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Archive for the ‘Lehman Brothers’ Category

Recommended reading: The upcoming FDIC quarterly contains a fantastic article on how, if Dodd-Frank were law then, Lehman Brothers might have been liquidated in a more orderly  and rapid fashion after its failure. The article is a nice summary of the events leading up to the Lehman failure, the relevant provisions of the Dodd Frank Act, and a description of how these would have been implemented in the case of Lehman.  I learned a number of things about how the financial regulation will look going forward. Something I did not know from Dodd-Frank’s orderly liquidation process is that “The Dodd-Frank Act provides that the FDIC may borrow funds from the Department of the Treasury, among other things, to make loans to, or guarantee obligations of, a covered financial company or a bridge financial company to provide liquidity for the operations of the receivership and the bridge financial company.” At least according to current law, any losses on this mini-bailout are born by the industry, not the taxpayer.

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The SEC now has a proposal for how to implement the Dodd-Frank requirement that institutions retain some of the risk of loans when securitizing and selling loans.  The idea of this requirement is to give originators better incentives to originate and sell good loans.  Not sure why the private sector screwed this up – one reasonably hypothesis is that a few large players screwed it up, AIG, Lehman and others — but anyway.  The proposed SEC rules are here for public comment.  To make things interesting, important government officials are now weighing in.  Here is the comptroller of the currency’s response (mostly concerned with fighting exemptions), and here is the press release for Tim Geitner’s (Treasury is supportive of the general rule and accepting of the specifics).  In my opinion, financial institutions need retain no common or systemic risk to be properly incentivized, they just need to hold the risk of the loans they originate relative to similar other loans.  Otherwise, systemic crises damage bank capital.  But I have blogged a fair bit on this before . . .

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In today’s Financial Times, under the headline “Lehman set to reveal new creditor repayment proposals,” is the striking out-take from the article: “Managers of the estate want to start paying our 60.1bn this year.” (FT 1/24/11, p. 19)  Really? This year? So soon?  Why not get things settled first.  Lehman went bankrupt in 2008; and its only 2011.

Let the record show that in addition to the legal costs of having had to whittle down a trillion dollars in claims to just $322bn (and the further costs from having to figure out 60.1 (less these legal fees) divided by 322), a major cost of bankruptcy is loss of liquidity.  A lot of assets are tied up in this bankruptcy.  So funds sit idle, which is costly for hedge funds or investors that pay experts to allocate assets.  Since presumably claims on Lehman trade at large discounts and are hard to use as collateral, do investors with claims on Lehman fire researchers and asset managers? Let them sit idle?

And doesn’t such a long and costly process make the next run on a large financial firm more likely?

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The FDIC has approved an “interim” rule on the orderly liquidation of large financial company here.  Dodd-Frank (Title II) moves on.  According to the law, in the event of the failure of a financial institution whose failure poses significant systemic risks, the FDIC can be made receiver and rapidly impose losses on equity and debt holders.  The idea is that rapid sale of assets can preserve business value, reduce actual bankruptcy (legal) costs (over a billion now for the Lehman bankruptcy), and reduce the uncertainty and illiquidity that affects claims during the bankruptcy process.  This may be a big step in limiting too big to fail.  The legal hurdles however are very large – can this mechanism resolve an incomplete contract in a complex institution without a big fight?  I would rather we never find out.

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My brother-in-law pointed out this post on the WSJ blog and it made me laugh. It has a  fair bit of truth: John Q. Public does not understand the extent to which derivatives and banks support business as usual during good times.  I think the quote is from the movie “A Few Gold Men.”

You want the truth? You can’t handle the truth. Son, we live in a country with an investment gap. And that gap needs to be filled by men with money. Who’s gonna do it? You? You, Middle Class Consumer? Goldman Sachs has a greater responsibility than you can possibly fathom. You weep for Lehman and you curse derivatives. You have that luxury. You have the luxury of not knowing what we know: that Lehman’s death, while tragic, probably saved the financial system. And that Goldman’s existence, while grotesque and incomprehensible to you, saves pension funds. You don’t want the truth. Because deep down, in places you don’t talk about at parties, you want us to fill that investment gap. You need us to fill that gap.

We use words like credit default swaps, collateralized debt obligation, and securitization? We use these words as the backbone of a life spent investing in something. You use them as a punchline. We have neither the time nor the inclination to explain ourselves to a commoner who rises and sleeps under the blanket of the very credit we provide, and then questions the manner in which we provide it! We’d rather you just said thank you and paid your taxes on time. Otherwise, we suggest you get an account and start trading. Either way, we don’t give a damn what you think you’re entitled to!

 

Source here.

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