Lehman: day of the death

Lehman Brothers collapse sounded the death knell for the financial status quo and quite a few other household names. Kit Chellel surveys the wreckage


Lehman: day of the deathIt was the day the world changed. Until the collapse of Lehman Brothers, one of the worlds largest investment banks, many had thought the worst of the credit crunch was over.

It took Lehmans demise to show how damaged the global financial system had become. Years of cheap credit had given rise to the shadow banking system a multitrillion-dollar industry dealing in complex loans and derivatives.

All the banks were exposed and no one was safe. In the panic that followed several household names were consigned to history.

In the UK, HBOS, which includes Halifax and Bank of Scotland, was taken over in a shock move by Lloyds TSB, while mortgage lender Bradford & Bingley was part-nationalised to prevent its collapse. Meanwhile, in the US Merrill Lynch, Wachovia and Washington Mutual were swallowed up by rivals and insurance giant AIG was brought back from the brink by the US government.

To prevent the whole financial system from plunging into chaos, governments around the world have been injecting billions into the banking sector. We have all seen the apocalyptic headlines. One lawyer described the situation as a watershed moment akin to the Big Bang.

But what does all of this mean for the legal industry? Lawyers had a pivotal role in the creation of these obscure products and they would also have a front-row seat as the system they helped build came crashing down.

In the short term there has been an upsurge in work for legal professionals. Winding up or buying a bank with billions of assets spread across the globe produces a staggering amount of work. Magic circle law firm Linklaters, for example, has an astonishing 20 partners working on the administration of Lehmans UK arm the biggest UK insolvency team in more than a decade.

Even those firms without places on the megadeals have been kept busy advising clients with investments linked to stricken banks whether they be hedge funds, private equity investors or even pension funds.

For their part, litigators are expecting a boom in instructions as disgruntled shareholders look to recoup some of their losses. Top 20 law firm Simmons & Simmons instruction from hedge fund RAB Capital over its action against Lehman administrators PricewaterhouseCoopers looks to be the first of many.

But despite some trophy instructions for the lucky few, the overall picture for the legal sector remains gloomy. Most City law firms rely on financial institutions for healthy slices of their fee incomes and will, as a result of the financial turmoil, have lost some big-billing clients.

In the US Cadwalader Wickersham & Taft will be feeling the loss of Lehman, formerly a major client, especially as it has just lost another banking stalwart, Bear Stearns, to the credit crunch.

Elsewhere, Merrill Lynchs takeover by Bank of America will have worried partners at several firms in the US, including Sidley Austin and Fried Frank Harris Shriver & Jacobson.

But more damaging than the loss of key clients is the deal drought, which is hitting lawyers across the board. Whether for the private equity funds that invest in growing businesses, property funds that support residential development or large companies looking to grow by taking over rivals, with no cash from bankers there are no instructions for the lawyers.

Corporate and real estate lawyers were already struggling to find work, and now partners are talking about no deals until Christmas.

The basic problem is confidence. Nobody knew exactly how much money the banks had invested in the US mortgage market, the source of the current crisis (see box, page 45), so confidence dried up and banks stopped lending to one another.

Institutions such as Lehman and Bradford & Bingley then got into trouble because they could not raise enough money to fund their activities. And when inter-bank lending stopped, the supply of cheap credit for investors dried up.

Some of the first casualties in the legal industry have been in-house lawyers at struggling financial institutions. Lehman employs some 70 lawyers in the UK. In the immediate aftermath of the investment banks collapse it was not clear whether they had jobs or, if they stayed on, whether they would be paid. It has now become clear that most of the in-house legal team will be retained by administrators PricewaterhouseCoopers to work on the disposal of Lehmans businesses and assets.

Once this work has been completed, however, most will lose their jobs. Legal recruiters have already been inundated with CVs from institutions such as Lehman, Merrill Lynch and HBOS, and with a glut of former in-house banking lawyers on the market their futures are unclear.

Many recruiters say the best opportunities lie in emerging markets such as the Middle East. Either way, this is not a good time to look for
in-house legal work in the banking sector.

But arguably the money markets had to hit rock bottom before things could start getting better. And action has finally been taken to deal with the toxic mortgage debts at the heart of the current crisis.

The US government finally approved a $700bn (404.06bn) bailout plan to take these debts into public ownership and restore confidence in the banking sector. The proposal was so controversial that the US House of Representatives initially rejected it a move that sent global stock markets into turmoil.

Will it work? Some are not convinced. Lovells New York chief Dave Alberts argues: Whether or not its a good idea remains to be seen, but there are no other ideas out there.

As the turmoil continued to escalate, European governments were also forced to take measures to shore up their banks. In the UK Chancellor of the Exchequer Alistair Darling unveiled a 400bn rescue package that included a 37bn cash injection into HBOS, Lloyds TSB and Royal Bank of Scotland in return for shares. Barclays, which was also offered financial assistance, turned down the Governments offer and decided to raise capital from private investors. The rest of the money will be used to boost liquidity in the banking system through a combination of loans and guarantees.

The long-term effects of the banking crisis are not yet clear, but it is likely that regulators in the US and UK will impose tighter restrictions on the behaviour of financial institutions. That means regulatory lawyers will have plenty to do over the coming years. Darlings scheme is the first such step, with signatories agreeing to have executive pay and share dividends capped.

As for the banking system, which saw trillions won and lost in complex stock market gambles, it can surely only survive in a drastically reduced form.

Your guide to the credit crunch

It seems astonishing that the global financial system could be brought to its knees by Americans who could not keep up with their mortgage payments.
Yet that is exactly what has happened.

At the height of the market boom unscrupulous investors were dreaming up ever-more ingenious ways to make money from selling debt.

They took bad mortgages, sold to US customers who could not afford them and packaged them up with less risky property investments.

The collateralised debt obligations (CDOs) were then given four-star ratings and sold on to banks, who invested huge sums of cash in them.

Only when the property market began to decline did the illusion shatter.

People began to default on their mortgages and CDOs were exposed as virtually worthless.

Yet the investment portfolios of the major financial institutions were so complex that no one knew how much money was invested in bad debt.

Banks were forced to write down the value of their investments to the score of billions of dollars and turned to shareholders to cough up extra cash by issuing extra shares.

In the ensuing atmosphere of uncertainty banks became unwilling to lend to each other in case the debt could not be repaid.

But in the frenzy of lending banks capital ratios had become dangerously low and they were reliant on short-term debt from the money markets to fund their daily operations.

When this also dried up, the failure of the banks most exposed to risky assets was inevitable.