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8/3/2019 1 - 16 Dec 2011 GLOBIS GRADUATE SCHOOL OF MANAGEMENT SEMINAR
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1
Lehman Shock
An Insider’s Perspective Jean-Paul LEBOUTET
GLOBIS UNIVERSITY SEMINARS, 16 December 2011
8/3/2019 1 - 16 Dec 2011 GLOBIS GRADUATE SCHOOL OF MANAGEMENT SEMINAR
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2 GLOBIS Seminar : Lehman Shock, an Insider’s Perspective 2
Jean-Paul Leboutet
French, born in ParisMarried, 2 “half” children!
H.E.C. (Finance)
8 major financial crisis15 years in Bank Internal Audit
10 years in Corporate Strategy and General Management15 years in Japan and AsiaAdvise entrepreneurs and investors as member of their
advisory boards, train professionals in finance
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3 GLOBIS Seminar : Lehman Shock, an Insider’s Perspective 3
Objective of the Presentation
1. Provide you with an insight on what happenedto Lehman Brothers
1. Draw some lessons for the future
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4 GLOBIS Seminar : Lehman Shock, an Insider’s Perspective
1. What happened to Lehman Brothers:What the “Lehman Shock” was
Global interbank market froze, stocks and bonds fell
Panic occurredBanks don’t know how much others own in or owe to Lehman Hundreds of thousands of deals are pending to be confirmed
Major banking systems - except Japan - ended inemergency rescue from their government by mid-October
1 – What happened2 – Lessons for the future
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5 GLOBIS Seminar : Lehman Shock, an Insider’s Perspective 5
1. What happened to Lehman Brothers: 2 key factors
2 key factors led to collapse
a) A unusual worldwide bubble exploded
b) A very large bank with a unique culture was
aggressively engaged in it
1 – What happened2 – Lessons for the future
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6 GLOBIS Seminar : Lehman Shock, an Insider’s Perspective 6
1. What happened to Lehman Brothers: a) A unusual worldwide bubble
What is a Bubble ?
With a pile of debt, asset prices rise, but will necessarily fall.
My homeDebt
Savings
At the beginning,borrowing is normal andnice
In a second time, new
borrowers and lendersare more aggressive andoptimists
Example of house loans (same for any investment):
1 – What happened2 – Lessons for the future
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1. What happened to Lehman Brothers: a) A unusual worldwide bubble
What is a Bubble ?Types of mortgage loans (US definition):
PRIME MORTGAGE:• At least 10% of initial down-payment (equity), i.e. no more than 90% of
the value of the property in loan• Loan reimbursement + interests < 38% of disposable income• Amount of the loan < ceiling defined by Federal regulation
ALT - A MORTGAGE:• Criteria close to prime mortgage, at least one qualifies
SUBPRIME MORTGAGE:• Everything else:
Large size investment, robust income growth prospect Low income families with good credit record NINJA: comes from nowhere, flies by night
1 – What happened2 – Lessons for the future
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1. What happened to Lehman Brothers: a) A unusual worldwide bubble
What is a Bubble ?
With a pile of debt, asset prices rise, but will necessarily fall.
My homeDebt
Savings
At the beginning,borrowing is normal andnice
In a second time, new
borrowers and lendersare more aggressive andoptimists
In the last phase, some
borrowers fall inforeclosure, provoking amarket downturn
Too much debt in the market comes from…?
• too low interest rates
Example of house loans (same for any investment):
1 – What happened2 – Lessons for the future
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1. What happened to Lehman Brothers: a) A unusual worldwide bubble
How did interest rates look like over years?
1 – What happened2 – Lessons for the future
0
1
2
3
4
5
6
7
8
9
10
Jan-91 Jan-93 Jan-95 Jan-97 Jan-99 Jan-01 Jan-03 Jan-05 Jan-07
Long term interest rates declined from 1995 to 2011, while shortterm rates were maintained very low from 2001 to 2005
Fed Funds 1 day US Treasuries 10 Years Euro Benchmark 10 Years%
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1. What happened to Lehman Brothers: a) A unusual worldwide bubble
Why were interest rates so low and for so long inUSA and Europe?
3 possible causes:
Tolerance for high inflation? NO Economic stimulus? Yes BUT not sustainableContinuous excess of capital inflows? YES
USA foreign current payments (trade, services, interests, dividends, etc)
accumulated deficits from 1990 to 2010: 7,386 billion $
China foreign reserves at end of 2010: 2,914 billion $ (34 billion $ in 1990)
Japan foreign reserves at end of 2010: 1,096 billion $ (88 billion $ in 1990)
1 – What happened2 – Lessons for the future
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1. What happened to Lehman Brothers: a) A unusual worldwide bubble
1 – What happened2 – Lessons for the future
BUT THIS WAS NOT ALL:
•Also a deregulation process in financial services from 1998 onward.
- More competition in investment bankingCommercial banks are allowed to enter
- Less capital needed per $ of riskRegulators accept banks’ internal valuation models to assess capital needs
The bubble has been exacerbated and under-estimated. How?
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1. What happened to Lehman Brothers: a) A unusual worldwide bubble
1 – What happened2 – Lessons for the future
HighCompetition
Low Returnon Assets
Assetcreation &“financial
innovation”
Struggle toreduce
Assets
Constant Lobby for
Deregulation
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1. What happened to Lehman Brothers: a) A unusual worldwide bubble
1 – What happened2 – Lessons for the future
Continuous asset creation: insurance on insurance on insurance…
Example:
•Bank A wants to reduce its risk on corporate X;
•It purchases to Bank B an insurance (under a Credit Default Swap agreement);
• It pays a yearly premium, and will receive an agreed amount if corporate Xdefaults;
•Bank C has heard that bank B sells insurance (CDS) on corporate X; though it
has no exposure to corporate X, it buys an insurance to bank B…
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1. What happened to Lehman Brothers: a) A unusual worldwide bubble
1 – What happened2 – Lessons for the future
HighCompetition
Low Returnon Assets
Assetcreation &“financial
innovation”
Struggle toreduce
Assets
Constant Lobby for
Deregulation
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1. What happened to Lehman Brothers: 2 key factors
1 – What happened2 – Lessons for the future
1. 2 key factors led to collapse:
a) A unusual worldwide bubble due to:
Trade imbalances Low interest rates for tool long Easyborrowing Leverage
Deregulation of financial sector Competition Lower yields Asset creation
b) A very large bank aggressively engaged
2. Lessons for the future
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1. What happened to Lehman Brothers: b) A very large bank aggressively engaged
For the year 2006
Ranking byamount of new
issuesGlobal Bonds US Bonds Global Equity US Equity US MBS
1 Merrill Lynch JP Morgan Chase Goldman Sachs Goldman Sachs Countrywide
2 JP Morgan Chase Citigroup Citigroup CItigroup Washington Mut.
3 Goldman Sachs Morgan Stanley UBS Morgan Stanley Lehman Br.
4 Citigroup Bank of America Morgan Stanley Merrill Lynch Residential Fund.
5 Morgan Stanley Lehman Br. Merrill Lynch Lehman Br. Bear Stearns
6 Barclays Capital Merrill Lynch JP Morgan Chase JP Morgan Chase Wells Fargo
7 Lehman Br. Goldman Sachs Credit Suisse UBS Goldman Sachs
8 Deutsche Bank Credit Suisse Deutsche Bank Bank of America Indy Mac
9 Bank of America Deutsche Bank Lehman Br. Credit Suisse New Century
10 HSBC Barclays Capital Nomura Deutsche Bank JP Morgan Chase
11 Credit Suisse Wachovia ABN AMRO Wachovia Option One
12 Bear Stearns UBS Daiwa Bear Stearns Fremont
13 Wachovia HSBC Bank of America Jefferies (JP M) Morgan Stanley
14 RBC Bear Stearns Macquarie Piper Jeffrey Credit Suisse
15 TD BNP Paribas BNP Paribas Thomas Weisel First Franklin
1 – What happened2 – Lessons for the future
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1. What happened to Lehman Brothers: b) A very large bank aggressively engaged
Lehman Brothers was a major actor, with 600 billion $ + in assets.
In the early 2000s already, market positions were close to 2006 level.
They were improved despite the emergence of “universal” competitors.
It means that in 2008 markets perceived it as “too big to fail”
1 – What happened2 – Lessons for the future
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1. What happened to Lehman Brothers: b) A very large bank aggressively engaged
1 – What happened2 – Lessons for the future
-3000
2000
7000
12000
17000
22000
27000
32000
1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 Q2 2008
Net income Net revenues Total stockholders' equityMillion $
Lehman’s Brothers growth and fall – 1994 ~ 2008
15% CAGR
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1. What happened to Lehman Brothers: b) A very large bank aggressively engaged
1 – What happened2 – Lessons for the future
Growth in revenues and net income had been strong since floatation in 1994: in line with the sector but among the high performers Income per employee was second only to Goldman Sachs (30,000 employees)
This meant both: faster market penetration, and faster asset turnover
This reflects the strategy: grow faster than competitors
to maintain independence as an investment bank.
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1. What happened to Lehman Brothers: b) A very large bank aggressively engaged,
with a unique culture
1 – What happened2 – Lessons for the future
A large size and a high growth through the bubble areonly part of the explanation for the collapse:
Before things turned really sour, problems were seen
But not voiced well enough
And not heard:
A culture behind success and failure.
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21 GLOBIS Seminar : Lehman Shock, an Insider’s Perspective 21
1. What happened to Lehman Brothers: b) A very large bank aggressively engaged,
with a unique culture
1 – What happened2 – Lessons for the future
Problems, at least a large part of them, were seen…
Example: Internal Audit
Alerted that the P&L was increasingly uncertain in 2006 and 2007
Called for a pause with growth for 2007 on sensitive areas
Questioned liquidity in the first half of 2007
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22 GLOBIS Seminar : Lehman Shock, an Insider’s Perspective 22
1. What happened to Lehman Brothers: b) A very large bank aggressively engaged,
with a unique culture
1 – What happened2 – Lessons for the future
…But not voiced well enough…
Internal audit allowed to be distracted by a different role
It carried messages through technicalities
Same for risk management, business development, etc.
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23 GLOBIS Seminar : Lehman Shock, an Insider’s Perspective 23
1. What happened to Lehman Brothers: b) A very large bank aggressively engaged,
with a unique culture
1 – What happened2 – Lessons for the future
Messages were not heard:
Governance proved deficient, so that remedy was late
How was Governance at Lehman Brothers?
Complying organization with external directors (high rating from ISS)Directors not meeting frequently enoughMany in position for 15 yearsFeedbacks from audit committee reflect questioning but on internal
control systems more than risks and governance
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24 GLOBIS Seminar : Lehman Shock, an Insider’s Perspective 24
Culture turned out to be too much aligned. This is amazing,considering the diversity of employees.
1. What happened to Lehman Brothers b) A very large bank aggressively engaged,
with a unique culture
1 – What happened2 – Lessons for the future
“Culture is the keyto survival”
LEHMAN GOLDMAN SSSB CITI SOCGEN
Fluidcommunication
YES NO NO NO
Absence ofbureaucracy
YES NO ~YES NO
Strong successtrack record
YES YES NO NO
Strong self-confidence
YES YES NO YES
Outlier personality YES NO NO NO
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25 GLOBIS Seminar : Lehman Shock, an Insider’s Perspective 25
1. What happened to Lehman Brothers: 2 key factors
1 – What happened2 – Lessons for the future
1. 2 key factors led to collapse:
a) A unusual worldwide bubble
b) A very large bank aggressively engaged Too big to fail is not a buzz word Faster growth was not only a result but also a strategy Governance was too weak to hear warnings
The culture ended working against the firm
2. Lessons for the future
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26 GLOBIS Seminar : Lehman Shock, an Insider’s Perspective 26
2. Lessons for the future:Have we learned anything? 3 concerns
1 – What happened2 – Lessons for the future
2. Lessons for the future
a) A better detection and management of bubbles?
b) Reforms of the financial markets?
c) More efficient corporate governance?
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27 GLOBIS Seminar : Lehman Shock, an Insider’s Perspective 27
2. Lessons for the future:a) Detection and management of bubbles?
1 – What happened2 – Lessons for the future
Bubbles repeat… The use of simple graphs and rules of thumb should guide
But the issue now is different… Countries debt
Hence, high risk of recession in 2012 and of inflation later on The next bubble seems far away…except in emerging countries ?
Country% of GDP in bail out of the
financial system and stimulus 2008
USA 50%
UK 25%
Germany 20%
France 20%
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28 GLOBIS Seminar : Lehman Shock, an Insider’s Perspective 28
2. Lessons for the future:a) Detection and management of bubbles?
1 – What happened2 – Lessons for the future
In Real Estate, a bubble most probably –
BRICs account for 18% of the world GDP (USA + EU + Japan: 58%)
Brazil house price index
China house price indexIndia house price index
Russia house price index
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29 GLOBIS Seminar : Lehman Shock, an Insider’s Perspective 29
2. Lessons for the future:a) Detection and management of bubbles?
1 – What happened2 – Lessons for the future
In Stock markets – this is less obvious
BRICs account for 18% of the world GDP (USA + EU + Japan: 58%)
010000
20000300004000050000600007000080000
BRAZIL IBOVESPA
0500
1000
1500
2000
2500
3000
RUSSIA RTSI
0
5000
10000
15000
20000
25000
MUMBAI SENSEX
0
1000
2000
3000
4000
5000
6000
7000
SHANGHAI Composite
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30 GLOBIS Seminar : Lehman Shock, an Insider’s Perspective 30
2. Lessons for the future:b) Reform of financial markets?
1 – What happened2 – Lessons for the future
A good point: some key weaknesses in bank accountinghave been addressed
Many don’ts in the financial markets have been listed
But no key text is yet implemented momentum has beenlost
And large banks now need time before being able to absorb
more stringent rules on capital and asset valuation
Once again, priority is now how to carry bank lossesthrough national debt without depressing the economy too
much
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31 GLOBIS Seminar : Lehman Shock, an Insider’s Perspective 31
2. Lessons for the future:c) Better Corporate Governance?
1 – What happened2 – Lessons for the future
In this context, confidence will come back only with bettergovernance:
Tax payers must learn that regulators are not the last resort insurer:they are…
It is better to claim transparency than require piles of reporting
Investors must learn that a diligent and capable board cannot workwithout proper information.So governance starts with, but goes beyond the composition of a
board.
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32 GLOBIS Seminar : Lehman Shock, an Insider’s Perspective
2. Lessons for the future:c) Better Corporate Governance
1 – What happened2 – Lessons for the future
Governance is the windshield for both Management andShareholders
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S i h Sh k I id ’ P i
1. What happened to Lehman Brothers: 2 key factors
1 – What happened2 – Lessons for the future
1. 2 key factors led to collapse:a) A unusual worldwide bubble
b) A very large bank aggressively engaged
2. Lessons for the futurea) With the national debt problems we may forget what a
bubble is
b) Reforms in regulation have lost momentumc) Corporate Governance is key