I recall three things from the weekend that Lehman went under. There was the NY Times alert, the emails going back and forth at work, and a series of phone calls in which we figured out what we actually had to do. It’s the why we had to do them that is important though.

I am going to put some things in context first. Lehman was heavily involved in the CDS markets. These markets – Credit Default Swaps (Credit Derivates). CDS was always risky, not regulated and dealing with debt it was always a house of cards. Now to get an idea of what I mean by heavily involved Lehman was leveraged to a ridiculous degree. By ridiculous I mean about $400 BN. From what I recall Lehman was actually only worth about $7 BN at the time. This is why the Fed acted in the manner they did. This is why we did what we had to do.

Let me outline the scenario from the weekend. You have Lehman with $400BN in CDS trading with a lot of other people. Since this is a weekend you have a lot of outstanding trades floating around. The way trading works is you have a trade date and a settlement dates. Depending on the market the day the trade settles is anywhere from T+1 to T+4. For CDS it is normally T+1. So now the weekend is here you have a lot of people with a position on outstanding trades, this includes the broker in theory. What happens if one party goes under with all these notes outstanding? All of a sudden you have $400BN in bad debt with no potential recourse. Something had to be done.

So the Fed told us to open our markets early. There is no real regulation on when we open the markets beyond the fact they cannot be closed for four consecutive days. By opening the market we allowed traders to come in and secure their positions on trades. Also we gave them a chance to try and recoup any potential losses. For us though there was a bigger reason to do this. Everyone had a big deadline approaching. Once the Federal District Court opened in NYC Lehman would file for bankruptcy. If they did this before the trades settled then there would be no chance to recover any loss. If these trades could be settled and cleared before hand then they’d not be voided. For us this was important.

In theory we never hold a position. We never have any actual risk because we merely facilitate the trade. The reality is we hold a position for a short time. This period is until the trade clears and settles. So you see the potential problem here. If Lehman filed with un-settled trades then we might be on the hook for all this money. Now we don’t want this, it’s not our job to be on the hook, we just broker the deal. This is why we had to get these settled.

So we opened the markets early, we allowed the trades to settle, we allowed the traders to secure their position. We also ended up having any trades done by Lehman subject to approval by the head of the relevant desks. We later removed their trading access. Lehman has also since that weekend been bought by Barclays. Lehman will end up surviving, and perhaps we averted a number of other failures by these actions.

There has been some debate as to why the government allowed Lehman to fail after it bailed out Bear Stearns. It’s a complex theory I have which I will visit later.

Some more information on Lehman

What CDS is

Lehman’s settlement with Barclays/Chase

The Looming Lehman CDS Unwind

Technorati Tags: bailout, cds, finance, lehman, The Economy

The article, the press in general really, has not properly conveyed the one thing that sits at the core of all these problems. What is this one thing? That our government has absolutely no idea how to properly control and contain this. If you look at the decisions that have been made. If you see the various reactions to the crisis you do not see any cohesive strategy. All you see is a series of after the fact reactions to a building storm. Let’s start with the various investment bank failures.

It started with Bear Stearns. We all knew Bear was in trouble. We expected it to have problems. We did not expect it to go under or Chase to be forced to buy them by the Federal Government in what was essentially the first bailout. I recall conversations regarding Lehman Bros. and Merrill Lynch and how they were most likely to be the next ones up on the block. As an aside both corporate sites now show how they are in bankruptcy/bought out.

The Lehman failure though was spectacular in a way none of us at work foresaw. Getting phone calls on a Saturday morning and being told we may need to open the markets early was very, very sobering. Being told we were opening them before Monday to help avert a potential disaster makes you pause in a big way. Being told it was the Fed directing this is even scarier. We opened them early to allow anyone with a position relating to Lehman a way to mitigate it. I later found out that any trades involving Lehman had to be directly approved by the desk heads. This also applied many to the Credit Derivative markets. A week or so later we shutdown their access. Merrill Lynch was also acquired around this time. It became a mere footnote though compared to the sheer insanity that was Lehman Brothers. AIG, which also was bailed out around this time was nothing compared to this.

The next big event was the general bailout of Citi. It is here that I saw the near panic and reactionary nature of our current administration the most. This was another thing that was mostly unexpected in the sheer scale of things. I plan on discussing what this bailout really is and means in a later post it really is that complex. At work we are dealing with how the government has decided to actually enact the $700 billion that it is bankrolling this with. It’s been rapidly changing nearly daily.

In all this one can sense a largely reaction stance to everything. We all knew it was coming. We could all see it brewing. In the end though, the ones we trusted to manage this, to control it, failed spectacularly. Why and how did it fail? We see all sorts of articles trying to explain it. In the end though it seems to come down to five things really.

They did not care. If you see their reactions they really didn’t have a depth of understanding that they acknowledged. They trusted that the markets, that the economy, would auto-magically fix itself. And when it did not? They threw a bunch of shit on the wall to see what would stick. And in the end they’ve stuck to a failed ideology in dealing with the economy for far too long. They still are trying to do so.

Some More Information On the Situation

• White House Philosophy Stoked Mortgage Bonfire
• AP Study Finds $1.6B went to bailed-out bank execs

Technorati Tags: bailout, bear sterns, bush, finance, lehman, ml, The Economy, work