Recovery and Resolution Planning: Not just another piece of Regulation

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Tuesday, August 18, 2015 4:40pm / PriceWaterhouseCoopers

The run up to the collapse of Lehman Brothers (“the Bank”) was fraught with confusion, panic, and several last minute attempts at saving the bank. Not just weeks before its eventual collapse, but several months prior.

As far back as August 2007, it was apparent to many in the financial world that all was not well at the Bank. Following the collapse of two of Bear Stearns hedge funds, Lehman’s shares fell sharply and cracks had begun to appear in the US housing market. It was no secret that Lehman was the largest underwriter of mortgage backed securities (MBS) and at this point, ought to have trimmed its mortgage portfolio. Rather it continued to underwrite more MBS than any other bank globally. By the end of 2007, Lehman had amassed a portfolio purported to be worth USD85billion, approximately four times its net worth.

In March 2008, following the near collapse of Bear Stearns (they were eventually bought by JP Morgan), Lehman stock fell 48%. Fund managers, aware of the size of Lehman’s portfolio, and already questioning its valuation, began betting against the firm. This precipitated a steady and unstoppable decline in the Bank’s share value. Management in a bid to stem the decline, embarked on overtures which sometimes appeared incoherent and largely unsuccessful.

Firstly, steps were taken to sell toxic assets to a newly formed hedge fund, which was staffed by former Lehman MDs and employees, and had Lehman as its main investor. Then there was the announcement that the Bank would be spinning off its asset management and commercial real estate portfolio to a ‘bad bank’ which would be then sold. This was followed by the frantic search for a buyer, including the Korean Development Bank. Unfortunately, the market had begun to realise Lehman’s plight and its valuation of the bank was less than the shareholders of Lehman were willing to accept.

Eventually, the bank was allowed to fail setting off the global financial crisis, effects of which are still reverberating around the world today.

The Financial Stability Board, Dodd-Frank and the Basel Committee

The contagion from the collapse of Lehman Brothers was immediate. Banks, insurance companies and hedge funds struggled to remain solvent. A few collapsed, while several had to be bailed out. The US and UK governments committed a total of USD29trillion and GBP850billion respectively of tax payer’s money to assist the ailing institutions.

In response to this global crisis, the G20 leaders at a summit held in 2009 announced the creation of the Financial Stability Board (FSB). The FSB was made up of central bank governors and its primary purpose, was to address vulnerabilities in the financial services sector.

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