Paul Hastings partner David Ereira acted for Lehman Brothers administrator PricewaterhouseCoopers while he was at Linklaters in 2009. Here, he tells the story behind the collapse and what we can learn from it almost a decade later.
When the clouds of the impending great financial crash were looming over Lehman in the summer of 2008, a senior corporate partner and I went to see Peter Sherratt, vice chairman and former head of legal at Lehman with the message that whatever might happen, our firm would be there for them if the need arose.
A couple of months later, in only a few days, Lehman unravelled. We got the call from Peter on the Thursday.
The UK board were concerned that the US parent was looking at rescue options which might affect the UK operations and they wanted some separate advice as to their duties as directors if things got rocky. We delivered a short memo.
By the Saturday, things had gotten worse and we advised that the board urgently needed to take the precautionary step of retaining on standby an insolvency firm.
On the Sunday, there was a brief and chilling call to Peter from the US which I listened in to. It was clear that all hope of rescue in the US had gone and there was no co-ordinated plan. All that anyone knew was that each Lehman business would fail when the markets started to trade on the Monday morning. A few hours later at 7:56AM in a meeting room at our office, PWC were appointed as administrators. The largest insolvency in UK history had begun.
Managing it required extraordinary efforts by all involved. We had to solve completely new legal and technical challenges on a monumental scale. But the solutions were found in the end.
What lessons have been learnt from the next 9 years of sorting it all out?
We are all connected – The spark at Lehman started a blaze that burned through much of the global financial system. Everyone was pulling their money out of any bank that might be vulnerable and the very few institutions believed to be strong were being inundated and refusing to take in new business.
We had billions in cash in the administration but couldn’t safely open any accounts with any banks. In the end, we placed the cash in an account at the Bank of England. We reasoned that if the UK central bank were to fail then losing the cash would be the least of our worries.
We all have a stake in the system – When money fails then so does our society. No government bailed out Lehman but afterwards billions in public money were spent to prevent it resulting in a complete meltdown.
“The transition from a confident belief that there would be a future to a complete collapse took 3 days”
The direct cost of bailing out the banks and financial institutions led to the Eurozone sovereign debt crisis and the global economic slowdown ever since. This has resulted in trillions of dollars of lost wealth and economic insecurity for millions. In 2017 we are still working through the political consequences of all that. We don’t know what the size of the final bill will be for the decision not to save Lehman.
We underestimate how fast things can turn – Lehman had been tottering for months but in the end the transition from a confident belief that there would be a future to a complete collapse took 3 days. When confidence evaporates it goes in an instant.
New bank resolution laws give regulators the powers to move quickly and impose losses on the private sector through “bail-in” rather than on the public purse through “bail-outs”. It’s not clear that the use of these powers has bolstered confidence. For financial investors the lesson may be that it’s better to run for the exit even faster rather than wait to see how you are “bailed-in”.
We all need a plan – there was no pre-planning for the collapse. Before the filing, no one at Lehman was allowed to contemplate a collapse as doing so could undermine confidence. As a result regulators now require banks to prepare resolution plans or “living wills”. Some planning is clearly better than none. Whether the plans are worth much in practice only time can tell.
We need to remember it’s about the people not the money – For every banker with a bonus there is a secretary or a trainee with a mortgage. Behind every hedge fund is a retired pensioner’s income. We operated an emergency room on the top floor of Lehman’s Canary Wharf HQ for several weeks in the aftermath of the filing. In between emergency calls on unwinding billion pound derivatives a young trainee came to see me with the unpaid expenses bill for her 6 week induction in New York. When you have just started work to both lose your job and have a huge credit card bill which your insolvent employer now won’t cover is a nightmare.
“The cost of that misjudgement has been years of economic misery”
We don’t know what things are worth – Lehman Europe has paid all its creditors in full, a grateful legal profession is now engaged in a blizzard of litigation about how to divide up the billions in surplus assets. It wasn’t bust, it was simply illiquid but no one knew that at the time.
There is a strong argument that if regulators and central bankers had hadn’t decided at that moment to play the “moral hazard” card and held their nerve by providing critical liquidity then it could have been unwound on a solvent basis or even survived.
The cost of that misjudgement has been years of economic misery. We should learn to recognise that we shouldn’t always be afraid of what we don’t know and that the sometimes caution can be the costliest option.
Absolute safety is an illusion – we don’t know where the next systemic crisis will come from. All we can be certain of is that there will be one and that all our preparation will, like the generals of old, be for the last war not the next one.
When it happens we will need to rely on our best protection, our flexibility, ingenuity and creativity which, as ever, I am confident will eventually see us through.
David Ereira is a partner in the restructuring and finance practice at Paul Hastings and is based in the firm’s London office. Read more global financial crisis coverage here.