Thursday, May 06, 2010

Colossal Division

The other interesting insight from A Colossal Failure, in the light of the current Goldman controversy, is that throughout 2006 and 2007, clever people within Lehman Brothers were intensely divided about the housing market.

As early as June 2005, Mike Gelband, the global head of fixed income, had warned a meeting of traders and analysts that the housing industry was pumped up like an athlete on steroids. He argued that the massive leverage was not grounded in any definition of reality. He said that the huge numbers of CDOs masked a huge problem of thousands of mortgages had been issued to people that could not afford them. Mike eventually resigned from his position over concerns about the high debt levels and leverage.

Alex Kirk the global head of high-yield and leveraged loans and Larry McCarthy the head of distressed trading gave a similar warnings. On the other hand, Dave Sherr, the head of global mortgage business, was adamantly staunch in the opposite view.

So Lehman was a house divided. Some leading people considered that mortgage-based CDOs were the way of the future, while others believed just as strongly that they were a disaster waiting to happen. This division fed through into the way the business operated. One part of the business was earning millions of profits by bundling mortgages and issuing CDOs hand over fist. At the same time, the distressed debt division was “shorting” many of the business involved in sub-prime mortgage debt.

The various divisions of Lehmans were free to pursue conflicting business directions. The CEO did not care what they did, provided each division turned a profit. Unfortnately, Dick Fuld gave more power to the bulls, so Lehmans backed the wrong horse and eventually the losses far outweighed any gains by those who had gone short on the market.

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