Decoding a debt matrix

Lehman’s ‘unknown unknowns’, and the secrets that came to light

This article was first published on the Financial Times website on 10 September 2018. 

When the administrators and lawyers walked into the Bank Street offices of Lehman Brothers on a sunny Sunday afternoon ten years ago, little did they know the complexity of the task which awaited them.

For all their vast experience, legal knowledge and financial acumen, this was a major challenge.

Michael Kent, Global Head of Finance & Projects at Linklaters, who was there that day in his role as an expert in financial law, is blunt in his assessment: “These great organisations were not built in the anticipation of going bust. There was no master plan or document that told you where things were, who the key custodians were. You could quickly see that some of the regulations designed to protect customers, for example in relation to client money, had not worked perfectly.”

One of the early lessons from the collapse of Lehman Brothers was the need for major organisations to have a ‘living will’ documenting where everything was and what should happen if the unthinkable occurred.

Once the administrators and lawyers had scratched the surface, however, the sheer complexity of Lehman’s business posed a major challenge.

But that wasn’t the only difficulty. The global financial crisis exposed some of the weaknesses in the division of responsibilities between the different regulators in the UK. As the lender of last resort, the Bank of England became the critical player in the process – but was not close to the Lehman business, as it had not been its regulator.

Interconnected financial infrastructure

“What many people didn't realise at the time was how large Lehman Europe was – in particular, they were amongst the largest traders of equities on the London Stock Exchange thanks to their strong prime brokerage franchise,” says Kent. “They were thus a critical part of the plumbing for equities trading.

“They went bust mid-settlement cycle on Monday morning, and it was not well understood what that meant – it was initially assumed delivery of the securities was in some way guaranteed, but it wasn’t.

“In contrast, the closing out of cleared Swaps worked as expected – with no counterparties losing anything in relation to their swaps transactions at the clearing house.”

Michael Voisin, Global Head of Capital Markets at Linklaters, says: “The key issue that emerged was interconnectedness. Lehman did business with many companies, other banks, financial market infrastructure such as payment systems, securities, depositories, and CCPs (central counterparties). But there was a lack of understanding of how all the different pieces fit together and the ramifications of one of those pieces falling over.


The very real concern that started to emerge was that if Lehman Brothers were to go insolvent, failing to meet its liabilities and obligations, other systemically important businesses would suffer a liquidity crunch. So, the risk of contagion was very severe.”

A playbook of lessons learned

Hundreds of lawyers and accountants managed to negotiate these choppy waters, eventually establishing that the European arm of Lehman Brothers was, in fact, balance sheet solvent, with a surplus of £5 billion.

Along the way those experts documented the process, so that if a similar crisis unfolded again, there would be a manual on how to wind up a bank. As part of this, they also gathered lessons and insights from a wider project management perspective, in order to develop a playbook that could be drawn upon not only for bank failures but also for managing other complex, high-stakes situations.

Perhaps the biggest lesson of all to emerge from the wreckage, however, was the inherent danger of allowing institutions to grow so large, unwieldy and complex that their collapse triggers other crises.

Ben Bernanke, the former Federal Reserve chairman, has warned against the danger of another Lehman domino effect, saying: “It’s very important for the long-term stability of our financial system to eliminate ‘too-big-to-fail’.

“We will not have completed the goals of regulatory reform if we have not adequately addressed the problem.”

A new ecosystem

While the blame game has unfolded over the course of a decade, the real issue was the sheer complexity of the financial system – and the role major players such as Lehman had – back in 2008.

“Everyone likes to have someone to blame, but actually if you read the de Larosière Group report into the causes of the financial crisis, quite interestingly it doesn't single out any particular player or even segment,” says Voisin.

“It shows that there's a really complex ecosystem that in many cases people didn't understand from beginning to end.”

Ten years on we know a lot more. But is it enough? Hopefully we will not be forced to find out any time soon.