Donald R. Van Deventer, Ph.D.

Don founded Kamakura Corporation in April 1990 and currently serves as Co-Chair, Center for Applied Quantitative Finance, Risk Research and Quantitative Solutions at SAS. Don’s focus at SAS is quantitative finance, credit risk, asset and liability management, and portfolio management for the most sophisticated financial services firms in the world.

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Case Studies in Liquidity Risk: Lehman Brothers (Dick Fuld was Right)

05/31/2011 01:44 AM

Today’s blog focuses on the consolidated funding shortfall that took place at Lehman Brothers, perhaps the most spectacular corporate failure during the 2007-2009 credit crisis. After the failure of Lehman Brothers, CEO Dick Fuld complained loudly that Lehman had been singled out for failure by the U.S. government. ‘So I’m the schmuck?” Fuld was quoted as saying by Andrew Ross Sorkin in his book “Too Big to Fail: The Inside Story of How Wall Street and Washington Fought to Save the Financial System – and Themselves” (Penguin, 2009). Today’s blog confirms that Lehman borrowed less money than many of the firms we have analyzed so far in this liquidity risk series.

This is the sixth case study in liquidity risk, following earlier blogs on AIG, Bank of America, Countrywide Financial, Merrill Lynch and a consolidation of the latter three firms.

On Sunday, September 14, 2008, Lehman Brothers filed for bankruptcy after the U.S. government declined to rescue the firm and after Bank of America decided to merge with Merrill Lynch instead of Lehman Brothers. Now that the Federal Reserve has released data on its extensions of credit, we can measure the funding shortfall at Lehman and compare it to other firms that were rescued during the crisis. Under the Dodd-Frank Act of 2010, the Board of Governors of the Federal Reserve was required to disclose the identities and relevant amounts for borrowers under various credit facilities during the 2007-2010 financial crisis. These credit facilities provide perhaps the best source of data about liquidity risk and funding shortfalls of the last century. This data is available for purchase from Kamakura Corporation and is taken from the Kamakura Risk Information Services Credit Crisis Liquidity Risk data base.

The data used for Lehman Brothers in this analysis is described in more detail below. The data consists of every transaction reported by the Federal Reserve as constituting a “primary, secondary, or other extension of credit” by the Fed. Included in this definition are normal borrowings from the Fed, the primary dealer credit facility, and the asset backed commercial paper program. Capital injections under the Troubled Asset Relief Program and purchases of commercial paper under the Commercial Paper Funding Facility are not included, but Lehman Brothers did not survive long enough to be the beneficiary of either program.

A detailed chronology of the credit crisis through February 28, 2008 is given in this recent blog post:

van Deventer, Donald R. “A Credit Crisis Chronology Part 1 Through February 2008: This Time Isn’t Different,” Kamakura blog, www.kamakuraco.com, May 13, 2011.

The key dates in the chronology relevant to Lehman Brothers are summarized here. The “Levin Report” refers to the bi-partisan study of the root causes of the credit crisis submitted to the U.S. Congress on April 13, 2011:

June 20, 2007
Merrill Lynch seizes $850 million in assets from the two
Bear Stearns hedge funds. Merrill tries to auction the
bonds, but the auction fails
June 17, 2007
Two Bear Stearns subprime hedge funds collapse
(Source: Levin report, page 47)
June 21, 2007
“Bear Stearns Fund Collapse Send Shock Through
CDOs” article on Bloomberg details losses on
mortgage-backed securities-related CDOs
July 17, 2007
Bear Stearns sends letter to investors stating that two
Bear Stearns hedge funds specializing in subprime debt
have lost at least 90% of their value. The funds invested
only in AAA tranches of subprime-related debt. (Source: investopedia.com)
August 1, 2007
Bear Stearns’ two troubled funds file for bankruptcy
protection and the company freezes assets in a third
fund. (Source: www.investopedia.com)
November 29, 2007
Bear Stearns cuts 650 more jobs, bringing total job
cuts to 1,500, 10% of its total work force.
(Source: www.ft.com)
December 19, 2007
Morgan Stanley announces $9.4 billion in write-downs
from subprime losses and a capital injection of $5
billionfrom a Chinese sovereign wealth fund.
(Source: www.ft.com)
December 20, 2007
Bear Stearns reports its first quarterly loss in 84
years, $854 million, after write downs of $1.9 billion
on mortgage holdings (Source: www.ft.com)
January 17, 2008
Lehman Brothers cuts 1,300 jobs in its domestic
mortgage division after previously cutting 2,500
jobs due to subprime lending problems. (Source: www.bankingtimes.co.uk)
January 17, 2008
Merrill Lynch announces net loss of $7.8 billion for
2007 due to $14.1 billion in write-downs on
investments related to subprime mortgages.
March 24, 2008
Federal Reserve Bank of New York forms Maiden
Lane I to help JPMorgan Chase acquire Bear Stearns
(Source: Levin report, page 47).
May 29, 2008
Bear Stearns shareholders approve sale
(Source: Levin report, page 47).
September 7, 2008
U.S. takes control of Fannie Mae & Freddie Mac
(Source: Levin report, page 47).
September 14, 2008
Lehman Brothers bankruptcy
(Source: Levin report, page 47).
September 14, 2008
Merrill Lynch announces sale to Bank of America
(Source: Levin report, page 47).

This blog reports on “primary, secondary, or other extensions of credit” by the Federal Reserve to Lehman Brothers during the period February 8, 2008 to March 16, 2009. Lehman Brother’s borrowings from the Federal Reserve can be summarized as follows:

Borrowing dates:
First borrowings March 18, 2008, with only 10
days of borrowings from the Fed on or before
September 12, 2008.
Average from
2/8/2008 to 3/16/2009
$195.6 million
Average when Drawn
$5.3 billion including borrowings after the September
14, 2008 bankruptcy filing, with no borrowing more
than $2.73 billion prior to bankruptcy
Maximum Drawn
$2.73 billion before bankruptcy announced, $28
billion on September 15, 2008 after bankruptcy
filing was announced

The graph below shows the Lehman Brothers 1 month (yellow line) and 1 year default probabilities for the Jarrow-Chava version 5.0 default probability models from Kamakura Risk Information Services. During the period from January 1990 to December 2008, over all public firms, the 95th percentile of 1 month default risk was 4.76%. Lehman Brothers’ 1 month default risk first exceeded this level on June 11, 2008. Note that Lehman was rated “A+” by Standard & Poor’s, for which the average 1 year default risk is 4-5 basis points, through May 30, 2008. Lehman was downgraded to A the next day and had an A rating on September 14, 2008, the day Lehman declared bankruptcy.

Kamakura Risk Information Services reported a 5 year cumulative default risk for Lehman Brothers of 41.67% on September 12, 2008:

Lehman’s first borrowing from the Federal Reserve was $1.6 billion on March 18, 2008. Lehman’s peak borrowing prior to filing for bankruptcy was $2.73 billion on March 24, 2008. The Federal Reserve reported that Lehman had outstanding borrowings from the Federal Reserve on only 10 days prior to its bankruptcy filing on September 14, 2008. Lehman had no borrowings from the Federal Reserve from July 29, 2008 to September 14, 2008. The surge in borrowings started with a $28 billion cash injection from the Federal Reserve on the day after the bankruptcy filing, September 15, 2008. The pattern of outstanding borrowings from the Federal Reserve was extremely modest prior to this date, as shown in the graph below.

In the chart below, we compare Lehman Brothers’ funding short fall to those firms whose liquidity risk we have previously analyzed in this series. Lehman’s average drawn borrowing of $5.25 billion, most of which came after bankruptcy, was smaller than the averages for AIG ($161.2 billion), Morgan Stanley ($16.2 billion), Merrill Lynch ($16.2 billion), Citigroup ($12.6 billion), and the consolidation of Bank of America, Countrywide, and Merrill Lynch ($14.1 billion): The gap is even larger if one notes that Lehman never borrowed more than $2.73 billion prior to bankruptcy.

If one ranks the same firms by largest outstanding borrowing on a single day, Lehman’s $28 billion post-bankruptcy peak is only 14% of the peak borrowing by AIG. Lehman’s pre-bankruptcy peak of $2.73 billion is only 1.4% of AIG. Morgan Stanley, the consolidated Bank of America and Merrill Lynch on a stand-alone basis had higher peak borrowings than Lehman Brothers.

Implications of Funding Shortfall Data

Lehman Brothers’ bankruptcy filing was followed by a significant $28 billion borrowing on September 15, 2008, despite having no borrowing outstanding from the Federal Reserve from July 29, 2008 through September 14, 2008. The dramatic erosion of Lehman Brothers’ ability to borrow is chronicled in detail in Sorkin’s Too Big to Fail. Compared to the U.S. government support of other institutions, Lehman Brother’s borrowings were medium sized at best. One can only conclude that, after allowing Lehman Brothers to fail, the U.S. government realized that it had made a mistake and changed its mind about who was too big to fail. Dick Fuld was, indeed, left as the only schmuck among CEOs of the big financial services firms.

Background on the Federal Reserve Data

A summary of the Federal Reserve programs that were put into place and summary statistics are available from the Federal Reserve at this web page:


Today’s blog focuses on one set of disclosures by the Federal Reserve: primary, secondary and other extensions of credit by the Fed. This includes direct, traditional borrowings from the Federal Reserve, the primary dealer credit facilities, and the asset backed commercial paper program described at the link above. These borrowings do not include commercial paper purchased under the Commercial Paper Funding Facility nor do they include the equity stakes taken by the U.S. government under the Troubled Asset Relief Program.

Kamakura took the following steps to consolidate the primary, secondary and other extensions of credit:

  • From www.twitter.com/zerohedge Kamakura downloaded the daily reports, in PDF format, from the Federal Reserve on primary, secondary and other extensions of credit from February 8, 2008 until March 16, 2009, approximately 250 reports in total
  • Kamakura converted each report to spreadsheet form
  • These spreadsheets were aggregated into a single data base giving the origination date of the borrowing, the name of the borrower, the Federal Reserve District of the borrower, the nature of the borrowing (ABCP, PDCF, or normal), the maturity date of the borrowing, and (in the case of Primary Dealer Credit Facility) the name of the institution holding the collateral.
  • Consistency in naming conventions was imposed, i.e. while the Fed listed two firms as “Morgan Stanley” and “M S Co” Kamakura recognized to the maximum extent possible that they are the same institution and used a consistent name
  • To the maximum extent possible, the name of the ultimate parent was used in order to best understand the consolidated extension of credit by the Fed to that firm.

For information regarding the Kamakura Credit Crisis Liquidity Risk data base, please contact us at info@kamakuraco.com. Please use the same e-mail address to contact the risk management experts at Kamakura regarding how to simulate realistic liquidity risk events in the Kamakura Risk Manager enterprise-wide risk management system.

Donald R. van Deventer
Kamakura Corporation
Honolulu, Hawaii
May 31, 2011

© Copyright 2011 by Donald R. van Deventer. All Rights Reserved.



Donald R. Van Deventer, Ph.D.

Don founded Kamakura Corporation in April 1990 and currently serves as Co-Chair, Center for Applied Quantitative Finance, Risk Research and Quantitative Solutions at SAS. Don’s focus at SAS is quantitative finance, credit risk, asset and liability management, and portfolio management for the most sophisticated financial services firms in the world.

Read More