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Lecture22_Books(2) - Lecture 22 Books and Tricks Nicholas M...

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Lecture 22: Books and Tricks Nicholas M. Kiefer Cornell University Economics 4230 c N. M. Kiefer Economics 4230: Banks 1/ 40
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Books, Accounting and Capital Banks are required to report capital positions quarterly. Regulators and market participants like to see capital positions above minimum regulatory requirements. FIs have a lot of flexibility in fixing their capital positions on the reporting date - reducing assets or moving them off the balance sheet. Categories: 1) legal, routine market activities; 2) near the edge activities, exploiting complexity and ambiguity in regulations and standards; 3) plainly illegal machinations. Management and supervisors should be suspicious of transactions with no clear business purpose. c N. M. Kiefer Economics 4230: Banks 2/ 40
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Lehman From FCIC report (good description of the timeline, no analysis, plenty of fingerpointing). Sept 10 2008 Lehman reported shareholder equity—the measure of solvency—of 28 billion at the end of August. September 12, ”experts from the country’s biggest banks met at the Wall Street offices of the Federal Reserve to ponder the fate of Lehman Brothers, and could not agree whether or not the firm was solvent.” In particular, bankers thought Lehman’s real estate assets were overvalued. c N. M. Kiefer Economics 4230: Banks 3/ 40
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Lehman Specifically, bankers doubted that 58 billion in real estate assets in the banking book was an accurate figure. If the assets were worth only half that amount (a likely scenario, given market conditions), then Lehman’s equity would be gone. Liquidity vs. capital: “The SEC traditionally took the view that liquidity was paramount in large securities firms, but the Fed, as a consequence of its banking mandate, had more of an emphasis on capital raising,” FCIC: ”Lehman built up its liquidity to 45 billion at the end of May.” [what might this mean?] c N. M. Kiefer Economics 4230: Banks 4/ 40
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Lehman Short-term financing: Lehman’s borrowings in the overnight commercial paper market were increasing, however, from 3 billion at the end of November 2007 to 8 billion at the end of May. It was reliant on repo funding, particularly the portions that matured overnight and were collateralized by illiquid assets As of mid-June, 62% of Lehman’s liquidity was dependent on borrowing against nontraditional securities, such as mortgage-related securities c N. M. Kiefer Economics 4230: Banks 5/ 40
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Lehman July: Federated Investors notified JP Morgan, Lehman’s clearing bank, that Federated would “no longer pursue additional business with Lehman.” Dreyfus, another large money market fund and a Lehman tri-party repo lender, also pulled its repo line from the firm. Tri-party repos: eliminate (or reduce) counterparty risk by having a 3rd party hold securities and cash. Not uncommon.
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