Yu Lia Chun, a retired hospital orderly in Hong Kong, never heard of Lehman Brothers Holdings Inc before she got a call last September from her banker.
“He said, ‘Did you hear the news? Something has happened to Lehman,’” Yu, 66, recalled in an interview in June. “I didn’t get it.”
Yu, who has a sixth-grade education, said she thought her money was in a savings account. She didn’t know she had lent it to a bankrupt American securities firm. Eventually, she found out that her HK$1.2 million ($155,000) nest egg was gone. Her children lost another HK$3.8 million because Yu had persuaded them to make similar investments.
“There is no way a person like me could understand any of this,” Yu said, dabbing her eyes with a tissue in a coffee shop in Hong Kong’s financial district. “Sometimes I feel like jumping off a building.”
What hit Yu and her family was a tidal wave triggered halfway around the world by the biggest bankruptcy in US history. The September 15, 2008, collapse of Lehman, with $613 billion in liabilities, had unforeseen and far-flung consequences that devastated those, like Yu, who didn’t know their fates were tied to the New York-based investment bank.
The chief operating officer of a private-equity firm in London jumped in front of a commuter train because he blamed himself for leaving the company’s money in a Lehman account, according to a coroner’s report. The Israeli managers of a hotel construction project on the island of West Caicos, northeast of Cuba, were taken hostage by Chinese workers when an anticipated Lehman loan didn’t materialise and wages weren’t paid. In Hong Kong, Yu and thousands of others who had invested in Lehman products camped out in the rain, thumping drums and chanting, “Give us our money back.”
The realisation that a US securities firm so woven into the financial system couldn’t pay its debts radiated out from New York, panicking investors around the world. It was a doomsday scenario that former International Monetary Fund chief economist Simon H Johnson likened to Kurt Vonnegut Jr.’s 1963 novel “Cat’s Cradle,” in which a single crystal of the fictitious substance ice-nine hardens all of the planet’s water.
What differentiated Lehman from previous financial crises was how fast the panic spread, said Richard Sylla, an economic and financial historian at New York University’s Leonard N Stern School of Business in New York.
“Communications made things happen faster,” Sylla said, describing how it took six months for the 1931 failure of Austria’s Creditanstalt bank to put stress on the British financial system. “The news of everything got spread around much quicker this time.”
The freezing of global credit markets following Lehman’s demise began with professionals who traded commercial paper in New York.
They were the first to feel the chill when the Reserve Primary Fund, the oldest money market fund, was inundated with requests for redemptions and seized up hours after the bankruptcy filing. The $785 million that Reserve had lent to Lehman was deemed worthless by 4 pm the next day.
Fear that more banks and financial firms might fail meant most investors stopped lending to anyone other than the government. Even New York-based Goldman Sachs Group Inc, which earned $11.6 billion in 2007, more than any US securities firm in history, wasn’t immune. The average annual cost of insuring $10 million of Goldman Sachs debt for five years soared to a record $545,000 from $182,557 in the three days after Lehman failed, according to data compiled by Bloomberg.
Lehman’s demise triggered a panic. Money fund managers were forced to raise cash to pay off investors. They tried selling what securities they held and couldn’t. The market was flooded, and prices were plummeting — if prices could be obtained at all. The Standard & Poor’s 500 Index suffered its worst decline in six years. Mistrust leaked into the corporate bond market.
The most widely traded 30-year bond of General Electric Capital Corp, the world’s biggest issuer of commercial paper, dropped by as much as 30 cents on the dollar to 62 cents by September 18 because of doubts that GE would be able to persuade money funds to renew its short-term notes.
At that price, the three-day loss for owners of the issue was more than $1.9 billion, according to prices provided by Trace, the bond-trade reporting system of the Financial Industry Regulatory Authority.
The US responded within a week to guarantee money markets and bank-to-bank lending. Within a month, Congress agreed to spend $700 billion to prop up banks under the Troubled Asset Relief Program, the Federal Deposit Insurance Corp guaranteed new bank debt, and Federal Reserve lending to financial institutions ballooned by $1 trillion.
Those programmes, which succeeded in stemming the panic, remain in place today. What they didn’t do was save Yu and thousands of other investors in Hong Kong, Singapore, Taiwan and elsewhere who had bought equity-linked notes or so-called minibonds connected to Lehman.
Equity-linked notes combine attributes of both bonds and stock by investing part of the proceeds in share options and the remainder in fixed income. Minibonds are custom-made securities linked to the creditworthiness of companies, backed by collateralised-debt obligations and sold in denominations of $5,000. They functioned like credit-default swaps in reverse, where the investor stands to lose his principal when the firm named in the note can’t pay its debts.
Yu, a mother of six who emigrated from mainland China in 1962, didn’t have a chance, according to Joseph Stiglitz, a Columbia University economics professor who won a Nobel Prize for his work on the effect of unequal access to information on buyers and sellers in financial markets.
