The Collapse of Lehman Brothers

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.

DOES IT FEEL LIKE POLITICS IS AT A BREAKING POINT?

Headshot of Editor in Chief of Mother Jones, Clara Jeffery

It sure feels that way to me, and here at Mother Jones, we’ve been thinking a lot about what journalism needs to do differently, and how we can have the biggest impact.

We kept coming back to one word: corruption. Democracy and the rule of law being undermined by those with wealth and power for their own gain. So we're launching an ambitious Mother Jones Corruption Project to do deep, time-intensive reporting on systemic corruption, and asking the MoJo community to help crowdfund it.

We aim to hire, build a team, and give them the time and space needed to understand how we got here and how we might get out. We want to dig into the forces and decisions that have allowed massive conflicts of interest, influence peddling, and win-at-all-costs politics to flourish.

It's unlike anything we've done, and we have seed funding to get started, but we're looking to raise $500,000 from readers by July when we'll be making key budgeting decisions—and the more resources we have by then, the deeper we can dig. If our plan sounds good to you, please help kickstart it with a tax-deductible donation today.

Thanks for reading—whether or not you can pitch in today, or ever, I'm glad you're with us.

Signed by Clara Jeffery

Clara Jeffery, Editor-in-Chief

We Recommend

Latest

Sign up for our newsletters

Subscribe and we'll send Mother Jones straight to your inbox.

Get our award-winning magazine

Save big on a full year of investigations, ideas, and insights.

Subscribe

Support our journalism

Help Mother Jones' reporters dig deep with a tax-deductible donation.

Donate

Share your feedback: We’re planning to launch a new version of the comments section. Help us test it.