Reconceptualizing Lehman

Abstract

In this paper we explain how Lehman can be simplified.

The tendency to date has been to focus on the large number of insolvency cases resulting from Lehman, as it justifies Lehman’s supposed uniqueness and the work done to resolve Lehman. And it makes good copy in the financial press.

We argue instead that Lehman is best understood as two or three operating companies, with many, many special purpose entities supporting these operating companies.

Reconceiving Lehman in this way has several important implications. First and foremost, it illustrates the problem that we term structural dependency, which is endemic in financial institutions. The vast majority of individual subsidiaries of Lehman and other financial institutions were never designed to operate as stand-alone entities, and instead function as little more than tools to finance the core operating companies. Addressing a financial institution as a series of corporations ignores the unique structure and balance sheets that exist in the entities that make up global financial institutions.

Additionally, once the structure of financial institutions is understood, it becomes clear that an international approach to financial distress amongst financial institutions is vital.

Finally, once Lehman is reconceptualized as we have suggested, we argue that the outlines of a possible solution begin to appear. We term this model the "turtle" approach to reorganization, inasmuch as we suggest that financial institutions can be best saved by retreating into their core operating companies in times of crisis, leaving the so-called structurally dependent subsidiaries to their own fate.

Keywords: Lehman, OLA, too big to fail, Dodd-Frank, resolution, Chapter 14, systemic risk, banking crisis, risk management, bailout

JEL Classification: D8, G11, G12, G13, N00, G24, G33, G38, K22, K29