I know Felix Salmon has been on this, but I highly recommend this post on FT about the bankruptcy of Lehman in Britain:
"as the bank collapsed and his team took over the European leg of the biggest and most complex bankruptcy in history."
Wow. I didn't realize this.
"In many countries, bankruptcies are handled by lawyers, but in the UK, the lead roles go to accountants."
I didn't know this.
"if Lehman was a global enterprise in health, in bankruptcy each of its regional operations would face its own set of legal rights and responsibilities."
Fascinating.
"There are two basic forms of insolvency. The first and more common is cashflow insolvency. This is when a company finds itself unable to pay its debts as they fall due. The second is balance-sheet insolvency, in which liabilities outweigh assets. Lehman’s European operations fell into the first category."
Okay. It can't pay its bills.
"Like many global corporations, the bank swept all the cash from its regional operations back to New York each night and released the funds the next day. The Friday sweep had taken about $8bn out of London. Without cash, the business could not meet its financial obligations on Monday morning. A thriving business of more than 5,000 staff and investments worth billions of dollars was suddenly flat broke."
Unreal. $8 billion gone, never to return. Weird.
See Felix Salmon here.
Also here.
"Every day, Lehman dealt with thousands of companies, other banks and investment funds. Opening another day’s London trading therefore ran the risk of destabilising the world’s markets. Equally pressing, trading without the cash on hand to meet obligations – technically, trading when insolvent – is against the law."
Again. Unreal.
"There are more than 200 legal entities in the bank’s European operations. The PwC team needed to identify which pieces ran the whole business, which assets needed immediate protection and which would actually be insolvent as a result of a lack of cash. As the night wore on, the partners gradually began to realise the true scale of what they were taking on. Schwarzmann settled down to look at the standard group structure. “Wow,” he said, “that’s quite complicated.” Andrew Wright, Lehman’s European finance director, turned round and answered: ”That’s just the summary.”
These quotes are self-explanatory.
"At Lehman, that meant Lomas’s team had to act fast on a number of fronts – from dealing with more than 50 exchanges around the world to persuading the contracted canteen cooks to keep coming in. Harder still, they were starting from cold."
I think that this means that they had to take on this immense and complicated bankruptcy immediately. Wow.
"Immediate tasks included securing the IT operations, notifying the thousands of exchanges and other counterparties which the bank dealt with, assessing the risks involved in its open trades, starting the search for cash, figuring out the way each division operated, discussing sales of business units with potential bidders and talking with the staff. Then would come the detailed work – still ongoing – of unwinding the bank’s vast trading positions and unravelling exactly who was owed what and by whom."
Just think of this.
"Having run most of its accounts through its New York parent, Lehman Europe had few deposit accounts of its own. Nor could it set up any with another bank, since that bank was likely to be a creditor or debtor and could try to seize any money parked with it. In the end, the Bank of England came to the rescue. The bankrupt bank now has more than 60 accounts with the central bank, covering currencies ranging from US dollars to Chinese renminbi to Norwegian krona. It expects to open still more."
So, in essence, a business must be created in order to bankrupt itself.
"On average, the bank was responsible for 12 per cent of all trades on the London Stock Exchange. Its prime brokerage business, which serves hedge funds, was one of the biggest in London and held some $40bn of client assets."
12% of the LSE frozen.
"By Wednesday, Lomas and Team were in a position to tell staff that a $100m loan would cover their salaries. Now the focus could shift to trying to sell as much of the business as possible and trying to unwind its trading positions."
Good luck.
"For many Lehman traders, the need to unwind the company intelligently meant a new pay package with a hefty bonus component if they managed to strike deals that were advantageous to the Lehman estate. Pearson knows he might come in for outside criticism for doling out these bonuses, since all funds are now owed to the bank’s thousands of creditors. But he defends the move. “It’s exactly what I did at Enron, so I knew exactly how I wanted to handle this. You’ve got a bunch of people here who know these markets so well, and with the right piece of information they can make you – or lose you – hundreds of millions of dollars,” he says. “The last thing you can afford to do in these circumstances is be cheap, because if you’re cheap, you can ruin the ship for a hap’orth of tar.”
These employees, who are going to eventually be terminated, are in a pretty good bargaining position.
"The juddering halt caused by the bankruptcy meant that the previous three days’ trades were not fully settled. They weren’t even fully recorded in the bank’s systems. This wasn’t an unusual time-lag, but one not helped by the fact that trading volumes had simultaneously shot up because of market panic, caused in part by fears about Lehman’s health. The unsettled trades caused chaos in the markets as stock exchanges began to work through the deals to reach settlement. The securities traded by Lehman were simply left hanging during some of the most volatile days ever seen in the markets."
Unreal.
"Then there were the cancellations, where counterparties such as banks or hedge funds with whom Lehman had traded rushed to trigger legal clauses to extricate themselves from some deals. Thousands of e-mail cancellations hit the bank. Either for itself or its clients, the bank held billions in securities such as stocks, currencies, commodities, bonds and various derivatives. On Friday, Lehman traders went home comfortable they had protected their risk on these holdings. Monday brought the realisation that the broken deals meant many hedges were no longer in place: the bank now had a book of holdings at risk of being crushed by the wild market swings."
It's a snowball effect from hell.
"To begin unwinding the “book”, Pearson called on outside help and used other banks’ trading teams operating under confidentiality agreements. These teams conducted the sales so the market would not know they were Lehman positions. If dealers had known that a particular trade was linked to the stricken bank, they could have tried to profit by pushing the price down, knowing Lehman had to sell."
They had to pretend they were someone else in order to avoid getting hosed. Too much.
"In fact, some of these trades actually ended up making the bank hundreds of millions of pounds as the team rode the rollercoaster market moves. “We ended up catching both sides of the market,” says Pearson. “We decided to close out some long positions [assets held in the expectation that prices would rise] when the market went up. We had some short positions [designed to profit from price falls], too, and the market then went down.” He won’t give exact figures but says: “Some positions that we moved, we made gains that exceeded the entire earnings of one of the divisions last year.”
That's pretty funny.
"Then there were the client positions, where the bank held assets on behalf of its customers, or stored them with another bank. Since Lehman’s collapse, hedge funds and others have been issuing increasingly frantic calls for the return of their assets – to no avail. This has produced some high-profile victims such as Luqman Arnold, head of the Olivant fund, whose entire 2.78 per cent stake in UBS is held by Lehman.
Certain hedge funds have claimed they are at risk of collapse because of trapped assets, which they cannot trade nor effectively hedge against, but PwC has warned it will take months before they can be returned. Even six weeks into the bankruptcy, the administrators were waiting on some of the 97 banks holding Lehman assets to clarify just what they held."
Wow. You don't know what the worth is of what you have, and you can't do anything with it.
"It’s all complicated further by a process known as rehypothecation, which affects a substantial proportion of the hedge fund assets held by the bank. In these cases, the funds pledged collateral (usually stocks or other securities) in return for a loan, while agreeing to the bank’s putting that collateral back in the market to make extra profits. With the music stopped, the hedge funds owed Lehman money in exchange for the collateral. To honour that, Lehman must itself go back into the market and unwind deals in which it reused the assets, paying out cash to get them back."
Oh hell no. Not another bizarre term to understand.
Okay.
1) Hedge Fund gives assets to Lehman.
2) Lehman gives money to Hedge Fund
3) Lehman uses assets to make money from third party.
Now:
1) Lehman pays money to get assets back from third party.
2) Hedge Fund gives money back to Lehman for assets.
“There are so many trades that need to be closed and then evaluations validated and reconciled before we can say, ’are you a debtor or creditor’,” says Pearson. “You can’t form views without all the facts. The danger is if you form a view on two or three facts, that a fourth fact could fundamentally change your conclusion. And in a number of the positions that we’ve been looking at, we’ve discovered a fourth fact and we’ve gone from the situation being black to it being white in terms of the resolution.” He adds: “We don’t know if there’s a fifth fact, by the way, because this diligence exercise has never been done before.”
I'm sorry, but here I'm lost.
"Confusion began to clear in the following days. Pearson and Lomas used their contacts to find the $100m – unsecured – emergency funding. Pearson and Jervis began the work of unwinding the bank’s vast and complex trading positions. Schwarzmann pursued outside interest in the investment banking and trading teams and in the second week secured a deal – with Nomura, for just $2 in cash. That deal put the Japanese bank in charge of half the staff, while allowing PwC to keep working on unwinding Lehman’s trading book. The arrangement had two advantages: Lomas’s team retained, for the time being, the expertise it needed, and Nomura got a bargain on an established London-based investment bank.
It’s not clear how long this arrangement will last – nor is it clear how long the PwC administrators have until creditors get antsy enough to sue for their money. "
I guess this qualifies as a clearing.
"So far, only one hedge fund has gone to court to try to speed up the return of its assets. The judge told it to give Lomas and his team more time. This is likely to be the response most creditors receive for some time, not least because who owes what, and to whom, is still far from clear. The final goal is to get as much money to creditors as possible. Only when the lawsuits stop rolling in will Lomas and his team know they are done."
Good luck.
"In the end, is Lomas surprised by the scale and complexity of what he is now dealing with? He thinks carefully. Not in terms of complexity, no. What did surprise him, though, was that Lehman’s collapse had been allowed to happen in the first place. “I was surprised that it had gone down and that authorities elsewhere in the world hadn’t found a way to avoid it going down – precisely because I could anticipate the complexity that there would be here.
“Surely others had seen just how big and ugly this was going to be?”
I think that this makes perfect sense. Calling chaos theory. The uncertainty thrown into the markets must have been terrifying to some people. Letting this happen was a dreadful mistake. The government not stepping in was foolish, and we can see why. There are some market processes, involving legal and trading complexities, that can cause terrifying chaos as they are sorted out. The market can't handle this on its own, any more than it can handle it without courts.
This post by Felix Salmon seems wrong in retrospect.
Here's a post from Bronte Capital about this:
"The deleveraging of debt markets following the Lehman failure left everyone (maybe except Uncle Warren) hoarding cash. [It also ran the Federal Reserve out of balance sheet in a single day – something that I will come back to in a later post…]
Lehman’s failure cracked this market – and it did so because the UK lacked the basic depression era legislation (the 1934 Act) and had encouraged reckless leverage by reducing capital requirements to low levels.
It was the failures of London that made Paulson’s decision wrong. I didn’t see it at the time – and nor did he. However I have never been CEO of a broker-dealer – and Paulson has. So one bad mark for me and three for him. I keep score…"
What capital levels? They were broke?
to A, where F is the fee and N is the total amount of A’s exposure, which in the case of a swap would be the 
. If E is the event “ABC defaults on its bonds,” then A and B have entered into a credit default swap where A is short ( DEFAULT ) on ABC bonds and B is long ( NO DEFAULT ). Thus, we can think in terms of a unified price for both sides of the trade and consider how the expected payout for each side of the trade changes as that price changes ( BASED UPON THE CHANCE OF DEFAULT ).
, then A will accept any fee less than .5 since A’s subjective expected payout under that assumption is 
. If B thinks that E will occur with a probability of 
, then B will accept any fee greater than .25 since his expected payout is 
. Thus, A and B have a bargaining range between .25 and .5. And because each perceives the trade to have a positive payout upon termination within that bargaining range, they will transact ( THEY BASE THEIR ACTUAL INVESTMENT ON THE PROBABILITY OF THE EVENT OCCURING IN THEIR OPINION ). Unfortunately for one of them, only one of them is correct ( THIS IS WHERE PEOPLE FEEL IT'S LIKE GAMBLING AND NOT LIKE INSURANCE ). After many such transactions occur, market participants might choose to report the fees at which they transact ( ON AN INDEX ). This allows C and D to reference the fee at which the A-B transaction occurred. This process repeats itself and eventually market prices will develop ( FORMING AN INDEX, AND, POSSIBLY, AN EXCHANGE ).
and 
respectively. If A has positive exposure and B has negative, then in general the subjective expected payouts for A and B are 
and 
respectively. If we plot the expected payout as a function of F, we get the following:
Posts
"After Bear Stearns, counterparties to banks were lulled into a false sense of security — assuming that default risks were reduced - or at least recovery rates increased - by a sort of faintly implicit guarantee from the US government against too-big-to-fail banks."
My only disagreement with this is that the implicit guarantee had been in effect since the S & L Crisis. Although there was a chance of not being bailed out, as Lehman showed, the underlying belief was that the government could not allow large and interconnected financial institutions to fail. This was so well understood, that there was really no Plan B for these large institutions.
From my perspective, the reaction to Lehman was panic at the thought that the government wouldn't intervene, and that there was no real Plan B.
I think that the idea that the people involved in this belief were adherents of zero government intervention on principle has been proven false. Rather, they believe that the government and Fed are an essential backstop to our financial system. Simply because people try to get around regulations or have them abolished for their own ends, doesn't entail that they don't welcome and depend upon government when it suits their interests. Free market rhetoric is very useful when you're trying to get the government out of your way, but it's not a binding contract on future behavior or behavior in other circumstances.
Phil Gramm and others might have actually believed their rhetoric, but the people with the real money are not so foolish as to not believe and expect that when they could really use government help, they damn well better get it. Surely actions speak louder than words, and the actions, after Lehman, said, "For God's sake help us, and don't bother mouthing nostrums about the free market, because if we go down we're taking you with us. Did you think we gave you all those donations for your eloquent defense of principles?"