Page 16 - Monocle Quarterly Journal Vol 1 Issue 1 Q4

BANKING
“It was a little bit like a game of musical chairs, and the institution that happened to be without a chair at the moment when the music abruptly stopped, was Lehman Brothers.”
cularly the now much-maligned structure known as the collateralised debt obligation. ey were simply the bank that was regarded by their peers as holding the worst of the assets, at least at the point in time when it most counted.
It was a little bit like a game of musical chairs, and the institution that happened to be without a chair at the moment when the music abruptly stopped, was Lehman Brothers.
e majority of investment banks at the time were very highly leveraged and all depended heavily on interbank loans and repos made between them to ll in their daily liability gaps. e gentleman’s agreement that existed between them – particularly at an individual trader level within their money market and treasury funding operations – was to always back their peers by providing such funding when it was needed.
When panic struck, survival instinct took over, and banks began hoarding cash. is meant that those banks that required roll-over of short term liabilities were exposed. Lehman was more exposed than most, and was culled from the herd. Richard Fuld, the CEO of Lehman at the time, was incredulous. It may be apocryphal but he is recorded to have asked Hank Paulson, the then Secretary of the US Treasury, “Why me?”
e Financial Crisis was caused by a build-up of overextended credit in the mortgage market, exacerbated by the construction of unfunded leveraged bets on credit worthiness, but was really jerked into panic mode by the liquidity crisis created in the interbank market.
ere are few real players in the interbank market, only the big investment banks and some of the large diversi ed banking groups. And like a game of Texas hold’em, when a player has blu ed on a poor hand and has gone all in, there is no mercy.
Consider once again then the risk of raising the CET1 ratio at an individual bank level. Should a disruptive market event occur, the capital requirement within an individual bank will be breached earlier now than it would have been previously. While this individual bank holds now substantially more capital than in a pre-Crisis world, it ironically has a far greater chance of technical ‘failure’. Once it is deemed to have failed – and to be clear the regulatory authorities have made capital breaches very public – all peer banks will shy away from rolling over funding to this miscreant bank. Before the capital bu er – built up over the past several years under the modi ed regulations called Basel III – is ever called upon to absorb any potential credit losses, this bank will be out of business owing to a short-term liability shortfall.
14