Financial Arson Watch IV
Over at Firedoglake “Masaccio” has a very interesting report on a legal complaint by the estate of Lehman Brothers against J.P. Morgan.
on September 9, 2008, JPMorgan insisted that Lehman sign further agreements, under which Lehman guaranteed all obligations of its subsidiaries, including obligations under derivatives, and lost the ability to access its collateral overnight. That jeopardized the capital position of Lehman.
Then JPMorgan demanded even more collateral, finally winding up with some $8.6 billion in cash and liquid securities (paragraph 72) which made it wildly over-secured not only as to the minimal intra-day exposure, but even as to JPMorgan’s share of the unsecured line of credit and any reasonably estimated obligations with regard to derivatives.
On September 12, JPMorgan refused to give Lehman access to its collateral. Lehman collapsed into an uncontrolled bankruptcy, with little cash and less planning.
The complaint says that JPMorgan admits that the additional collateral was not needed to cover exposures under existing agreements such as the unsecured loan agreement and the Clearance Agreement. It says that the purpose was to collect “… on the possibility of closing out derivatives contracts on favorable terms in the event of a [Lehman] bankruptcy.”
Mmm sure smells like financial arson to me.
Read the whole thing (Dimon is much more creative than me. The point of the bankruptcy appears to have been to prevent Lehman from paying premiums on CDSs it had bought from JP Morgan causing the contracts to terminate automatically).
$$ http://bit.ly/au8D2A $DO $BP $FAZ
This makes for some interesting drama, but the core problem is still the practice funding 30:1 long term leverage with overnight repos.
JP Morgan can always just say they had an epiphany and all of a sudden realized this could be detrimental to the financial well being of JP Morgan, and who could argue with that?
In fact To Big to Fail suggests precisly that that Jamie realized there would be trouble and decided to protect JP Morgan against such a failure.
When your survival depends on your rivals you deserve your fate.
In a business based upon trust like the financial services industry, if the industry looses credibility you are toast as well. The whole business of banking is based upon borrowing short and lending long, although deposits tend to be sticky and rarely go to zero. The whole idea of riding the yield curve and borrowing by repos requires that confidence be maintained or there can be a run, just like before the FDIC there were runs on bank deposits. (And apparently there was one on WaMu just before it failed all be it electronic). The money market industry came close to dissolving in sept 2008 as well.
There are a couple of things. One is the new bankruptcy code which enables JP Morgan to seize collateral right through chapter 11. Another is the exact contracts governing JP Morgan written CDS. The fact that JP Morgan’s liabilities are cancelled due to Lehman’s bankruptcy creates gains from deliberately driving a firm bankrupt — that is from financial arson.
Both suggest regulatory reform.
I think the bankruptcy code should be re-reformed — it would be best to start by repealling the bankruptcy reform entirely. Collateral sent to a single mandatory clearing house would help (as it is JP Morgan did very well by itself by thinking of buying Lehman or perhaps by pretending to).
I think allowed CDS contracts have to have a provision for the bankruptcy court to keep rights to possible payments (by paying premiums) if the court thinks it is in the interest of creditors as a group.
Also I wonder if JP Morgan owned naked CDS on Lehman debt. Perhaps a bit too obvious (it was the form of financial arson which I thought of). But with no reporting requirementsand all that.
For a while I bought the argument that the short sellers ganged up on Lehman for no good reason.
But in hind sight the shorts were right, the Lehman balance sheet was a huge bag of toxic goop, and Lehman was misleading shareholders. Lehman was going down sooner or later.
The story on Lehman a couple months ago was “Repo 105”. Here it came out that Lehman was doing repo financing with European and London banks. The reported reason was that Lehman didn’t really trust their Wall Street shark buddies for anything so critical to the biz as overnight repo financing.
So I think we still need to wait for the whole picture to emerge here.
I think, as always, the shorts are the last ones to the party. They can’t figure out phony balance sheets either.
I think the Repo 105 issue centered on doing the repo deal at the end of each quarter, which is called “window dressing” or “whitewashing the balance sheet.”
The shorts read the balance sheet before the SEC.
The other part of it is that when doing a repo, you must post collateral. The lender gets to inspect the details of the collateral, not just the mark to market (or model) price. So say it was a CDO loaded with NINJA mortgages, the lender side would discover that. So some speculate Lehman wanted to do that with non-competing banks in the far corners of the world.
So much for EMH and free markets regulating banks. Then the SEC wasn’t there either.
The Sec in general believes that if you discolose things then its ok, that is the philosophical basis of its actions. Note that a lot of the actions are about someone in a position to know something not telling the world. As far as Lehman et.al. The law did not provide any regulation for them, they agreed to be regulated lightly by the Sec in order to be able to do business overseas. So the real question the SEC looks at is did their financial statements fully and properly disclose their business. (Enron got tripped up on improper disclosure BTW).
It is not just the 2005 Consumer Protection and Bankruptcy Act. The 2001 Financial Modernization Act must also be changed to allow regulation of derivatives.