Tweet
photo: Tambako the Jaguar via Flickr
The lawsuit (pdf) filed by the bankruptcy estate of Lehman Brothers against JPMorgan Chase contains yet another description of a giant bank eating a customer. And just as you would guess, the heart of the problem is derivatives.
The complaint begins by explaining the relationships between Lehman and JPMorgan. Lehman was a full-service stock broker. JPMorgan provided clearing services for Lehman’s securities business. JPMorgan was the lead lender and administrator on a $2 billion unsecured revolving line of credit. Lehman also had a large derivatives portfolio with Jamie Dimon’s bank.
The clearing relationship was governed by a Clearance Agreement dated in 2000. When clients buy securities, JPMorgan lends Lehman the money to pay the seller. This is called “intra-day exposure”, because JPMorgan is making an unsecured loan to Lehman for a few hours, until the securities are delivered. Almost all trades clear, that is, the securities are delivered and payment is made, by the end of the day, so there is very little overnight exposure. To cover intra-day exposure, the Clearance Agreement required Lehman to post collateral with JPMorgan. Lehman was allowed to use that collateral overnight, when the intra-day exposure, if any, is miniscule. This was important because it enabled Lehman to count the collateral towards its capital position for regulatory purposes.
In the August, 2008, JPMorgan insisted on amending the Clearance Agreement. It required Lehman to guarantee all intra-day exposure of its subsidiaries, and required additional collateral to support those guarantees. The amendments did not change Lehman’s access to its collateral overnight.
In early September, 2008, JPMorgan, which already had intimate knowledge of the business and prospects of Lehman, learned a lot more about Lehman’s ability to survive. That new information came from its status as clearing institution and lender and its efforts to become the agent for a potential purchaser of Lehman. Lehman gave JPMorgan access to its people and records and an early look at its third quarter financial statements, hoping to borrow more money.
Most important, Jamie Dimon, CEO of JPMorgan, and other senior bankers were meeting with government officials, including Fed Chairman Ben Bernanke and Secretary of the Treasury Henry Paulson, where they learned that Lehman would not be protected by the government.
With this information in hand, 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.
Why did JPMorgan do this? if Lehman was going into bankruptcy, why grab collateral in excess of reasonable exposure? All that would do is make everyone angry, and complicate the bankruptcy, because JPMorgan would have to give back any excess collateral.
There are only ugly explanations. One involves derivatives. 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.”
… JPMorgan has since asserted that the September Agreements guarantee and secure over $3 billion in purported derivatives obligations of [Lehman] subsidiaries that were previously unsecured, as well as approximately $720 in claims arising out of losses incurred not by JPMorgan, but by its customers who invested in JPMorgan funds. (para. 51, emphasis in original.)
Lehman held a net positive position in derivatives with JPMorgan, that is, if the derivatives terminated, JPMorgan would have to pay Lehman more than $1 billion. Given time, Lehman could have tried to screw JPMorgan by selling positive derivatives and then filing bankruptcy, still holding the loss derivatives. Those losing derivatives would be an unsecured claim, paid less than the total amount owed. But, if Lehman filed bankruptcy before it could sell the positive derivatives, that would be an event of default on all of the derivatives, allowing JPMorgan to terminate them and collect termination fees from Lehman. In the usual case, the termination fees would be unsecured, but due to the excess collateral, JPMorgan could claim that the collateral covered the termination fees. At worst, it would be able to net the derivative positions out, and only owe the net amount.
The complaint says, in so many words, that JPMorgan was at least partially responsible for the sudden collapse of Lehman into an uncontrolled bankruptcy. The purpose was to prevent Lehman from selling its credit default swaps and other derivatives for the benefit of Lehman’s unsecured creditors, and as a side benefit, giving JPMorgan the chance of making a bunch of money for itself and its customers.
Mission accomplished: Lehman eaten, unsecured creditors screwed, legal fees for all.
———–
Wonky additional note: JPMorgan in fact made the claims described in the paragraph quoted from the complaint. Proof of Claim 23009 (pdf) filed by an affiliate of JPMorgan is an example. A proof of claim is a sworn statement filed in Bankruptcy Court asserting that the bankrupt entity owes money to entity that filed the claim. It says that Lehman owes JPMorgan money arising from derivatives, including credit default swaps, and asserts that the claim is secured. In other proofs of claim, JPMorgan asserts that funds it manages are secured by the excess collateral.
10 Comments
Support this site!
Subscribe to the newsletter
Advertise on Firedoglake
Send
us your tips
Make us your homepage
About Firedoglake
Did they know this before Lehman did? Talk about your ‘insider trading’…fraud, bad faith negotiations, we have here a star-studded cast.
“Why Grandmother, what nice collateral I have here,” said Little Red Riding Hood.
“The better to see how vulnerable you are, my dear”, said Grandmother (gloating and licking her sharp, pointy incisors).
Do I have the gist right on this bit?
Pardon me while I go repair my jaw, which has just hit the floor with a thundering jolt, dislodging some of my teeth.
Okay, I kind of thought this might have been what happened from the news reports, but I didn’t really ‘get it’ until this post.
I think that I have to re-read for this to sink in.
…. actually, I’m starting to have fits of giggles that these piranas spend their lives screwing each other like this. On one level, I find it almost ludicrously hilarious. Problem is, there are social effects, which is what irks me no end; those are decidedly ‘un-funny’.
“Nice assets you got there: it’d be a shame if anything happened to them.”
I didn’t look carefully, but the stories I checked didn’t explain the derivatives part. If you click through on the proof of claim link, you can see the description of the derivatives, including the credit default swaps. The entire Lehman docket is on-line and it’s free, you don’t have to use Pacer.
Is that because the press doesn’t understand them?
Or the editors thought it would be too much info?
After reading your posts the past 18 months, I assume
assetsderivatives lurk behind a lot of the implosion we see. And Nomi Prins and Yves Smth and others document this view.It seemed as if Lehman Bros. was an artifact of the past but it’s really on life support in chapter 11 hospital. It’s looking to get a major blood transfusion back from JP Morgan, the vampire that sucked its blood and sent to the hospital.
The question is how can JP Morgan which itself was able to be propped up by a government transfusion going to be able to survive repaying what it sucked from Lehman? Something tells me that the TARPP bailout for these firms that demanded no real change or had no investigation of the root problems and basic bankruptcy of all of them is going to be played out in slow motion legal proceeding felling millions of trees.
The press almost certainly didn’t read past the first few paragraphs of the complaint, which describe the complaint in general terms, but don’t give much on the derivatives angle.
If I were cynical, I’d also guess they didn’t do it because it would add more weight to the Blanche Lincoln statute requiring these slugs to spin off their derivatives trading business from the banking business. After the fireball created by the SEC complaint against Goldman, the financial interests wouldn’t like that.
In consumer bankruptcy, the judge has the power to require money be given back to any party, whether originally from bankruptcy petitioner to a creditor, vice-versa, or from petitioner to any third party, if the money in question was a transfer between such parties within six months prior to petition filing.
Is it different in Ch 9 & 11 bruptcy? If not, Lehman estate should definitely be getting some big bucks from JP.
First of all, be clear: Chapter 11 bankruptcy is one in which the company expects to come out of bankruptcy alive. Chapter 7 bankruptcy is a liquidation, i.e., the company comes out of bankruptcy dead. Chapter 9 bankruptcy is for municipalities and governmental entities which go broke.
Oversimpfying vastly, normally there’s very little limit within the Bankruptcy Code on how the judge can act to get assets back for the bankruptcy estate (i.e., the company on life support). But, there was a part of the 2005 Bankrupcty amendments bill (you know, the one which made credit card companies invulnerable to bankruptcy and such) which put derivatives outside of the normal rules relative to recovering money to the bankruptcy estate. So, this is pretty much uncharted territory and only resembles a consumer bankruptcy in that it’s taking place in the same courthouse.
Thank you for the clarifications…I knew I was out of my depth, but was too lazy to go look things up…thx again…
That said, I am always impressed by the latitude available to most trial courts, e.g., most anything on the court’s own motion, toward which appellate courts are generally quite deferential.
Am I again too far over my head, imputing to bruptcy cts powers and processes generally available in fed and state civ and crim proceedings? Or is there perhaps sufficient room for discretion by judges moved by outrageousness of many current disputes twixt corporate and other entities? (Sufficiency in this case meaning, the govt could actually do something to the cheaters?)
And now, to bed, and to read my nightly fairytale.