Toomre Capital Markets LLC

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Lars Toomre's blog

Possible Gossip About Joe Gregory of Lehman Brothers??

The New York Post is published by Rupert Murdoch and is well-known in the New York City area for its Page Six section which reports on various gossip items that might be appealing to the greater community. In the November 10th 2008 edition of Page Six, the following tidbit appeared under the section Just Asking:

WHICH wife of a top Lehman executive went on a $132,000 shopping spree at the Americana Manhasset Mall the day after her hubby filed for bankruptcy?

Toomre Capital Markets LLC ("TCM") has written previously about the Possible Bankruptcy for Joe Gregory of Lehman Brothers. Mr. Gregory was the former President and Chief Operating Officer of Lehman Brothers who Dick Fuld relieved of his position back in June 2008 simultaneous with the replacement of then Chief Financial Officer, Erin Callan.

FT: Winding up Lehman Brothers

On Friday afternoon November 7th 2008, The Financial Times published an excellent article entitled Winding up Lehman Brothers written by Jennifer Hughes. This article is a great summary of what Tony Lomas and his team at PriceWaterhouseCoopers have gone through in starting to wind up the European affairs of Lehman Brothers. This bankruptcy case is likely to continue for many years to come and no doubt there will be further stories about the bankruptcy administrator's conduct.

What emerges from this story is how virtually no one connected with the large investment bank Lehman Brothers (management, employees and clients) expected what then was the fourth largest investment bank to file for bankruptcy on Monday September 15th. Tony Lomas and team were the bankruptcy administrator for Enron's European operations (and still are working on that case some seven plus years later). In that case, they had two weeks to review the operations and prepare for the bankruptcy filing. In the case of Lehman Brothers, the PriceWaterhouseCoopers team had slightly more than twenty-four hours. No wonder from afar the European bankruptcy seemed so chaotic in its first days.

Toomre Capital Markets LLC ("TCM") suggests that any reader in the subject of Lehman Brothers and/or bankruptcy read this article.

Barack Obama In; Dick Fuld Out

On the day after the election of Barack Obama as the next President of the United States, The Washington Post examined why he won in an article entitled Measured Response To Financial Crisis Sealed the Election. The conclusion of the article is that Barack Obama won because of the sudden collapse of Lehman Brothers on September 15th. That bankruptcy filing triggered "the biggest corporate collapse in U.S. history and an international financial meltdown", ultimately transforming the presidential race.

Is it any surprise then on the day after Obama's election, Bloomberg News reports that Lehman Brothers' much vilified Chairman and CEO Dick Fuld will be "terminated" by the bankrupt company by year-end without any bonus or severance pay?

Dick Fuld has been rightly criticized for driving the fourth largest investment bank into the ground and for the seemingly "large" amount of compensation he received over the years. For instance, Dick Fuld was openly criticized at an Oct. 6 hearing by Henry Waxman, chairman of the House Committee on Oversight and Government Reform, for taking excessive pay, which was estimated at $484.8 million since 2000. He is also being investigated long with 12 other individuals by three federal criminal probes focusing on Lehman Brothers.

Surely, Dick Fuld has become a regular punching bag on Wall Street. Both there and on Main Street, Fuld's various failures and excesses have been ridiculed by politicians, the media, and fellow bankers and executives to illustrate what is wrong with the way Wall Street operates. Equally well, Main Street citizens are quite angry about the Wall Street types who made many times the annual compensation of professionals in other lines of work like academics or engineering.

However, does not this vilification of Dick Fuld seem like a bit much? Many on Main Street have little appreciation of how the mortgage securitization process lowered homeowner mortgage rates for many years. That process saved hundreds and sometimes thousands of dollars each month on both residential and commercial real estate. Spread across the many mortgages in the United States this "benefit" to Main Street offsets some of the amazing "profits" that Wall Street rang up in an environment of particularly low volatility and risk premiums.

Toomre.com Website Upgrade

During the past week, Toomre Capital Markets LLC ("TCM") has been working behind the scenes to upgrade the underlying software that is used to dynamically present web pages to the reader based on various criteria and preferences. The initial phase of this upgrade is now largely complete. As a result, the complete content of Toomre.com website again is now available and the website has changed its appearance.

Laid Off By Lehman Brothers: One Broker's Story

In the event that the reader has not yet seen this tale of gallows humor, Toomre Capital Markets LLC ("TCM") hopes that the reader of this website might enjoy this recent posting on Youtube about the supposed tale of one Lehman Brothers broker's journey through the bankruptcy experience. Part of why the humor works so well is that there is quite a bit of truth in the experiences referenced.

The Lucky Lehman Brothers Dozen: Subpoenas

At the Thursday October 16th 2008 hearing before the judge overseeing the bankruptcy of Lehman Brothers, the lead bankruptcy lawyer representing Lehman Brothers, Attorney Harvey Miller from Weil Gotschal, indicated that the firm is presently the focus of three grand jury investigations. According to Attorney Miller, the Southern and Eastern Districts of New York as well as the New Jersey U.S. Attorney offices are looking into various undisclosed aspects of Lehman Brothers' collapse.

In conjunction with these investigations, apparently a dozen subpoenas have been issued to a dozen current and former senior executives. New reports have subsequently suggested that CEO Dick Fuld and former-CFO Erin Callan are included on that list. Others have speculated whether former-COO Joe Gregory, the former head of Lehman Mortgage Capital Ted Janulis and Mark Walsh, the former head of the Lehman CMBS real estate business, might or might have received such subpoenas. CNBC reported that Joe Gregory's successor, Bart McDade had not received such a summons from Federal investigators.

Like many other observers of the demise of Lehman Brothers, Toomre Capital Markets LLC ("TCM") wonders who else was on the list of the lucky dozen to receive such Lehman Brothers subpoenas.

Lehman Brothers Bankruptcy Costs Non-Americans More than $300 Billion

On Monday October 13th 2008 comes news (via Reuters) that the bankruptcy of Lehman Brothers caused losses outside of the United States of more than $300 billion. The relevant part of the article reads:

The financial fallout outside the United States from Lehman Brothers Holdings' bankruptcy has been about $300 billion, the head of Germany's financial regulator said on Monday.

"We're still licking the wounds of Lehman," said Jochen Sanio, president of the German Federal Financial Supervisory Authority, at an international banking conference. "It caused international damage of $300 billion outside the U.S."

The U.S. government allowed investment bank Lehman Brothers to file for bankruptcy protection on September 15 instead of trying to intervene as it had done with investment bank Bear Stearns and later did with giant insurer American International Group.

Toomre Capital Markets LLC ("TCM") agrees with many commentators that the bankruptcy of Lehman Brothers in retrospect had many unintended consequences and was a primary contributing factor to the current economic crisis. Whether or not Treasury Secretary Hank Paulson made the right decision in letting Lehman fail will be debated for many months to come.

However, with such large losses among America's trading partners, it is certain that future decisions about rescuing financial institutions with potentially systemic risk implications will be made much more carefully. Hopefully, future such decisions will be made in consultation with America's global trading partners because in a highly interconnected, global world, such decisions affect far more than just the American "Main Street" economy.

Outlook After TARP Rejection

The news in the financial markets continues to be quite grim. Over the past few business days, Washington Mutual was seized by its regulators and quickly sold to JPMorgan Chase bank. Today the regulators assisted in the forced sale of Wachovia to Citigroup. Then this afternoon the United States House of Representatives rejected the Troubled Asset Relief Program ("TARP") program that would have enabled the Federal government to purchase up to $700 billion in "toxic" mortgage assets. Once the news of the no vote spread, the equity markets quickly turned even further south, ending up with the largest ever loss in the Dow Jones Industrial Average. Ahead of Tuesday's end of the month and the third quarter, the market for commercial paper is virtually frozen and what trading there is for very short terms, often overnight and generally a week or less.

In light of all of the above, several clients and professional contacts have reached out to Lars Toomre for his perspective on where things might go from here. In short, I am quite pessimistic. There is an old saying that the markets have a tendency to extract maximum pain for many parties before a correction can start. I fear that the sell-off witnessed this afternoon in the equity markets will continue and get worse as investors wonder which institution might be next. Also, I sense that equity investors are beginning to adjust downward their expectations for future earnings as consensus begins to build that the United States and perhaps the world is entering a major recession.

As bad as the equity markets might be, I am even more worried about the debt markets. The bankruptcy filing of Lehman Brothers has had far more repercussions than the Federal regulators originally projected. If you have not read the front-page story from the September 29th 2008 Wall Street Journal entitled Lehman's Demise Triggered Cash Crunch Around Globe, go read it now!

Lehman Brothers was one of the two largest dealers in commercial paper plus it had quite a bit of its own commercial paper outstanding. Its absence as a market maker has hurt the commercial paper market. The breaking of the proverbial buck by Reserve Primary Fund (due to the amount of Lehman Brothers commercial paper it held) caused many larger investors, primarily corporations and institutions, to question whether money market funds were money good. Hence, more than $150 billion of the $1.7 trillion money market funds were redeemed and much of the cash apparently has been parked in Treasury bills driving such holdings down to yield just a few basis points.

All markets are driven by the marginal buyer and seller. With few buyers in the commercial paper market, the rates required to roll over outstanding commercial paper have risen quite a bit and could well go even higher if the financial panic stays constant or worsens even further. The coming year-end is going to be truly horrendous as almost all financial institutions want to hold as much cash as possible and make their all-important year-end balance sheets look as pristine as possible. Hence, I suspect that there will be limited funds available for commercial paper issuers who want to take out bank loans instead of rolling their paper. Also, with such uncertainty about financial credits, it is also will be likely that issuing longer term debt in the corporate bond market will be very difficult, if not impossible for all but the safest credits.

Finally, market participants do not seem to be focusing on what is going on in the hedge fund sector. Many hedge funds are suffering net losses for the year and as a result, many hedge fund investors are submitting redemption notices. Even though most hedge funds have substantially reduced their leverage, many still employ leverage in the range of 3:1 to 5:1. The redemptions and margin calls from the decline in the equity markets will cause yet more selling from hedge funds. Hence, I would expect that many markets will be under pressure from further hedge fund deleveraging.

Toomre Capital Markets LLC ("TCM") consults with clients who are involved with structured finance securities, derivatives and other "hairy" investment opportunities like weather derivative contracts and life settlement portfolios. Many of these investment alternatives are illiquid, even in the best of times. As a result, we have a keen appreciation of what is termed "liquidity risk". Two of the clients today independently asked that I highlight a past post entitled Can Wall Street be Trusted to Value Risky CDOs?. Both found it extremely helpful and useful in thinking about the value of liquidity and what may lay ahead for the rejected TARP program.

Reader comments and thoughts are welcome.

FBI Investigates AIG and Lehman Brothers Failures

On Wednesday September 24th 2008, The TimesOnline website is reporting that FBI Investigates Fannie Mae and Lehman Brothers. Apparently the Federal Bureau of Investigation ("FBI") has launched an inquiry into Fannie Mae and Freddie Mac, the mortgage companies; Lehman Brothers, the bust investment bank; and AIG, the nationalized insurance company.

"It is understood that investigators are trying to ascertain whether fraud helped caused some of the troubles at the four groups. The investigation includes whether executives deliberately misled the stock market about the health of their businesses." At AIG, news reports in the past ten days or so have suggested that the former senior management did not appreciate until just recently the full extent of the problems in their derivatives subsidiary AIG Financial Products. That led to the effective take-over of AIG.

Lehman Brothers apparently failed because market participants had little confidence in where its mortgage assets were marked-to-market. News reports about the meetings at the New York Federal Reserve Bank during the weekend of September 14th suggested that a number of market participants from other investment banks were surprised to see the relatively "rich" (or high) prices to which many of Lehman Brother's mortgage assets were marked. It has been suggested that from CEO Dick Fuld, President Bart McDade, (and former-COO Joe Gregory before him), former-CFO Erin Callan, and others down to the recently-retired global head of the Mortgage Capital division, Ted Janulis, all saw gold in what many others viewed as lumps of coal.

No doubt one or more of these executives will be answering questions for the FBI about possible allegations that there were mis-statements of asset values, particularly in the mortgage area. David Einhorn of the hedge fund Greenlight Capital raised numerous questions about the valuation of mortgage assets at Lehman Brothers after its first-quarter 2008 earnings report. At the time, various Lehman Brothers executives strongly rejected his allegations.

Possible Bankruptcy for Joe Gregory of Lehman Brothers

During the past few days, there have been a large number of readers of the Toomre Capital Markets LLC ("TCM") website looking for more information on the bankruptcy filing of Lehman Brothers. Some of those inquiries have been looking for details on both "Joe Gregory" and "bankruptcy".

This was a bit surprising because there were few other searches for the names of other Lehman Brothers executives in combination with the term bankruptcy. Perhaps the readers were looking for more information about Joe Gregory's extravagance of using a helicopter to commute back and forth to work in mid-town Manhattan from his (plural) homes on Long Island. TCM has previously written about Joe Gregory and his extreme example of hubris and excess in the posts Employee Losses in Lehman Brothers Stock Holdings and Initial Reflections on Demise of Lehman Brothers.

On Sunday, September 21st 2008, New York Magazine published an article about the pain of sudden down-sizing that many are feeling with the demise of Lehman Brothers in an article entitled The Rage of the Previously Rich. Buried in the middle of that article was the text:

On Friday, September 12, the Wall Street Journal reported that Lehman’s former president, Joe Gregory, who was demoted along with former CFO Erin Callan in a management shake-up in June, was listing his Bridgehampton house on Surfside Drive for $32.5 million. The collapse of Lehman’s stock is a blow to Gregory’s lifestyle. He reportedly used to travel by helicopter to midtown from his $3.5 million mansion in Huntington, which was recently renovated, according to a Sotheby’s broker. According to one source, Gregory’s financial adviser was in negotiations with Lehman’s attorneys at Simpson Thacher & Bartlett, working to avert his filing for bankruptcy, after he borrowed money against his Lehman stock to pay for the renovation. “He owes a lot of money for it. They called the margin loan” late last week, the source said.

If You Took The Week Off ... You Didn’t Miss Anything!

The week of September 15th to 19th 2008 will long be regarded as the week that Western finance forever changed. Lehman Brothers filed for largest bankruptcy in history. Merrill Lynch merged into the stronger arms of Bank of America. The world's largest insurer, AIG, was rescued at the last minute with a $85 billion loan from the United States Treasury and Federal Reserve Bank.

For only the second time in history, a major money market fund -- The Primary Fund managed by Reserve Management – broke the proverbial buck as some of its short-term investments were suddenly valued at zero with the bankruptcy of Lehman Brothers. The assets of that fund plunged from $64 billion down to approximately $23 billion. There were reports that other money market funds saw heavy redemptions as well, primarily from institutional clients who feared that the upheaval in the capital markets would cause other financial institutions to fail and file for bankruptcy. The final money market redemption numbers for the week are not yet available, but are likely to have been quite sizeable (north of the $150 billion redeemed through Wednesday).

Thursday was a day of particular mayhem as various fund managers, financial institutions and the two remaining independent investment banks saw their common stocks plunge and then rebound on very high volume. Credit default swaps on those same institutions widened considerably. In some sectors of the capital markets, particularly in the credit sectors, trading came to a complete halt and some securities were unable to trade at all or at any price. The Dow Jones Industrial Average ended up down more than 450 points on the day.

Thursday night came the announcement from Hank Paulson and Ben Bernanke that the government would seek permission from Congress to begin to purchase mortgage-backed securities from various financial institutions, hopefully thereby freeing up their balance sheets so that they can start to lend again. The amount of authorization sought is going to be quite large, maybe as much as $700 billion. Simultaneously, the Treasury announced a new program to guarantee the principal value of registered money market funds. The Federal Reserve provided more liquidity to the primary dealers and banks through new programs to purchase both agency discount notes and asset-backed commercial paper. Finally, the Securities and Exchange Commission ("S.E.C.") banned the short-sale of the common stock for approximately 800 financial institutions through October 2nd.

The net result of all of these actions is that the equity markets soared on Friday, September 19th 2008 and there seemed to be a bit more sanity in the money market sector. Some credit-default swaps narrowed dramatically and the rush for the safety of Treasuries abated somewhat. All in all, it was quite an end to a most stressful and trying week.

The New York Times helped to put the week in perspective with the quote: "In the end, the market closed on Friday at nearly the same price it did last week before all the mayhem. An e-mail message circulating around Wall Street on Friday carried the subject line: “If you took the week off ... you didn’t miss anything.”"

Initial Reflections on Demise of Lehman Brothers

The weekend of September 14th 2008 certainly will be known as a most remarkable weekend for American high finance. Both Lehman Brothers and Merrill Lynch have disappeared; the first to bankruptcy, the second to a Fed-directed merger with Bank of America. Several people have contacted Lars Toomre to ask various questions about might lie ahead in the near and longer-term future, and what "I" might know.

As a former employee of Lehman Brothers, I am sad to see that franchise disappear seemingly into thin air. Yet as readers of this blog no doubt are aware, I have been very contemptuous particularly of the former Capital Market managements of Citigroup, Merrill Lynch and UBS and their risk management teams. Clearly, the leaders of those firms really did not understand what types and amounts of risk they were taking on with all of their accumulation of sub-prime mortgages, CDOs, SIVs and other structured finance products. Why they had to own so many billions of these products made no sense except if they were making the bet that they could make a spread between the asset yields and where those products could be funded.

Back in the late fall of 2006 and early winter of 2007, I became extremely worried about the irrationality of the fixed-income markets. On February 5th 2007, I wrote the post It's All Fun and Games Until Someone Gets Hurt where I highlighted

Toomre Capital Markets LLC has been quite concerned about the irrationality of the United States fixed-income markets. Recently, the current coupon mortgage-backed security has traded with a negative option adjusted spread ("OAS"). Buyers of the current coupon MBS apparently were paying little heed to the fact that the underlying mortgages could be pre-paid. Rather the demand for nominal yield far outweighed the risk of prepayment. It will be very interesting to observe what happens with this market sector in the coming months as the Federal Reserve seemingly remains on hold. Is it a time to reach for yield? Or is it a time for safety ahead of one of the bond market's periodic up-heavals?

That post was followed up by one the next week entitled Hedge Funds, Investment Banks and the Value of Liquidity? In that post, I wrote "The financial markets now are full of much liquidity. Are investors, speculators and their bankers appreciating and pricing in liquidity risk? Toomre Capital Markets LLC would suggest that liquidity risk presently is greatly under-valued in the search for 'alpha', absolute return and portfolio yield. The stretch to get ten percent return (after fees) appears to be making rational people start to do irrational things."

Apparently, the folks running Lehman Brothers were not fully paying attention to what they were doing with their mortgage business. Somewhere in my reading of the past few days, I saw reference to why Michael Gelband resigned as the head of Lehman Brothers fixed-income division in June 2007. Apparently, the Lehman Brothers COO Joe Gregory did not want to reduce the risk profile of the fixed-income business (and may even have wanted to expand the risk even further to help fund the firm's global expansion plans).

Ut Oh… Barclay's Walks Away from Potential Lehman Brothers Acquisition

According to both Bloomberg and the BBC, Barclay's has walked away from its potential acquisition of the "good bank" portion of Lehman Brothers. This leaves the reluctant Bank of America as the only apparent acquirer of that "valuable" asset. As has been the case for the past three days, the key stumbling block appears to be credit / financial support needed to ring fence the approximately $85 billion in "bad" real estate assets at the heart of the Lehman Brothers crisis.

The Federal government is the deep pocket that all of the major financial players want to come to the table. However, Treasury Paulson appears to be sticking to his statement that there will be no Federal funds available for a Lehman Brothers rescue. Prepare for a really rough market in the days to come!!

Size of Lehman Brothers Bad Assets

Lehman Brothers is dying and effectively dead. In the next few hours the world will learn whether there is some type of forced rescue or whether this investment bank will be the first major institution that is "too big" and yet allowed to fail. The consequences of that failure are likely to rattle the markets in the United States, Europe and the Far East.

The Wall Street rumor website Dearlbreaker has a posting from early Sunday morning September 14th 2008 entitled We Have Reached A Deal For Lehman, Sources Say. That article starts, "We understand that a deal has been reached to divide Lehman Brothers into two entities, with a "bad bank" taking the toxic, real-estate assets amounting to around $85 billion. The deal will be financed without any government backing. Lehman chief executive Dick Fuld will resign."

Toomre Capital Markets LLC ("TCM") has watched the Lehman Brothers story evolve with some interest over the past year. This $85 billion number is far greater than Lars Toomre ever recalls being talked about before.

If this figure of bad assets is indeed accurate, Dick Fuld, Joe Gregory, Ted Janulis, Dave Sherr and all of the rest of the Lehman Brothers senior management (past and present) truly deserve to be taken out drawn, quartered and then shot. Where did this amount of "bad assets" come from?? My impression from all of the talk of liquidations is that were something on the order of $30 billion in troubled real estate holdings. If there truly was almost three times as much, that fact was not clearly communicated to the market participants. And if it was communicated, let me then repose the question, "Where the heck were Lehman Brothers' enterprise risk management controls that allowed the mortgage department to build such enormous positions???"

Employee Losses in Lehman Brothers Stock Holdings

My original Wall Street firm, Lehman Brothers, is in the process of melting down. Since the start of September 2008, the common stock has lost something close to 70% of its value. On the seventh anniversary of 9/11, the common stock closed at $4.22 per share. It appears highly likely that this investment bank's days as an independent are over, perhaps as early as this coming weekend.

The Lehman culture strongly preached the concept of team. Its employees were repeatedly encouraged to stay invested in the firm when a significant portion of their compensation was paid in the form of restricted common stock. In the time since its spin-off from American Express back in 1994, the employee's percentage of ownership apparently grew to be as large as thirty or percent or so. That percentage was diluted some by the additional equity capital raised earlier this year.

On Friday September 12th 2008, The Wall Street Journal wrote about how the decline in the stock price is effecting that ownership stake. The article is entitled The Lehman Stock Slide Hits Home: Employees Face $10 Billion in Losses and written by Randall Smith, Susanne Craig and Annelena Lobb.

All employees holding the stock have taken massive personal losses since the beginning of the year. The CEO and Chairman Dick Fuld, for instance, owns approximately 10.1 million shares and that stake is now valued at $45.8 million, down some $649.2 million or about 93% since the end of January 2008. The other four senior executives listed in statements filed with the SEC owned 2.6 million shares and suffered comparable paper losses.