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Lehman Brothers

A Crisis of Value

Oonagh McDonald

This book explains the fundamental causes of the bank's failure, including the inadequacy of the regulatory and supervisory framework. For some, it was the repeal of the Glass-Steagall Act that was the overriding cause, not just of the collapse of Lehman Brothers, but of the financial crisis as a whole. The book argues that the cause is partly to be found both in weak and ineffective regulation and also in a programme of regulation and supervision that was simply not fit for the purpose. Lehman Brothers' long history began with three brothers, immigrants from Germany, who sold selling groceries and dry goods to local cotton farmers. Dick Fuld, the chairman and CEO, and his senior management, ignored the increased risks, choosing to rely on over-valuations of the firm's assets. The book examines the regulation of the Big Five investment banks in the context of the changes which took place in the structure of banking after the repeal of the Glass-Steagall Act. It describes the introduction of the European Union's Consolidated Supervision Directive in 2004. The book examines the whole issue of valuing Lehman's assets and details the regulations covering appraisals and valuations of real estate, applicable at the time and to consider Lehman's approach in the light of these regulations. It argues that that the valuation of Lehman's real estate assets was problematic to say the least, as the regulators did not require the investment banks to adopt a recognized methodology of valuation, and that Lehman's own methods were flawed.

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Oonagh McDonald

4 Regulating the ‘Big Five’ This chapter will examine the regulation of the Big Five investment banks in the context of the changes which took place in the structure of banking after the repeal of the Glass-Steagall Act and the introduction of the European Union's Consolidated Supervision Directive in 2004. Immediately after the financial crisis, various reasons were found for the failure of so many banks, and indeed for the collapse of Lehman Brothers. This is despite the obvious fact that the major investment banks were

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The domino that did not fall

Why China survived the financial crisis

Shalendra D. Sharma

per cent of the 450 million laborers in the countryside (World Bank 1996b, 50–1; Yabuki and Harner 1998, 144; J. Y. Lin, Cai and Li 1996, 179–81). Central to China’s economic growth has been the liberalization of the foreign trade and investment regime, and the adoption of an ambitious “open-door” strategy. Prior to the introduction of the Deng reforms, China remained a backward and closed economy, with foreign trade amounting to a minuscule 4.7 per cent of GNP. However, the liberalization of the foreigntrade and exchange-rate regimes, followed by further wide

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Indonesia

Crisis, reform and recovery

Shalendra D. Sharma

per cent to 42 per cent – with a corresponding rise in the share of manufactures in GDP from 8 per cent to 20 per cent by 1990 (Jomo 1997, 133; Booth 1999, 113). By 1993, manufactured exports reached US$21 billion and accounted for 53 per cent of total exports (World Bank 1996, 216). It is important to note that, unlike what happened in many other developing countries, Indonesia’s proportional shift from agriculture to industry did not come at the expense of agriculture. On the contrary, the first five-year plan (or Repelita 1) introduced in 1969 emphasized

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Korea

Crisis, reform and recovery

Shalendra D. Sharma

foreign-exchange crisis. The following sections will show that because of the eased control on short-term external borrowing, Korea’s big businesses, in particular the chaebols, undertook an aggressive investment drive. This investment drive was financed mainly by large increases in borrowing from domestic banks, in particular merchant banks. As a result the number of merchant banks and the volume of their foreign-currency business expanded rapidly. These changes in the institutional framework contributed greatly to the rapid growth in foreign-currency borrowing

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From Hubris to Nemesis

January to September 2008

Oonagh McDonald

’ using horizontal reviews that look across a group of firms to identify common sources of risks and best practices for managing those risks, and the use of models and data analysis to identify vulnerabilities at the firm level and for the financial sector as a whole. 45 It was the lack of understanding of the linkages which led to the calamitous decision to allow Lehman Brothers to fail. One can only speculate on what might have been if the Big Five investment banks had been placed under the Federal Reserve's Consolidated Supervision in 2004. All

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Oonagh McDonald

Five investment banks, only to banks regulated by the agencies: the Office of the Comptroller of the Currency (OCC), the Federal Reserve, the Federal Deposit Insurance Corporation (FDIC) and the Office of Thrift Supervision (OTS). That left another regulatory gap. The SEC did not examine the real estate risks Lehman ran, lacking a mandate and regulations to do so. In other words, it was not the process of bankruptcy that destroyed value. Lehman's real estate assets did not have the value the company had attached to them. Ultimately, the value of the derivatives

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Thailand

Crisis, reform and recovery

Shalendra D. Sharma

rates for more than a quartercentury before the financial meltdown in July 1997. Rather, this chapter argues that it was the volatile convergence of a mounting current account deficit, a sharp export slowdown, currency and maturity mismatches among Thai commercial banks, the maintenance of a rigid exchange rate, a rapid build-up of private short-term foreign-debt liabilities, an overheated investment bubble in real estate and stock markets, and an external environment that unexpectedly turned sour in 1996–97, that led to the crisis. All that this convergence needed was

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Introduction

Issues, debates and an overview of the crisis

Shalendra D. Sharma

underside to “Asian values,” that the success of too many Asian businessmen depended less on what they knew than on whom they knew. Crony capitalism meant, in particular, that dubious investments – unneeded office blocks outside Bangkok, ego-driven diversification by South Korean chaebol – were cheerfully funded by local banks, as long as the borrower had the right government connections. Sooner or later there had to be a reckoning. The following chapters will illustrate that cronyism and corruption was indeed a big problem and played a significant role in undermining

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Beyond the Asian crisis

The evolving international financial architecture

Shalendra D. Sharma

impossible to tell what would have been the level of finance available from the markets without packages. Yet, having noted this (as discussed earlier), it is true that bailout packages have allowed errant private creditors (especially big commercial banks) to escape from bad lending decisions at relatively little cost.6 It is also true that financial intermediaries in Asia enjoyed both explicit and implicit government guarantees in case of default (and therefore undertook excessively risky ventures based on the highest possible return rather than expected values), just as