1 - 16 Dec 2011 GLOBIS GRADUATE SCHOOL OF MANAGEMENT SEMINAR

8/3/2019 1 - 16 Dec 2011 GLOBIS GRADUATE SCHOOL OF MANAGEMENT SEMINAR

http://slidepdf.com/reader/full/1-16-dec-2011-globis-graduate-school-of-management-seminar 1/33

1

Lehman Shock

An Insider’s Perspective Jean-Paul LEBOUTET

GLOBIS UNIVERSITY SEMINARS, 16 December 2011



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




Objective of the Presentation

1. Provide you with an insight on what happenedto Lehman Brothers

1. Draw some lessons for the future



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




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 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):



http://slidepdf.com/reader/full/1-16-dec-2011-globis-graduate-school-of-management-seminar 7/337 GLOBIS Seminar : Lehman Shock, an Insider’s Perspective 7


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





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):





How did interest rates look like over years?


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%




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)



http://slidepdf.com/reader/full/1-16-dec-2011-globis-graduate-school-of-management-seminar 11/3311 GLOBIS Seminar : Lehman Shock, an Insider’s Perspective



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?





HighCompetition

Low Returnon Assets

Assetcreation &“financial

innovation”

Struggle toreduce

Assets

Constant Lobby for

Deregulation





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…





HighCompetition

Low Returnon Assets

Assetcreation &“financial

innovation”

Struggle toreduce

Assets

Constant Lobby for

Deregulation





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



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





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”






-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





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.



1. What happened to Lehman Brothers: b) A very large bank aggressively engaged,

with a unique culture


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.







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







…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.







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




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,



“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






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:Have we learned anything? 3 concerns



a) A better detection and management of bubbles?

b) Reforms of the financial markets?

c) More efficient corporate governance?




2. Lessons for the future:a) Detection and management of bubbles?


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%






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






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




2. Lessons for the future:b) Reform of financial markets?


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




2. Lessons for the future:c) Better Corporate Governance?


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.



32 GLOBIS Seminar : Lehman Shock, an Insider’s Perspective

2. Lessons for the future:c) Better Corporate Governance


Governance is the windshield for both Management andShareholders



S i h Sh k I id ’ P i



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

1 - 16 Dec 2011 GLOBIS GRADUATE SCHOOL OF MANAGEMENT SEMINAR

Documents

Transcript of 1 - 16 Dec 2011 GLOBIS GRADUATE SCHOOL OF MANAGEMENT SEMINAR