This chapter describes the effects of the Financial Stability Board’s review of interest rate benchmarks. The Board’s report recommended a number of measures to help improve security, notably by underpinning existing IBORS with transactions data and by developing alternative, nearly risk-free rates. New benchmarks would be developed with reference to the ISOCO Principles published in July 2013. The chapter explains these principles and how they were put into practice.

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This concluding chapter addresses the question of why so few senior bankers have borne the consequences of market manipulation carried out by their subordinates. It argues that the huge fines imposed on banks have failed, both in terms of justice and in terms of bringing about changes in culture and behaviour. Tracing the changes in the senior management regime from the 1990s to the present, it weighs up the possible means of ensuring that senior figures are held responsible in the future.

in Holding bankers to account

Mayer Lehman Brothers' long history began with three brothers, immigrants from Germany, setting up a small shop in Alabama, selling groceries and dry goods to local cotton farmers. Their business soon evolved into cotton trading. Dick Fuld made a series of acquisitions, designed to lessen Lehman's dependence on fixed-income trading, and focus attention on mergers and acquisitions, investment banking and raising capital. He began the process of restructuring the company so that it consisted of three major operating units: investment banking, equities and fixed income. He refocused the company's activities on high-margin business such as mergers and acquisitions, bringing in experienced senior staff to manage the business. The description of the company's activities reflected both the move away from fixed income trading, and Fuld's ambitions for Lehman Brothers.

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January to September 2008

In its financial report for the fiscal year ending 30 November 2007, Mayer Lehman Brothers reported record revenues of nearly $60bn, and record earnings in excess of $4bn. Lehman's March 2008 results were revealed that its liquidity pool had increased from $35bn to $54bn. To bolster liquidity and to help the financial markets function more effectively, the Federal Reserve established the Primary Dealer Credit Facility. Before the announcement of its third quarter results, Lehman's shares were very volatile, falling by 13 per cent on one day and rising by 16 per cent on another. The Consolidated Supervised Entity Programme, designed to ensure that a firm could withstand the loss of its unsecured financing for up to a year, was abruptly ended on 26 September 2008. The downfall of Bear Stearns, Lehman Brothers, and Merrill Lynch was not completely due to the regulators; they brought their downfall on themselves.

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On 10 September 2008, Dick Fuld presented what would be the firm's last earnings report, announcing the loss of $3.9bn, the second quarterly loss that had increased from the previous quarter's loss of $2.8bn. It also released some plans and proposed actions, which included the increase in total stockholders' equity, spin-off of certain commercial real estate assets, and a potential deal with a Korean sovereign wealth fund. All of the proposed actions were no more than plans, as opposed to completed deals or agreements. Just two days after Mayer Lehman filed for Chapter 11, Barclays announced that it would acquire Lehman Brothers North American investment banking and capital markets operations and supporting infrastructure. That included Lehman Brothers' New York headquarters and two data centres, all for $1.75bn, a price which the New York Times described as a 'fire sale' and which was much less than Lehman expected.

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This chapter examines the regulation of the Big Five investment banks in the context of the changes which took place in the structure of banking after the repeal of the Gramm-Leach-Bliley Act 1999 (GLBA). It also examines the introduction of the European Union's Consolidated Supervision Directive in 2004. The Act did not 'repeal' the Glass-Steagall Act in its entirety, but only repealed sections 20 and 32, which prohibited member banks from affiliating with organizations dealing in securities. The Federal Reserve became the 'umbrella' supervisor for any Financial Holding Company owning a bank; under its 'streamlined supervision' remit, the Federal Reserve was limited in its day-to-day authority to oversee functionally regulated non-banking subsidiaries of the holding companies. Though the Securities and Exchange Commission had adequate tools and statutory backing for taking on the consolidated supervision of the Big Five investment banks, its inability to carry out effective supervision was revealed soon.

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The Lehman Chapter 11 bankruptcy case represents the 'largest, most complex, multi-faceted and far-reaching bankruptcy case ever filed in the United States'. After the bankruptcy process completed, there was no further investigation of the Examiner's conclusions about the 'colorable' claims. This chapter explores the main issues cited for the cause of the bankruptcy and reasons why Mayer Lehman conducted its business without proper oversight. To hide the extent to which Lehman Brothers Holding Incorporated (LBHI) was leveraged, the company developed and used a version of Repo 105 and Repo 108 in 2001. But it used the device much more extensively in 2007 and 2008, as focus on the leverage ratios of investment banks increased. The Examiner appointed by the Bankruptcy Court found sufficient evidence to support that 'Lehman did not appropriately consider market-based yield when valuing Principal Transactions Group (PTG) assets in the second and third quarters of 2008.'

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This chapter considers who should have been responsible for keeping an eye on the value of assets in which Mayer Lehman Brothers chose to invest heavily, and on its risk management procedures. It considered three questions. The first is what exactly was the Lehman board expected, indeed, required to do. The second is whether Lehman's board was able to carry out its duties. The third is whether the board actually meet the corporate governance requirements. What the Examiner's analysis of corporate governance shows is that, for a company incorporated in Delaware's General Corporation Law, as well as the Sarbanes-Oxley Act, it is very difficult to find colourable claims against Lehman Brothers. Lehman informed the Securities and Exchange Commission in their regular meetings that the firm-wide risk appetite limit was a real constraint of Lehman's risk-taking, although it was treated as a 'soft' target within the firm.

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This chapter covers the leading theories of the markets. The dominant theory of the Efficient Market Hypothesis distracted regulators, market participants and central bankers from paying attention to market prices as signals or from recognizing the existence of bubbles in the housing market, as Alan Greenspan admitted. The behavioural theorists shift the emphasis away from examining trends in the market data and developing models to explain them, to the behaviour of investors in the market, or rather to the factors influencing their behavior. There are two building blocks of behavioural finance: one is that in an economy where rational and irrational traders interact, 'irrationality can have a substantial and long-term impact on prices'. The second building block is psychology. Swedburgh's paper is important in that it points out that trust underlies the smooth, or one might say, efficient functioning of the market.

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Under its dramatic headline, 'Mayer Lehman's chaotic bankruptcy filing destroyed billions in value', the Wall Street Journal proclaimed that a 'less hurried Chapter 11 bankruptcy filing would have preserved tens of billions of dollars of value'. International derivative contracts were not the only problem. Its collapse resulted in over 75 separate and distinct bankruptcy proceedings immediately, and affected thousands of financial market participants through its wide range of contracts. It is important to focus on the procedures set out by International Swaps and Derivatives Association (ISDA) and to consider what contribution the Master Agreements were able to make to sorting out the enormous number and the wide range of derivatives, running into trillions of dollars. In the aftermath of the financial crisis, regulators turned their attention to capital, liquidity and supervision, in order to prevent the failures of what then became known as 'systemically important financial institutions' (SIFIs).

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