It is conventional wisdom that in the days leading to Lehman’s bankruptcy filing on the night of September 15, 2008, sheer panic and utter confusion ruled ever back- and middle-office, over concerns that a counterparty, any counterparty, but especially Lehman, would end up being “not money good“, and the result was that trigger-happy margin clerks had the potential to make or break a company, by demanding just enough variation margin that would send the notice recipient promptly into bankruptcy. It is also conventional wisdom, that it was precisely several such margin calls mostly out of JPMorgan that precipitated the Chapter 7 filing by Lehman brothers, as the firm was finally unable to mask the fact that it was terminally overlevered, and even more terminally illiquid. It is certainly conventional wisdom, that Lehman was certainly massively overlevered, holding billions of overmarked CMBS on its balance sheet, and was doing everything in its power to hold on to precious liquidity, taking every opportunity to window dress its balance sheet as far better than it truly was (Repo 105 at the end of every quarter promptly comes to mind), over fears of avoiding precisely such a margin call onslaught, where the first margin call would cascade into many, likely lethal, margin calls.
Which is why, over four years after the filing of Lehman’s bankruptcy and the fight for who was responsible for what in the Lehman Chapter 7 saga still waging, most actively between the Lehman creditor estate and tri-party repo stalwart JP Morgan, we were not surprised to learn that the Lehman estate had attempted to force yet another sworn testimony from a (former) employee of JP Morgan, in hopes of catching the firm as engaging in a malicious act of defrauding Lehman of precious liquidity in its final hours, or said in layman’s terms, forcing it to liquidate.
What did catch our attention was that Lehman named the infamous JPM Chief Investment Office, and specifically its very infamous trader Bruno Iksil, accountable along with others for the London Whale fiasco, as the person responsible for an initial margin call to the tune of $273.3 million, made the same day “that JPMorgan made its first of two demands that week each for $5 billion of extra cash collateral that it had no right to obtain and that drained Lehman of $8.6 billion” (as per the Lehman filing). One could make the argument that this initial margin call was the straw that broke the camel’s back, as in the avalanche of money requests, every dollar flowing out of Lehman may have been the one that pushed it under.
If, of course, the Lehman estate claim was credible.
At this point, virtually everyone in the media said “no way” and moved on: this has to be just another desperate attempt by the Lehman unsecureds to force a settlement from JPM, and a few more cent recovery on the bonds. After all, how on earth can someone hold now former JPM employee Bruno Iksil accountable for what he did nearly 5 years ago (however still within the statute of limitations). We, too, almost ignored the story as just too incredible to be true.
And then we decided to do some digging.
What we found was stunning, and frankly shocking, because it appears that the Lehman estate wasabsolutely correct.
In other words, a chronological forensic analysis of the events surrounding the margin call in question confirm, beyond a shadow of a doubt that the margin call issued by JP Morgan’s CIO unit was absolutely unwarranted.
But it gets worse – because the mistake that led to the issuance of what may have been the defining margin call that was the beginning of the end of Lehman, was so ridiculously naive, and idiotic, that we have a hard time believing it was made in good faith, even if it JPMorgan tries to put the blame on some 19 year old NYU intern as being responsible. In fact, we have an easier time believing that the margin call was purposeful, malicious and made with full intent to destroy Lehman, which in turn would mean that, despite the repeated mockery of even the sophisticated media, Lehman may well have been the mark of a JPM-spearheaded campaign to force the bank to shutter as margin call after margin call led it to lose all liquidity.
So what exactly happened? Here are the events as seen by the Lehman side:
On September 9, 2008, the same day that JPMorgan made its initial demand for $5 billion of additional collateral and extracted new one-sided legal agreements from Lehman, JPMorgan also insisted that Lehman post $273.3 million before close of business as derivatives variation margin.The $273.3 million derivative margin demand was primarily attributable to three disputed trades which Mr. Iksil managed or discussed with Lehman. Lehman was certain that JPMorgan’s marks were erroneous and that in fact Lehman owed no additional margin. All three CDS referenced a well known and liquid index for which readily-available third party valuations corroborated Lehman’s marks, not JPMorgan’s, which were off by $273.3 million. Nevertheless, Lehman bowed to pressure from JPMorgan executives, including Investment Bank Chief Risk Officer John Hogan, to accept JPMorgan’s marks and immediately post the requisite collateral. Accordingly Lehman sent the $273.3 million demanded. That JPMorgan was able to force Lehman’s compliance is particularly telling considering JPMorgan’s marks were so clearly wrong.
The trades primary responsible for the $273.3 million derivatives margin dispute were 3 CDS index tranche trades booked through JPMorgan’s CIO, two of which were managed by Mr. Iksil. Lehman had repeatedly asked Mr. Iksil to correct the mark on the third large disputed trade throughout August and early September without success. Contemporaneous emails attached here reflect how JPMorgan’s mismarks grew into a multi-month ordeal due to the inaction and unresponsiveness of JPMorgan, and of Mr. Iksil in particular.
On September 10, 2008, Lehman’s relationship, operations, and trading personnel mobilized to resolve the mismarks of Mr. Iksil’s trades and secure the return of the nearly 300 million dollars in excess collateral they had been pressured to post to JPMorgan the day before.
Late in the morning on September 10, Lehman reached out once again to Mr. Iksil to request that he correct his marks. This time, Mr. Iksil immediately referred Lehman to a JPMorgan colleague who conceded within minutes that Lehman’s marks were correct and an error on JPMorgan’s side had caused the problem. Less than an hour later JPMorgan agreed in full to Lehman’s September 10 collateral call, which included JPMorgan returning the entire $273.3 million Lehman had delivered to JPMorgan the day before.
That JPMorgan would run roughshod over Lehman’s objections and insist on getting collateral immediately based on marks that were so quickly seen to be erroneous provide a window into JPMorgan’s mindset and operating procedures the week prior to LBHI’s bankruptcy: Get cash now, ask questions later. JPMorgan has taken the position in this litigation that JPMorgan was solicitous of Lehman’s welfare and demanded collateral only after carefully calculating the amount required. Yet, JPMorgan failed to correct its marks despite weeks of requests to do so and allowed a valuation dispute to fester for nearly a month. And on September 9, 2008, although even the most minimal diligence would have revealed JPMorgan was in the wrong, JPMorgan demanded that Lehman accept JPMorgan’s marks and post $273.3 million in disputed collateral overnight. That demand came on the very same day that JPMorgan made its first of two demands that week each for $5 billion of extra cash collateral that it had no right to obtain and that drained Lehman of $8.6 billion.
While we do not know if the $257 million extra in cash that Lehman would have retained on its books would have avoided the subsequent $10 billion in JPM margin calls, or if it would have avoided the firm’s bankruptcy as the final outcome, we know we are, and Lehman, are right in alleging that it was JPM’s fault in completely screwing up the calculation that led to the massive margin call. Here is the Bloomberg Chat transcript (Lehman Exhibit M) between Lehman (again very, very young CDX trader) Zahid Hassan, and Bruno Iksil first, and then Iksil’s supervisor in London, Luis Buraya: