What Really Happened When Lehman Failed... and Why a Spanish Default Will Be Exponentially Worse

Phoenix Capital Research's picture


Countless pages have been written about why Lehman caused the system to almost implode. However, the reality is that Lehman nearly took down the entire financial system for two reasons:


  1. Lehman’s $155 billion worth of bonds were used as collateral in hundreds of billions of Dollars’ worth of trades.
  2. Lehman’s 8,000 clients who were all using Lehman to make trades saw the collateral that they had placed with the firm (to backstop their portfolios) frozen.


Lehman’s client list included some of the biggest names in the financial world. Remember that before the 2008 collapse, the big broker-dealers (Lehman, Merrill, etc) were all standalone entities (the Merrill/ BofA merger and the others had yet to happen). So all of the big banks, with few exceptions, had their collateral parked with broker dealers like Lehman.


The below story reveals that both Bank of America and Dubai’s sovereign wealth fund both saw collateral frozen when Lehman went bust. I can assure you many other big names were caught in a similar situation.


            Lehman: One Big Derivatives Mess


It turns out that Lehman, like other big dealers, was running a perfectly legal but highly risky game moving money from firm to firm. It used the collateral from one trading partner to fund more deals with other firms. The same $100 million collected in one deal can be used for many other transactions. "Firms basically can use [the money] as their own collateral for anything they want," says Kenneth Kettering, a former derivatives lawyer and currently a professor at New York Law School. But when the contracts terminate as the result of bankruptcy, the extra collateral is supposed to be returned.


As part of those transactions, buyers had put up collateral in the event of losses. But weeks after Lehman's demise, large sums of leftover collateral have yet to be returned to the trading partners. Bank of America (BAC) executives tried several times to persuade Lehman officials via e-mail and phone calls to fork over funds, according to a suit. But BofA was rebuffed. In one e-mail exchange, a Lehman employee wrote to BofA: "All activity has been suspended until further notice."


Nasreen Bulos, a lawyer for one of Dubai's sovereign wealth funds, got the same chilly response. The Global Strategic Equities Fund of Dubai, part of the gulf state's $12 billion investment portfolio, gave Lehman $40 million in June as part of a deal pegged to energy giant BP's (BP) stock. According to an affidavit, Bulos started contacting Lehman on Sept. 15 to get back $27 million in collateral. Four days later, Lehman told Bulos it would not honor the request or say anything further on the matter.




Normally, a client’s collateral would be unfrozen soon after the bankruptcy of a broker dealer. In Lehman’s case it wasn’t. And that, combined with Lehman’s $155 billion worth of bonds becoming worthless, created a severe collateral shortfall in the system.


This is why the market held together for a little over a week after Lehman went bust: the players who had collateral with Lehman thought they’d get the money freed. When they didn’t, the system imploded as collateral calls were issued. What followed was widespread liquidation as banks did everything they could to free up capital to meet funding needs or to buy new higher grade collateral (hence the skyrocketing rally in Treasuries at the time).



This is the reality of what happened in 2008, though few know it. And this is why a default in Spain or Italy (whose €1.78 and €1.87 trillion in sovereign bonds are collateral for likely more than €100 trillion in trades) would bring about a collapse that would make Lehman appear minor in comparison.


Remember, if Spain goes bust, they over €1 trillion in collateral would vanish triggering a chain reaction in at least €50 trillion if not €100+ trillion in trades at the large banks/ financial institutions.


Again, and I cannot stress this enough: when Spain defaults (and it will) the system will experience a collateral crunch that will be exponentially higher than that which occurred following the Lehman bankruptcy.


This is why I’ve been warning that the 2008 was just a warm-up. It’s why the Powers That Be in Europe are absolutely terrified of what’s happening there. And it’s why those investors who do not prepare in advance for what’s coming will lose everything.


If you do not want to be one of them, you need to get moving.


We have produced a FREE Special Report available to all investors titled What Europe’s Collapse Means For You and Your Savings.


This report features ten pages of material outlining our independent analysis real debt situation in Europe (numbers far worse than is publicly admitted), the true nature of the EU banking system, and the systemic risks Europe poses to investors around the world.


It also outlines a number of investments to profit from this; investments that anyone can use to take advantage of the European Debt Crisis.


Best of all, this report is 100% FREE. You can pick up a copy today at:



Best Regards,


Graham Summers


PS. We also offer a FREE Special Report detailing the threat of inflation as well as two investments that will explode higher as it seeps throughout the financial system. You can pick up a copy of this report at:




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Quinvarius's picture

Good thing everyone can borrow at zero percent from the Fed these days.

BraveSirRobin's picture

Really, well I went to the local FED office (bank) just the other day and asked for a new business loan. They asked me how much debt I had. I told them I did not have any debt. I pay off all my bills when due, and have cash on hand 3x's current income, and twice the amount desired. In addition, I have other assets equal to 4 times the amount desired. They denied me credit. No credit history, you see.

Now, if I was just $16,000,000,000,000 in debt, then I could get a loan.

Likstane's picture

Anyone allowing Graham(2 years behind) Summers to play with their money deserves to lose it.

BraveSirRobin's picture

Graham must pay Tyler a handsome sum to get top of the fold exposure.

BinAround's picture

So a Spanish bond might default.  Oh.  I doubt that would be news to the financial world.  Is it plausible that any derivatives dealer today would accept a Spanish bond as collateral for anything?  I doubt it.   Whomever hold the bonds, I suppose mostly Spanish banks, then some other European banks, will write them down a bit.   They'll be some sort of restructuring deal.  The banks will be supported by the Troika.  Blah Blah Blah.  No.  I doubt the world will end. 


WeekendTrader's picture

At the risk of being rude, you are a fucking idiot.

Of course there are tons of institutions who are taking spanish bonds as collateral otherwise one would not be able to short them. Do you think the ECB refuses them as collateral???

I was quite involved in the Lehman thing. We had multi billion positions both at Lehman US and another desk had a couple of billion  with Lehman in London (not so good). It was quite clear that Lehman was having issues because of the behavior at their repo desk so in the weeks prior to the blowup we simply let positions roll off and went somewhere else and ended up with zero damage. And no, it wasn't being lucky, it was about paying attention to seemingly irrelevant details.

WeekendTrader's picture

At the risk of being rude, you are a fucking idiot.

Of course there are tons of institutions who are taking spanish bonds as collateral otherwise one would not be able to short them. Do you think the ECB refuses them as collateral???

I was quite involved in the Lehman thing. We had multi billion positions both at Lehman US and another desk had a couple of billion  with Lehman in London (not so good). It was quite clear that Lehman was having issues because of the behavior at their repo desk so in the weeks prior to the blowup we simply let positions roll off and went somewhere else and ended up with zero damage. And no, it wasn't being lucky, it was about paying attention to seemingly irrelevant details.

disabledvet's picture

you'd be surprised. first "you have to find out who owns it." as we now know relative to Mortgage Backed Securities (MBS's) "we really don't know who owns that." those that "don't know that" now includes the totality of US States Attorney General...4 years after the collapse. Needless to say this caused a complete collapse of the US financial system...something that still exists even today. The only thing i would quibble with is the lack of defining the "where" in this article...namely "in Europe." other than that i agree with everything in this article.

Bansters-in-my- feces's picture

Gee,ya think you might have done a story that mattered,like who CAUSED Lehman to go down,and then add the Spain add on.

FutureShock's picture

A big point that was not mentioned was the bankruptcy laws in London when Lehman wnet down mean your business in down and out, ass on the street, not still operating like the US.  This is where Paulson, Bernake and Geithner majorly fucked up. Accounts collapsed due to differing bankruptcy laws and that was a major point missed here. Zero hedge promotes enough fear do we need more profiting from fear gain and pains?


Rearranging Deckchairs's picture

such blatant false advertising. I was curious so I used an account devoted to being a spam recepticle to download this free report about how anyone can profit from the coming eurocalypse. let me sum it up for you. Short the big european banks especially the french ones. Otherwise short a couple of ETFs.



Jack Sheet's picture

Yes, and to get the timing for purchase and sale of the recommended ultra-leveraged ETFs you have to become a subscriber to the PRIVATES Wealth Advisory. Classic cock-teaser!

Rearranging Deckchairs's picture

basically there is going to be a massive collapse worse than 2008 which should collapse the system and yet were supposed to be safe being short on european banks. Yeah right. We will wake up and discover our brokerage and options accounts have been stolen or confiscated by the administration under its new emergency powers.


If a Euro collapse is definitely coming then we should all be in tangible gold, silver, guns, ammo, food and water and not pieces of paper. 


GreatUncle's picture

"have been stolen or confiscated by the administration under its new emergency powers"

Will not happen that way what you will find is all you thought you were worth will be devalued away. There really is no need to confiscate anything if you manipulater the economy to create the same effect.

NEOSERF's picture

I agree, PMs and fiat money only matter if the collapse isn't apocolyptic.  If it as bad as he says in the article, a can of Spam and the right ammo will be the only thing worth anything...

Zero Govt's picture

Graham has been scraping the bottom of the barrel for hysteria on Europe this past year but I can tell him something pretty concerning that reflects the European mentality

yesterday loads of strikes kicked off in Spain in the public sector against "austerity". My fiance, a gym-bunny, trotted down the gym last night and found it, 'On Strike'. The complex had all the shops, bars and cinema open, the only thing not open for biz was the private sector gym and its instructors, out in 'sympathy' for the public sector railing against what needs to be done without delay, austerity (dieting) for Jabba the Hut obese Govt

WTF are private sector gym instructors doing on strike with the Union loonies???

Orly's picture

Thanks for the Report, Phoenix.  I hope you are able to respond to this thread, as I have a simple question that has been bugging me for some time and seems to be the driving force behind major moves in the 4X markets:

The PTB over in Europe or in America (definitely somewhere...) have been mortified of the Euro dropping below 1.28 to the USD.  Can you think of any reason why this is?  Maybe it is because there is $500 Billion in European 4X swaps from very early in the crisis and this is the break-even?

It's the only thing I can think of.  Anyway, thanks so much for your insight and if you have any ideas about this, please let me know.



Jack Sheet's picture

You are perhaps well-intentioned but are wasting your time. Long-time Graham-admirers have proved conclusively that he doesn't grace the comments section with his presence.

Orly's picture

Worth a shot!

But if anyone else has any ideas about it, I would be happy to hear them.


falak pema's picture

Past DEc 21 anything is possible. even xmas!

TruthHunter's picture

"-$40/oz. You'll have to pay someone to take it"  /sarc   ??

Under Stalin, Silver or Gold ownership was more than a -$40/oz liability...Either way, thumbs up.


Of course there is always Isaiah 2:20 to think about:  "In that day a man shall cast away his idols of silver, and his idols of gold, which they made, each for himself to worship, to the moles and to the bats"

BTW, who's that strange little deity on the Liberty quarter?

Money Squid's picture

Rev 3:18 I counsel thee to buy of me gold tried in the fire, that thou mayest be rich;

LawsofPhysics's picture

How many people throughout history who had PMs in their possession have starved again?

falak pema's picture

those africans had it under their starving feet again and again. Never learnt.

Fuh Querada's picture

Shit ! I thought Lindsey Williams is the only one left who quotes the Bible these days

Money Squid's picture

The bible is a fantasic source of information, for you can find any quote you want to support any position you want. I have known many religeous people and I found it very interesting that no two had the same understanding nor could they agree upon the same basic concepts even when they were in the same belief system. Everytime somone quotes the bible to support some their view I simply find a quote that states the opposite.

BraveSirRobin's picture
Deuteronomy 23:10

New English Translation (NET)

10 If there is someone among you who is impure because of some nocturnal emission, he must leave the camp; he may not reenter it immediately.

I think that one is pretty clear, eh?

Oldballplayer's picture

Best to get that stuff out of the way before nightfall!

silverserfer's picture

the colapse will be so bad, physical silver will be worth -$40/oz. You'll have to pay someone to take it from you! Its going to be CRAZY!!! forget ZIRP it NVPS! Also when this happens a miracle will occur. Bankers will actualy tell you the truth about gold and silver.

whotookmyalias's picture

I better dump my gold and silver now while it's still worth something. Let me load up the canoe.

bank guy in Brussels's picture

A ZeroHedge classic, about how the whole Western economic world almost blew up 84 hours after the Lehman bankruptcy.

'How The World Almost Came To An End At 2PM On September 18':

« On Thursday (Sept 18), at 11am the Federal Reserve noticed a tremendous draw-down of money market accounts in the U.S., to the tune of $550 billion was being drawn out in the matter of an hour or two. The Treasury opened up its window to help and pumped a $105 billion in the system and quickly realized that they could not stem the tide. We were having an electronic run on the banks. They decided to close the operation, close down the money accounts and announce a guarantee of $250,000 per account so there wouldn't be further panic out there.

If they had not done that, their estimation is that by 2pm that afternoon, $5.5 trillion would have been drawn out of the money market system of the U.S., would have collapsed the entire economy of the U.S., and within 24 hours the world economy would have collapsed. It would have been the end of our economic system and our political system as we know it.

We are no better off today ... »


disabledvet's picture

well...while i agree with everything said here...what i think would have happened had nothing been down would have been a far different "new normal." the whole "end of the world" thing is so overwrought it gets a little trite after awhile. "For Whom the Bell Tolls" perhaps...

Money Squid's picture

The explanation is from one of many crooked congressmen. The Fed could have easily created $20 Trillion to stem the "outflow", if there was actually an outflow at all. But, you need to create a crisis to manage expectations so that sheeple willingly give up their rights and take on more debt to make the richest even richester. Its all a scam. Remeber the color warning system? Green, yellow, orange and red? Oh my gosh the color changed from yellow to orange, get the plastic and duct tape. Oh no, the color changed from orange back to yellow, what to do with all that plastic and duct tape. The whole color alert was a fucking scam to scare the stupid people. And, it worked fabulously well. Then, it suddenly disappeared, no longer needed. Poof, it was gone.

Urban Redneck's picture

What's never properly detailed about that day is the breakdown between gross unleveraged dollars and net ponzi dollars being yanked out of the giant bankster jenga stack of dough.

El Viejo's picture

As I understand it Lehman went under because it didn't have access to the FED discount window and two weeks later it would have. Their lawyers supposedly made this statement in court. (from the book "Too Big to Fail")

Everybodys All American's picture

that was the outcome. Goldman and Morgan Stanley gained access to the window otherwise they would have been gone as well. The reason Lehman complained is because that solution for Goldman and Morgan was granted after they were taken under. The failure at Lehman though chiefly had to do with the trading losses on their books and no one wanted their exposure or had a solution to save them at the time.

kaa1016's picture

This is at the root of the problem. This is why even Greece can not be allowed to default, a real default. It's like the whole sublprime is contained thing. Daisy chains...

Zero Govt's picture

Greece gets a cold, Brussels catches the flu and New York gets a fever

so what were 300 over-paid, excessively legislated Regulators doing worldwide on the issue of systemic crisis?

my guess, suffocating healthy young small firms while leaving the goalposts wide open for the diseased dinosaurs to kick home goals as i've seen in every industry with regulators (the systemic cronies of monopolists)

Zero Govt's picture

"collateral calls" as in calls on paper contracts (IOU's) ...Govt Bonds as collateral? Only Govt, bankers and the accountancy profession could make this crap up their paper promises are as solid as a rock

It's like the blind leading the blind all signed off by Auditors they've got A1 eyesight 

So Graham, when's the 'Big Day' that Spain goes 'Bang!'

all suspense and tension-building is lost without a call ...you're just no fun anymore 

bank guy in Brussels's picture

Maybe it's good Graham is not making bold 'predictions' in the same way ... This is one of Graham's better pieces, with some good details and not just current affairs re-hashing

Intersting to look at Graham's websites. His main website comes off well, where he makes some strong claims for his returns:

« Since inception in June 2010, The Perfect Trade model portfolio has returned over 215% vs. 28% for the S&P 500.

In 2011, the Private Wealth Advisory model portfolio returned 9.5% vs. the S&P 500’s 0.3% return, and didn’t close a single losing position in the entire second half of the year. »


Fuh Querada's picture

Harry Browne's first law of Investment advice:
The investment advisor with a perfect record will lose his touch as soon as you start acting on his recommendations.

Alhazred's picture

We could solve half of his paper stupidity if we didnt let them print money from thin air.


we need to end the fed and get back to a metal standard.



stormsailor's picture

in this case, even gold standard would not help.  lehman used the same "collateral" to secure hundreds of deals.  like getting hundreds of mortgages on the same house, i guess this explains why i will never be a billionaire banker,  i can't conceive how this could be legal, let alone ethical.


leveraged 130 to 1,  banks create non-existant dollars to invest with,  and when it goes south, less than 1% loss wipes out liquidity, when trading partners demand more collateral or quit trading with them, and investors smell the stench and start yanking out investments.  game over.

disabledvet's picture

in other words "it's the type of people doing it" and not the people themselves. i did find this interesting: http://www.foxbusiness.com/industries/2012/11/13/ivy-asset-management-to... "as long as everyone does it...then you better be doing it too" is as Wall Street as it gets. "until you're not suppose to" is the hard part.

stormsailor's picture

yeah dv,  i wonder how many super intelligent, educated, moral, and ethical people were passed over and/or fired simply because they would not go along with this.  they spent years of their lives in education and then learning how the market functions, only to lose their jobs or remain in some dead-end department.


its  funny how greed and corruption permeates from the small single person working their hardest and doing their best, all the way to the tops of the towers, and then to the government.   sad really,  some of the smartest business men the world has ever known are probably asst managers at best buy somewhere,  hating themselves, and their lives because of their ethics and morality.


i hope someday that ethics, morality, and honor will be valued, just as i hope justice will punish the evil and reward the good.


from the look of things,  our world could use it



myptofvu's picture

I thought that the problem started when Lehman started getting Short Sold out of existence. Any of that true or just stuff made for movies, actually I think I read that in Rolling Stone of all places.

Zero Govt's picture

you want to replace the corruption and stink caused by a monopoly money system with a new monopoly, a Gold standard

how about a free market in money rather than a Gold cartel replacing a paper cartel?

Manthong's picture

But all that is just not a problem when you have a sound triple ledger accounting system and Phantom Zone Swaps.