. Then again probably most banks were in the same boat but managed to trade throuth

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