Survivor Bias and TBTF Tyranny
As I wrote in Ring Fences and Rustlers before Lehman failed in 2008:
The key to having a happy insolvency, if such a thing exists, lies in ensuring that when a globalised bank goes bust, all the best assets are inside your borders and subject to seizure by [your banks or] your liquidators on behalf of your creditors.
If one were cynical, and one believed that Lehman was going to be allowed to fail pour encouragement les autres one might wonder if Lehman was quietly bidden – or even explicitly ordered – to sell off its foreign holdings and repatriate the proceeds to asset classes within the US ring fence. This would ensure that US creditors of Lehman received a satisfactory recovery at the expense of foreign creditors. It would also contribute to a nice pre-election illusion of a “flight to quality” as US dollar and assets strengthened on the direction of flow.
If one were really cynical, one might even think that a wily bank supervisor might arrange to ensure 100 percent recovery for its creditors with a bit of creative misappropriation thrown in the mix. Broker dealers normally hold securities and other assets in nominee name on behalf of their investor clients. Under modern market regulation, these nominee assets are supposed to be held separately from a firm’s own assets so that they can be protected in an insolvency and restored to the clients with minimal loss and inconvenience. Liberalisations and financial innovations have undermined the segregation principle by promoting much more intensive use of client assets for leverage (prime brokerage and margin lending) and alternative income streams (securities lending). As a result, it is often very difficult to discern in a failed broker who has the better claim to assets which were held to a client account but reused for finance and/or trading purposes. The main source of evidence is the books of the failed broker.
HT: EconoMonitorOn the wholesale side, margin and collateralisation in connection with derivatives and securities finance arrangements mean that creditors under these arrangements should have good delivery and secure legal claims to assets provided under market standard agreements. As a result, preferred wholesale creditors could have been streamed the choicest assets under arrangements that will look above suspicion on review as being consistent with market best practice.The official report of the court appointed examiner confirmed my worst suspicions. We now know that the Federal Reserve Bank of New York and the SEC co-located staff inside Lehman from March 2008 to oversee the global repatriation of assets and cash in the run up to the insolvency in September. The Fed kept Lehman on life support during this period with more than $20 billion of liquidity which it paid back to itself from Lehman cash on the day Lehman filed for liquidation. In the meanwhile, from March 2008, Lehman looted its affiliates and client accounts worldwide by using prime broker and securities lending mandates to lend assets to the US affiliate which were sold (hence the sharp fall in Eastern Europe and Asian markets and growing volatility eleswhere from March 2008) and the proceeds streamed to US creditors as margin payments on derivatives and other obligations. The official receiver elected not to challenge the cash transfer to the Federal Reserve or any of the transfers of cash or securities made to major Lehman counterparties and creditors.
Those following the MF Global failure have noted a strikingly similar pattern of conduct by JP Morgan in advance of failure as occurred with Lehman, although without obvious official mandate. Yves at Naked Capital has been covering the parallels admirably. Carrick Mollenkamp, Lauren Tara LaCapra and Matthew Goldstein at Reuters have provided a very substantive story of how JP Morgan used its superior knowledge of MF Global’s trading and credit position to enrich itself at the expense of MF Global and its clients before precipitating the MF Global failure....MORE
