I hope the following video will be available for as long as this blog is online.
http://www.youtube.com/watch?v=ATDsUk10BKE
According to hedge fund insider, Jim Cramer, this is what happened.
Lehman Brothers had $158 billion in debt.
Hedge funds bought $365 billion worth of credit default swaps* (bond insurance) on Lehman Brothers debt. The SEC, under the corrupt aegis of Bush-appointed Christopher Cox, allowed for this to happen. This should have never happened because why would a rationale person insure something for more than it is worth (and at this magnitude).
Hedge funds then set to destroy Lehman Brothers by collapsing its equity through short selling of their common stock. They assumed correctly that the government would not bail out this investment bank. With the loss of confidence, credit rating downgrades, investor panic, covenant violations, and with no savior, Lehman Brothers had no choice, but to file for bankruptcy. As a result of the bankruptcy, Lehman Brothers bonds were in default and the hedge funds were set to gain $365 billion in insurance proceeds
An analogy of what the hedge funds did - you buy a house for $1 million, but insure it for $20 million. You then set the house on fire and collect $20 million in insurance proceeds.
AIG was one of the largest counterparties in this type of deal. They were essentially insurers of Lehman's solvency and now had to pay the hedge funds hundreds of billions in insurance payments for which the hedge funds only paid a pittance in premiums.
AIG faces a financial crisis and the government bails out AIG using billions of US tax dollars so that AIG could fulfill their insurance obligations.
Take-away message: Hundreds of billions of hard-earned US tax dollars (your money) is given to diabolical hedge funds who brilliantly exploited the system.
Lamentation: What's the point of working? Our wealth just gets stolen anyway.
Additional note: To top off collecting a $365 billion insurance jackpot, hedge funds also profited handsomely by short selling and buying put options.
*Credit default swaps can be thought of as bond insurance. The buyer pays a fee (premium) to a counterparty who will insure a bond's payment. In the event of the bond's underlying company defaulting, the counterparty will make a payout to the buyer according to the agreed terms (which in many cases is the principal and interest that the defaulted company should have paid).
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This doesn't seem to completely make sense to me. If Lehman's debt portfolio was comprised mainly of good, quality, low-risk instruments, it wouldn't have mattered if hedge funds had shorted Lehman's stock all the way to zero; Lehman could still continue as an operating concern.
ReplyDeleteConversely, if Lehman had poor quality, high-risk debt on its books, hedge funds could have aggressively bought its stock driving it to $1,000 a share, and it would still be bankrupt.
You can't affect the financial health of a company by dealing in its stock, unless there's an IPO involved.
Once the short-selling plan had begun, Lehman Brothers faced a liquidity crisis. They were probably going to face a bank-run, but they had ill-liquid assets and no ready access to capital for redemptions and withdrawals. With a drop in credit ratings, certain covenants may also have been activated, forcing Lehman to post collateral that they simply could not do. The debt markets were in turmoil at the time and Lehman's low stock price prevented any meaningful capital raising through additional equity offerings. Without a government bailout or merger with a stronger bank, they were forced into bankruptcy. Had the stock price not dropped so much (which the hedge funds caused), there would not have been such a loss of confidence and Lehman would have had access to the equity markets and been able to possibly survive. But the hedge funds made the environment impossible for Lehman to remain solvent.
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