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.

Colossal Failure of Common Sense

I have just finished reading a book called A Colossal Failure of Common Sense: The Inside Story of the Collapse of Lehman Brothers by Lawrence McDonald with Patrick Robinson. Although called an “inside story”, this is probably not totally true, as McDonald only worked for at Lehman Brothers for a couple of years, so he did not really have full insight into all aspects of the organisation. As a consequence, he is very supportive of the people that he worked with, while negative about many others. This is not a balanced view, but it is still very interesting.

McDonald’s major theme is that Dick Fuld the CEO of Lehman Brothers Fuld was isolated from reality on the thirty-first floor of his ivory tower, so he was unable to hear warnings from people that things were not right. Fuld rose to the top of Lehmans on the coattails of Lew Glucksman. When Glucksman was joint CEO with Peter Peterson, he had ousted Peterson and seized control of the company. McDonald suggests that Fuld feared the same thing would happen to him, so he surrounded himself people who were not a threat.

Fuld’s isolation meant he was unchallenged as he made numerous mistakes that eventually led to the demise of a healthy business. Several opportunities to sell the business at a high price or to expand the capital base were rejected by Fuld. When the pressure eventually came on, Fuld floundered and failed.

This is a common pattern. Arrogance and isolation lead to failure.

Lehman Brothers Collapse

Governemnts round the world are warning that bankers have not learned the lessons of the financial crisis.

A more serious problem is that governments have not learned the lessons from the financial collapse. Governments created the legal and banking system that allowed bankers to act foolishly. Assuming that further government regulation can solve problems caused by faulty laws and regulations is very foolish.