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"Rehypothecation" May Have Done In Lehman

"We knew the jig was up," one hedge fund manager told me, "early in 2008 when hedge funds had trouble getting their money and securities back from Lehman, supposedly a "prime" broker, because Lehman had "rehypothecated" them." That is, Lehman had used its CUSTOMERS' collateral as security for its own debts. This is a practice that is legal (just barely), but is probably neither ethical, nor a good business practice. It smacks of  "commingling" customers' funds (and interests) with your own.

After that, no hedge fund manager in his right mind would leave his cash or securities
with Lehman. Meaning that Lehman ran out of collateral. Meaning that the company was overexposed on its own debts. The only solution was to rein in both debt and the scale of operation to safe levels before the rest of the world "caught on."

But Lehman executives failed to do this, worried more about their bonuses than the company's survival. Warren Buffett knew, and went about his business-elsewhere,  David Einhorn knew, and shouted it from the rooftops to the whole world. We believe that this is the right thing to do.

A company whose survival is predicated on the confidence of others is by definition, "not sound." Such a company doesn't deserve to survive. Because it is doing so by running a "(con)" fidence game.