New Revelations On Lehman's Funding Tactics

Yesterday's Wall Street Journal contained an article by Peter Eavis in the Heard On The Street column entitled Lehman's Flighty Funding Lesson.

If true, what Eavis contends is that Lehman was misleading lenders and regulators for months prior to its collapse. In fact, apparently as early as February of that year, just prior to Bear Stearns' demise. Among its moves were securitizing junk collateral to pass it off as better-quality for loans from Chase, as well as the Treasury's Primary Dealer Credit Facility.

A Chase executive pointedly alleged that Lehman knew it substantially overstated the value of the illiquid, underlying instruments in the collateral securities.

The Journal article quotes from a June, 2008 email written by then-New York Fed senior official William Dudley,

"I think without the PDCF, Lehman might have experienced a full-blown liquidity crisis."

Eavis notes that the recently-passed 'Dodd-Frank' financial regulatory bill is largely silent or vague on the use of repo markets by large, highly-leveraged financial institutions.

This is particularly disturbing, since so much of what occurred in 2007 and 2008 ultimately depended upon excessive leverage in the form of short-term financing.

I've written elsewhere, for years, that the modern broker/dealer is, for all intents and purposes, merely an extension of the broker/dealer lending desk of its creditors, which are typically money center banks.

As such, since said banks all have investment banking units, the separate broker/dealers, when they still existed, were necessarily competing with lower-cost rivals who also funded them. And used less leverage, plus had access to the Fed window and insured consumer deposits.

There aren't any large independent broker/dealers anymore. In part, they failed because, to compete with their lenders, they had to take more risk, which ultimately proved lethal.

But, as Eavis notes, you'd expect the recently-passed regulatory laws to address this. They don't. They essentially allow regulators latitude in how and when to apply limits on various funding sources.

It seems almost comically narrow-minded that the FCIC is just now discovering the essentially fraudulent means by which Lehman managed to survive for its last 6-7 months, but new financial sector regulatory laws were passed months ago. And clearly missed focusing on what we are now learning were key practices which aggravated and worsened the 2007-08 financial markets crisis.