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FT stumbles into central bank admissions of market manipulation

Section: Daily Dispatches

Puzzle over Banque de France's Lehman Role

By Henny Sender
Financial Times, London
Wednesday, July 7, 2010

When Lehman Brothers engaged in the Repo 105 deals that flattered its balance sheet to the tune of $50 billion, a string of powerful banks acted as counterparties. But according to financial experts sifting through the Lehman wreckage, there was one surprising name on that list: the Banque de France.

In the final months before Lehman's demise, the Financial Times has learnt, the French central bank was often on the other side of the bank's deals, taking collateral in the process.

The reason for its involvement as a counterparty is unclear.

... Dispatch continues below ...


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There is no suggestion that it was seeking to present Lehman's balance sheet in a better light. But its presence as a counterparty raises questions about the roles played by central banks in markets and how much of that activity should be made public.

The Banque de France continued to cut deals with Lehman even as other private sector enterprises were cutting their ties with the bank -- or demanding "ridiculous levels" of compensation to engage in such dealings, according to internal Lehman e-mails included by Anton Valukas, the Lehman Examiner, in his report.

When Lehman collapsed, the French central bank, like the private-sector participants, was forced to unwind the deals, selling the collateral it had taken as part of the counterparty transactions. It did this for a profit, which then went to the Lehman estate, according to financiers involved in these deals.

The French central bank has not commented on this deal in public and declined to do so when contacted by the Financial Times. However, the saga points to a wider aspect of modern global financial markets. For while private sector banks' repo deals have grabbed attention, in fact central banks have long engaged in repo transactions, swaps, and other financial dealings -- not just with each other but with the private sector.

These opaque deals, sometimes struck by central banks to maintain confidence in the health of troubled institutions, can have an unseen impact on the behaviour of markets.

The best-known examples date from a couple of decades ago.

In one case, the Bank of Japan and the Bank of England engaged in repo transactions that kept Salomon Brothers alive after it was indicted for its behaviour in the US government bond markets.

Central banks have also sought to shore up the balance sheets of other central banks and to stabilise markets, as the US did with Mexico in the 1990s.

"Such manipulation is not uncommon and practised by central banks, financial institutions, companies, and countries," said Gunter Baer, former superintendent of the Bank for International Settlements, the "central banks' central bank."

The issue has come to the fore again as the eurozone debt crisis has unfolded.

In October 2008 amid the turmoil that followed Lehman's collapse, the National Bank of Hungary disclosed that it had entered into a E5 billion repo line with the European Central Bank, giving the cash-strapped government a source of funding.

It was only in May this year that the Hungarian central bank disclosed that it had converted half of that line into a swap line in January, in order to secure access to foreign exchange.

"For months it was never disclosed," one senior ECB official said. "In principle, it could have been used at the government's request."

Government officials and economists disagree over how much should be disclosed about this kind of financial support.

When Mexico was going through its financial crisis in the 1990s, the US Fed and the Treasury engaged in agreements with the Mexican central bank that apparently gave its struggling southern neighbour access to large dollar lines from the US in return for pesos credited to the US.

But it also gave the impression that the Bank of Mexico had large and growing dollar reserves. The fact that the dollars were locked up in New York and that Mexicans could not use the swap lines to access dollars was never disclosed, according to Fed officials past and present.

"In those days, transparency was not as prevalent," said Ted Truman, a former official at both the Federal Reserve and the Treasury and now a senior fellow at the Peterson Institute for International Economics. "We wanted to do a swap line so they could just say they had enough money."

When Argentina came under similar pressure, the BIS stepped in with similar support, Mr Truman said.

In other cases, banks have helped cash-strapped governments through gold swaps, as the BIS did with Yugoslavia in the 1990s, central bankers said.

"Exchange markets tended to assess the ability of central banks to defend their exchange rates on the basis of foreign exchange reserve holdings," Mr Baer said.

Today, such transactions have become less frequent -- and nothing spooks bond market investors more than a sense of incomplete or misleading information.

That, after all, is one of the reasons Greece and Hungary are in the headlines today. The Fed, for its part, decided such transactions were manipulative and has abandoned them, Mr. Truman said.

"Regulators and supervisors have been taking a much closer look at these practices and some of the obvious loopholes have been removed," Mr Baer said. "But by no means has the scope for manipulation been fully removed."

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Lehman Was No Exception for Banque de France

Financial Times, London
Thursday, July 8, 2010


With reference to your report "Puzzle over Banque de France Lehman role" (July 7):

Central banks, in the conduct of monetary policy, or in the management of their reserve portfolios, regularly conduct transactions with a large number of international commercial and investment banks. Banque de France is no exception in this regard.

All central banks hold US dollar-denominated assets. As such they engage in counterparty relationships with US-based institutions and their European-based affiliates. For Banque de France, Lehman Brothers was one among a number of counterparties.

Our selection of counterparties and the modalities of our relationships are guided by the sole motive of portfolio management and the protection of our patrimonial interests, for which the central bank is accountable.

Risk management considerations dictate that transactions are concluded with a large number of counterparties, and there has not been any specific policy as regards Lehman Brothers.

For the management of its portfolios, Banque de France, like many central banks, conducts a variety of market transactions. Reverse repos are always collateralised by assets, and conducted within the frame of standard market contracts (master agreements) to manage the cash position of the portfolios. These contracts allow one of the parties to trigger an early termination of the transactions when the other party is unable to fulfil its obligations.

Regarding Banque de France's past operations with Lehman: first, monetary policy -- when Lehman Brothers Paris was put under administration, Banque de France sold in the market the collateral pledged by Lehman, and the excess over the compensation payment was returned to the administrator of the bank. We communicated on these transactions.

Second, reserve management -- the open transactions we had with Lehman's entities in New York and London were terminated according to the terms provided by the different master agreements with these counterparties, and the collateral sold.

Christian Noyer, Governor
Banque de France

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