More on the Charge That JP Morgan Withheld $17 Billion From Lehman, Triggering Collapse

Reader Saboor passed along the day’s updates on the case filed by Lehman creditors last week, alleging that JP Morgan, Lehman’s clearing bank, refused to give Lehman access to $17 billion of excess funds held at the bank, precipitating the firm’s failure.

I did not see an link to the case yet in a quick Google search, and I suspect Gretchen Morgenson will have her teeth into this one post haste. But the latest stories did provide more detail on the court filings.

One thing we need to stress: Lehman was a goner. Before it went under, many observers labored under the mistaken belief that if the firm, say, managed to sell Neuberger & Berman for $10 billion, or got a nice chunk of change form the Koreans, it could soldier on for a while, and in the unlikely event that the real estate and LBO paper quit deteriorating in value, the firm might pull through. But there was a reason none of the last-minute prospective buyers (Barclays and Bank of America) came forward with a bid. The firm had a gaping hole in its balance sheet, vastly bigger than what the public at large believed.

But that said, JP Morgan was not entitled to stick a knife in and twist, if that is what it effectively did.

From Times Online:

JP Morgan has been accused by its Wall Street rivals of dealing the final hammer blow that forced Lehman Brothers into collapse in a sensational claim that threatens to spark a colossal legal battle.

The giant American bank is alleged to have frozen $17 billion (£9.6 billion) of cash and securities belonging to Lehman on the Friday night before its failure.

According to Lehman’s biggest creditors, this was what precipitated the liquidity crisis that embroiled the firm, forcing it into Chapter 11 bankruptcy protection on the morning of Monday, September 15….

The funding lines provided to Lehman to finance its everyday operations amount to $188 billion, according to court filings.

The creditors are now demanding that JP Morgan open up its books to the bankruptcy court to allow the transactions to be assessed.

“The creditors’ committee understands that LBHI [Lehman Brothers Holding Inc] had at least $17 billion in excess assets which were held at JPMC [JP Morgan Chase] on the Friday going into the weekend before its bankruptcy filing,” the documents said.

“The creditors’ committee further understands that, on September 12, 2008, JPMC refused to allow LBHI access to its excess assets and instead ‘froze’ LBHI’s account. In freezing LBHI’s assets, JPMC was purportedly holding all of LBHI’s assets as a potential offset against any claims JPMC may have had against LBHI.”

I’m no securities lawyer, but if that is indeed what happened, that is unconscionable. A clearing bank is supposed to act in a custodial capacity. Freezing the assets is tantamount to seizing the assets. It’s self-dealing, pure and simple. More from Bloomberg:

JPMorgan, the biggest U.S. bank by deposits, financed Lehman’s brokerage operations with daily advances, while money market funds and other short-term lenders provided overnight loans, according to bankruptcy court documents. When JPMorgan shut Lehman off from funds, Lehman “suffered an immediate liquidity crisis that could have been averted by any number of events, none of which transpired,” according to the filing….

Lehman seemed to have enough liquidity to meet its obligations on Sept. 12, the Friday before its bankruptcy filing, creditors said, referring to the cash and collateral at JPMorgan. In addition, the bank held “highly liquid” securities bought with secured financing amounting to $188 billion from banks and other lenders, they said.

The “freezing” of Lehman’s account meant it no longer had funds to support its operations, they said.

Explaining Lehman’s collapse to the judge after the bankruptcy filing, company executives and lawyers said the $188 billion pool of loans mostly financed the bank’s least liquid assets, subprime mortgages and structured financial instruments.

“Secured financing fell out of reach” because of the devaluation of assets securing the loans, forcing Lehman to deplete its cash to continue trading, said lawyer Shai Waisman of Weil Gotshal & Manges in a Sept. 16 court hearing. “This began the stranglehold on Lehman,” Waisman said.

JPMorgan is Lehman’s largest secured creditor, with an estimated claim of $23 billion, according to a Sept. 25 court filing. Unsecured creditors have claims on Lehman that might be worth 15 cents on the dollar or less, according to analysts including Peter Plaut of Imperial Capital LLC.

After Lehman’s filing, JPMorgan advanced the company $87 billion on Sept.15 and $51 billion the next day to pay short- term lenders and settle trades, according to court documents.

This Bloomberg story fails to note that at least $87 billion of those advances were repaid by the Fed. From an earlier Bloomberg report:

Lehman Brothers Holdings Inc., the securities firm that filed the biggest bankruptcy in history yesterday, was advanced $138 billion this week by JPMorgan Chase & Co. to settle Lehman trades and keep financial markets stable, according to a court filing.

One advance of $87 billion was made on Sept. 15 after the pre-dawn filing, and another of $51 billion was made the following day, according to a bankruptcy court documents posted today. Both were made to settle securities transactions with customers of Lehman and its clearance parties, the filings said.

The advances were necessary “to avoid a disruption of the financial markets,” Lehman said in the filing.

The first advance was repaid by the Federal Reserve Bank of New York, Lehman said. The bank didn’t say if the second amount was repaid. Both advances were “guaranteed by Lehman” through collateral of the firm’s holding company, the filing said. The advances were made at the request of Lehman and the Federal Reserve, according to the filing.

 Originally published at Naked Capitalism and reproduced here with the author’s permission.