Lehman Bros: What Failure Felt Like

Posted on | September 18, 2009 | 5 Comments

Lehman Bros Bankruptcy date - Sept 15 2008 It’s been a year since the bloodshed on Wall Street took Lehman Brothers down. Finally, stories about what really caused their downfall are starting to filter out. And oh boy, what juicy business lessons there are to learn in all of it.

September 15, 2008 was the date of Lehman’s demise. Their bankruptcy filing came about three months after world stock markets precipitously dropped some 25% due to the meltdown in securitized sub-prime mortgage market. It also came about a year and three quarters into the Great Recession, given that December 2007 became the US National Bureau of Economic Research officially-recognized downturn start date.

Now how important was the Lehman bankruptcy? Humongous! With over $600 billion in assets, Lehman’s has been the largest Chapter 11 filing in U.S. history to date. Further, it caused the Dow Jones average to fall over 500 points the day they filed as well as causing an even bigger fall on 2 weeks later which, it turns out are two of the biggest one day falloffs in history

Did Lehman See Trouble Coming?
Every wonder what it felt like inside Lehman Brothers as the storm clouds gathered and then finally broke in a torrential financial downpour? What do you think went wrong at their executive level to cause this catastrophe?

Well David DeMuro was an insider who experienced these things first hand. A senior executive who’d been at Lehman Brothers for nearly 25 years, DeMuro recently was interviewed by the BBC. From the report on their website, here are some of the astounding things he had to say about his reaction and the lead up to the Lehman bankruptcy:

"I was absolutely stunned", says Mr DeMuro. "There was a belief that the government wouldn’t let us collapse. When I got the message on the Sunday that we would be filing for bankruptcy the next day – yeah, stunned was the right word."

Mr DeMuro was the head of global compliance at Lehman, in other words he was in charge of making sure it obeyed all the market rules. He admits that he had been worried for some time about the firm’s exposure to property-backed investments.

"Of course I wish I’d been more vocal. But would it have made any difference? I don’t know," he says.

"Do you want to put me up against a PhD in mathematics in order to test a particular business model? I can tell you that my instincts were that something didn’t feel right about it. Did I ever think it would be as catastrophic as it turned out to be? No, I did not."

Mr DeMuro is now an attorney for international law firm O’Melveny and Myers. He’s learnt one overriding lesson from his experiences at Lehman – the need for much stricter financial rules.

Well there you have it! The now ex head of Lehman Brothers Global [Regulatory] Compliance [who should have been tasked with ensuring the firm ran only reasonable risks] says he was powerless to stop the foolishness. Why? Because his sense of what was right and not right, developed over a 25 year career at Lehman Brothers, couldn’t compete in the eyes of top management and the board with the fancy modeling that was being done by some cocky, over-confident, probably-nerdy PhD in mathematics! Furthermore, Lehman’s top management thought they were too big fail! They believed (wrongly) that the US government would bail them out should some business problem of theirs prove too big to handle. Talk about feeling entitled!

Reading the above makes me shake my head and ask: why did they think pigs could fly? And why did they think their firm would be and should be immortal?

The Operational Source of Lehman’s Trouble
Lehman’s downfall came as a result of a misguided and mismanaged love affair with subprime mortgage securitization (off balance sheet lending), the ‘super juice’ that fueled the post 9/11 economic recovery.

SubPrime Mortgage Securitiztions - house of cards

The cracks in Lehman first came to the public’s attention in August 2007, when Lehman closed its subprime lender, BNC Mortgage. In doing this, they eliminated 1,200 positions in 23 locations, and took a $25-million after-tax charge and a $27-million reduction in goodwill. At the time, the firm said that poor market conditions in the mortgage space "necessitated a substantial reduction in its resources and capacity in the subprime space"

However, in 2008, Lehman faced an unprecedented loss due to the continuing subprime mortgage crisis. Lehman’s loss was apparently a result of having held on to large positions in subprime and other lower-rated mortgage tranches when securitizing the underlying mortgages. Whether Lehman did this because it was simply unable to sell the lower-rated bonds, or made a conscious decision to hold them, is unclear.

In any event, huge losses accrued in lower-rated mortgage-backed securities throughout 2008. In the second fiscal quarter, Lehman reported losses of $2.8 billion and was forced to sell off $6 billion in assets. In the first half of 2008 alone, Lehman stock lost 73% of its value as the credit market continued to tighten. In August 2008, Lehman reported that it intended to release 6% of its work force, 1,500 people, just ahead of its third-quarter-reporting deadline in September.

On August 22, 2008, shares in Lehman closed up 5% (16% for the week) on reports that the state-controlled Korea Development Bank was considering buying Lehman. But most of those gains were quickly eroded as news emerged that Korea Development Bank was "facing difficulties pleasing regulators and attracting partners for the deal. “It culminated on September 9, 2008, when Lehman’s shares plunged 45% to $7.79, after it was reported that the state-run South Korean firm had put talks on hold.

Investor confidence continued to erode as Lehman’s stock lost roughly half its value and pushed the S&P 500 down 3.4% on September 9, 2008. The Dow Jones lost nearly 300 points the same day on investors’ concerns about the security of the bank. The U.S. government did not announce any plans to assist with any possible financial crisis that emerged at Lehman.

On September 10, 2008, Lehman announced a loss of $3.9 billion and their intent to sell off a majority stake in their investment-management business, which includes Neuberger Berman. The stock slid 7% that day.

On September 13, 2008, Timothy F. Geithner, then president of the Federal Reserve Bank of New York called a meeting on the future of Lehman, which included the possibility of an emergency liquidation of its assets. Lehman reported that it had been in talks with Bank of America and Barclays for the company’s possible sale. The New York Times reported on September 14, 2008, that Barclays had ended its bid to purchase all or part of Lehman and a deal to rescue the bank from liquidation collapsed. It emerged subsequently that a deal had been vetoed by the Bank of England and the UK’s Financial Services Authority Leaders of major Wall Street banks continued to meet late that day to prevent the bank’s rapid failure. Bank of America’s rumored involvement also appeared to end as federal regulators resisted its request for government involvement in Lehman’s sale.

Finally, Lehman Brothers filed for Chapter 11 bankruptcy protection on September 15, 2008. (Thanks Wikipedia for this historical recap)

Colossal Failure Of Common Sense
For a more detailed insider account of the fall of Lehman Brothers, check out this book recently published by Crown Business on July 21, 2009: “Colossal Failure of Common Sense: The Inside Story of the Collapse of Lehman Brothers” by Lawrence G. McDonald.

Apropos my post ‘Why CEO’s Are Blind to Trouble!’ from earlier this week, reading the following book summary is enough to convince me the Lehman bankruptcy was a predictable surprise waiting to happen, one right minded people saw coming but which neither those who controlled the organization nor the regulators seemed capable of avoiding or stopping given their determined mindset and how they structured themselves.

One of the biggest questions of the financial crisis has not been answered until now. What happened at Lehman Brothers and why was it allowed to fail, with aftershocks that rocked the global economy? In this news-making, often astonishing book, a former Lehman Brothers Vice President gives us the straight answers—right from the belly of the beast.

In A Colossal Failure of Common Sense, Larry McDonald, a Wall Street insider, reveals, the culture and unspoken rules of the game like no book has ever done. The book is couched in the very human story of Larry McDonald’s Horatio Alger-like rise from a Massachusetts “gateway to nowhere” housing project to the New York headquarters of Lehman Brothers, home of one of the world’s toughest trading floors.

We get a close-up view of the participants in the Lehman collapse, especially those who saw it coming with a helpless, angry certainty. We meet the Brahmins at the top, whose reckless, pedal-to-the-floor addiction to growth finally demolished the nation’s oldest investment bank. The Wall Street we encounter here is a ruthless place, where brilliance, arrogance, ambition, greed, capacity for relentless toil, and other human traits combine in a potent mix that sometimes fuels prosperity but occasionally destroys it.

The full significance of the dissolution of Lehman Brothers remains to be measured. But this much is certain: it was a devastating blow to America’s—and the world’s—financial system. And it need not have happened. This is the story of why it did.

Conclusion
There are a number of lessons that can be drawn from the Lehman collapse.

First is Mr DeMuro’s: the need for much stricter financial rules. (Translation for Right-wingers everywhere: for the sake of the world financial system, the global economy and the wealth and health of Americans and everyone else, there is a pressing need for more, not less, government regulation – not on mundane matters but on important ones like capital requirements, off-balance sheet transactions, corporate governance, etc.)

Second, companies need more effective management and governance structures to avoid what, in hind sight can only be called, high stupidity. (The Lehman debacle is the corporate equivalent of Jonestown – really, what flavour of Killer Kool-Aid were they drinking?)

Third, if this is capitalism today, something’s broken and we better be quick and smart, not stupid or ineffectual, in how we fix it. (Let’s all pray that’s what it is and not the fact that our world is running out of enough resources, room and opportunity to meet the needs of our increasingly over-populated planet.)

Great Recession Black Humour

© Blog.TonyJohnston.biz & Compass North Inc. 2009

Article by –

Tony Johnston, CMC, CGA, MBA, BA (Econ)
President
Compass North Inc.
18 Balding Court
Toronto ON
M2P 1Y7
Office: 416-342-5652
Mobile: 416-346-4140
www.CompassNorthInc.com
www.CNiRapidResearch.com

Tony Johnston is a results-oriented executive & management advisor with success in 4 turnarounds and many significant other business accomplishments to his credit who helps companies drive:
› top line growth (revenue)
› bottom line improvement (profits)
› cashflow management (credit line control)
› growth strategy (more / new)
› financing & stakeholder relationship management (debt / equity)
› enterprise value maximization (mkt price)
› acquisition planning & execution (find / close)
› divestiture preparation & execution (prep / negotiate)
› information gathering (competitive intel / market research)
› crisis control (turnarounds & wind-downs)
› enterprise leadership (CEO / CRO / CFO)

Compass North Inc. is a management & advisory services firm that helps companies access and use money brilliantly so they achieve important, challenging goals. Examples of what we do include helping companies and their owners:
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Comments

5 Responses to “Lehman Bros: What Failure Felt Like”

bizsugar.com
September 18th, 2009 @ 1:27 pm

Lehman Bros: What Failure Felt Like | Biz Money Matters |…

Lehman Brothers, on the one year anniversary of this largest bankruptcy in US history, there are lessons to be learned from this financial system catastrophe. Here they are……
Dave Brock
September 18th, 2009 @ 4:38 pm

Very insightful post, Tony. It continues to amaze me that people involved refuse to accept personal responsibility. Mr. DeMuro has learned the need for tighter financial regulations and is undoubtedly pointing the finger to government and regulators about their lack of action.

Countless Lehman people have been interviewed and knew things were wrong. No one had the personal courage to stand up and say something was wrong–even in the face of management arrogance and PhD number crunchers. Those aren’t reasons, they are excuses.

Leadership is about personal courage and doing the right thing, sometimes at great personal and professional risk. No one was demonstrating leadership.

Mr. DeMuro has not cited standing up and doing the right thing is something he has learned. Can one trust that he will do so in his current role.

I don’t mean to pick on Mr. DeMuro, he is just an example of dozens to hundreds of executives who have failed to lead.

Sorry to be on my soapbox, but your post struck a nerve. Thanks for an outstanding post!
Tony Johnston
September 18th, 2009 @ 6:03 pm

Dave, many thanks for your comment and compliment. I agree with you about the failure of Lehman leadership. However, I will say it does take an exceptionally strong character/ethos to do the right thing and put your job on the line over an objection about management practices or a significant difference of opinion about company policy or direction. That’s because one runs a high risk of being ‘outed’ by others and even the potential of having to bear a financial hardship and/or career crisis as a result. Having done it myself, I know. Nonetheless, it is the right thing to do and it is what I firmly believe everyone and society expects. That’s why I hope more people will join you on your soapbox.
fix credit issues
October 12th, 2009 @ 12:44 pm

fix credit issues…

I enjoyed this post – thank you for sharing it with everyone!…
Corporate Boards: 14 Questions for You | Biz Money Matters
November 11th, 2009 @ 3:09 pm

[...] (These topics I covered in the following previous blog articles: Don’t Lead Your Company into Trouble; CEO Hubris, Fraud & How to Prevent It; Why CEO’s Are Blind To Trouble!; and Lehman Bros: What Failure Felt Like) [...]

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Tony Johnston
President
Compass North Inc.

Tony provides executive management and advisory services that help companies get MORE !!

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Tony delivers the leadership or leadership support needed that can make remarkably outstanding results happen operationally, economically, financially and in the eyes of customers, lenders & transaction counterparties.

If you are a decision maker in a company that wants MORE, give him a call at 416-342-5652 or check out the Compass North Inc website [click here].

Tony's ability to help companies achieve important/challenging goals is well demonstrated by his long record of success, which includes:
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