lehman 4/18

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Commentary

1. A Lehman Lesson for the British Pound

   Apr 18, 2016 | Bloomberg View

   By Mark Gilbert
   
   
   ...As the derivatives edifice built on rotten subprime mortgages started to crumble in 2008, it rapidly became apparent just how interconnected the world of finance was. If the collapse of Lehman Brothers on Sept. 15 was the butterfly, then the storm that hit a part of the market called the carry trade was the ensuing tornado.

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Client Attorney Privileged/Attorney Work Product/At Request of Counsel

Commentary

1. A Lehman Lesson for the British Pound

   Apr 18, 2016 | Bloomberg View

   By Mark Gilbert

   Here's a party game for anyone interested in the interaction between politics, economics and financial markets: Guess how much value the British pound will lose in the wake of the June 23 referendum if the U.K. votes to exit the European Union?

   The most recent opinion poll puts the pro- and anti-EU camps running neck and neck at 39 points, leaving the "don't knows" with the power to dictate the outcome at 22 points. So the outcome is far from clear.

   The Bank of England said this week that the uncertainty is already undermining investment appetite. World Bank President Jim Yong Kim warned that the economy "is not going to do well with more uncertainty." And investors typically shun the currencies of countries with ambiguous political or economic outlooks.

   The pound is already the worst-performing Group-of-10 currency against the dollar this year, with a decline of about 4 percent. So what do previous currency-market ructions tell us about the potential for post-referendum declines for the U.K. currency?...

   LEHMAN'S RECORD BANKRUPTCY, SEPTEMBER 2008

   As the derivatives edifice built on rotten subprime mortgages started to crumble in 2008, it rapidly became apparent just how interconnected the world of finance was. If the collapse of Lehman Brothers on Sept. 15 was the butterfly, then the storm that hit a part of the market called the carry trade was the ensuing tornado.

   The carry trade involved borrowing a currency with a low interest rate -- the Japanese yen, for example -- to invest in one paying a much higher rate of return -- the Australian dollar, for example. Lehman's demise, though, killed off liquidity throughout the markets, forcing traders unwind carry trades that had already been in trouble as the credit crisis worsened and prompting a drop of 40 percent in the Australian dollar's value against the yen in just six weeks:

   STERLING VOLATILITY, APRIL 2016

   Traders are already speculating on post-referendum swings in the pound's value against the dollar, with implied volatility in the options market surging this year to double its average value in the past five years:

   What do all these examples tell us about Britain's situation today? On one level, very little: Just as every unhappy family is unhappy in its own way (as Leo Tolstoy pointed out), so every currency crisis is unique.The sustainability of the pound's ERM rate had been questioned for months, and it wasn't only George Soros who was betting against it. The 1992 election outcome was a surprise, but the impact of government policies on currencies is typically a slow burner. Russia's devaluation was brutal and rapid, producing the kind of currency shock that's highly unusual, while Lehman's demise came in the middle of a true financial crisis that amplified market moves everywhere.

   For full story: http://www.bloombergview.com/articles/2016-04-15/a-lehman-lesson-for-british-pound-facing-brexit-vote

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