The collapse of Lehman Brothers is a salutary reminder of the mechanics of financial firm collapse. Firms do not collapse when they run out of assets; they collapse when no-one will deal with them. According to the US Chapter 11 filing, Lehman was solvent when it filed. What made it file was counterparties’ unwillingness to take on new exposures to it. In other words, no-one wanted to be the last man in. This is a function of the state of mind of market participants. And in these markets, state of mind is a fragile thing.
Now is not the ideal time to introduce law reform proposals which have the effect of discouraging counterparties from taking on exposures to UK banks. However, this is exactly what the UK Government is in the course of doing. The essence of the new Special Resolution Regime (SRR) – destined to become law early next year – is to make it harder for market counterparties to recover debts owed to them by banks.
