03 Aug A Colossal Failure of Common Sense: The Inside Story of the Collapse of Lehman Brothers – by Lawrence C. McDonald
My new series reviewing each and every book that comes out regarding the economic collapse of 2008 is bound to cover a lot of topics – many factual and historical, while many others philosophical and ideological. The intent of the series is to not allow any major books to get away with a revisionist portrayal of what has happened over the last year or so, while simultaneously repudiating many of the economic fallacies that play into much of the commentary currently being written about the debacle. I am trying to tackle this assignment with nuance and fairness, and I am thoroughly enjoying it.
McDonald’s new 350-page book about the fall of Lehman Brothers gives me the opportunity to review some of the history of went on there, and also to clarify some major misunderstandings about the great collapse of 08’. It is difficult to stay on task of merely reviewing his book, as one is awfully tempted to review the actions of Lehman itself when addressing all that happened here. I have a lot of good and a lot of bad to say about this book, but one thing is for certain: No comprehensive addressing of the financial collapse of 2008 can possibly exist without substantial coverage of the Lehman failure. It was, as fate would have it, the catalyst to so much more.
When I began reading the book, I was somewhat turned off by McDonald’s long rendition of his own biography (and even his family’s). I was anxious to get right into the main course as it pertained to Lehman. However, the book grew on me, and I do believe one of the more entertaining parts of the book is following McDonald’s road from youth, to boiler room cold-caller, to failed Merrill Lynch stock broker (with successes along the way), to dotcom convertible bond analyst, to distressed debt trader at Lehman. One thing McDonald spends a lot of time doing in the book as blasting their disgraced CEO, Richard Fuld, as having no feel whatsoever for what was going on in the organization. He uses the fact that many traders never met Fuld as evidence for his lack of connection to the daily grind of the firm. The “I never even met Richard Fuld” play cuts both ways, though. Yes, it really does show Fuld as a disconnected, arrogant, aloof CEO. But it also discredits the author to a certain degree, does it not? He is writing the “inside tale”, but is clearly not an “inside guy”. I wish the author could have gotten us inside the 31st floor (the book’s metaphor for the offices of Fuld and company President, Joe Gregory) more effectively.
With that said, the book brings to light many things that must be considered. I do not know if it is true or not, but the author states on p. 214 that Lehman Brothers spent more money on, and had more people employed in, their “diversity” division, than all of Risk Management. If that is true, than this wonderfully multi-cultural and minority-friendly beacon ought not be surprised at the destruction which pulverized this once great firm. Sadly, people of all ethnicities were devastated by what happened to Lehman Brothers. A focus on diversity worked, here – it was an equal opportunity time bomb that went off.
One of the most annoying things about this crisis has been the amazing supply of people who “knew all along what was going to happen”. There are so many bar patrons, newsletter writers, media pundits, and taxi drivers who “totally called all of this” that it really is remarkable that we suffered any kind of crisis at all. I do not have any right to judge McDonald’s claim that he and the entire bond trading crew he worked with knew everything that was going to happen, and tried their best to stop it; I just know that he is now in a club whose membership apparently includes everyone in society – people that swear they had this thing pegged. Forgive me for thinking that there may be some serious revisionist history going on. Maybe I am wrong, and every guy at the gym and the coffee shop who “called this” got rich by “shorting subprime”. But suffice it to say, hindsight is always 20/20, and I am more than a little tired of third rate newsletter writers and other such bystanders who had no skin in the game whatsoever lying through their teeth. None of this is directed at McDonald in particular; I just question the book’s assertion that his whole bond desk called the real estate collapse as early as 2005. I would prefer to save my criticism of this book for a few factual and ideological catastrophes it delves into, as opposed to the cartoonish claims that he figured out how bad the subprime mess was going to be by having a secret beer with some hot shot mortgage brokers in Southern California (though his description of the parking lot at New Century, and extraordinary arrogance of sales people he came into contact with, was humorous, and did provoke some painful memories of similar encounters with that breed). McDonald does not have a lot of importance to say in this book, but he does talk a lot about important things.
One of the things McDonald does very well is document not just the greed of Fuld, and not just the stupidity, but the pathology. The idea that Lehman went on a commercial real estate buying binge because of Richard Fuld’s jealousy of the success the former Lehmanites who ran the Blackstone Group were having in that space is very interesting, and not at al surprising when one thinks about human nature. After all, wasn’t this entire crisis caused by someone’s envy and covetousness? If homeowners of the Inland Empire in Southern California just had to have that home (which they could not afford) to keep up with their co-workers, why would Fuld be different when it came to billion dollar projects and acquisitions? The 10th commandment is universal, and not class-specific.
I think the strongest part of Fuld’s book is the last chapter, and the epilogue, at least in terms of suspense and drama. For those who lived through this crisis post-Lehman, day by day, hour by hour, it is painful to read. As he was describing 500 point down days in the market that were followed by 600 point down days in the market, I mentally and physically recalled those very incidents like they were yesterday. There is no doubt that each and every day from the moment Lehman declared bankruptcy, until at least October 13 (and frankly, well past that), were made-for-TV events.
McDonald all but asserts that the reason Lehman was allowed to fail was because of the personal animosity that existed between Richard Fuld and Hank Paulson, Bush’s Treasury Secretary who happened to be the former CEO of Goldman Sachs. There is no doubt in my mind that one of the major issues that will have to be addressed by historians and economists is why the decision was made to let Lehman fail. I do not believe Geithner or Bernanke or Paulson when they hide behind a laissez-faire philosophy in making this decision, and they apparently have been abundantly non-laissez faire in every other aspect of this escapade. On one hand, I do suspect that they regretted the decision, and found themselves mortified by the effects it had on AIG and the credit default swap market just two days later (not to mention the effect it had on money market stability, as trillions of dollars were pulled from money market funds after the Fidelity Reserve fund “broke a buck” a couple days later). The post-Lehman effect on financial credit markets were hellish, from top to bottom. And it was not Richard Fuld who suffered, as Paulson would have known quite well (he was a centi-millionaire who the world was never going to see again). It is easy to look at the devastation that Lehman’s BK caused, and pontificate in hindsight that we would all be better off if they had been rescued. And frankly, relative to the massive bailout programs that ended up being implemented post hoc, if it were really just a matter of a $30 billion lifeline to Lehman, surely the taxpayers would have been far better off. But my thesis is this: Lehman was allowed to fail, because we were well past the point of no return, anyways. It was time to take our medicine. Paulson and Bernanke could have used Lehman as the catalyst, or Merrill, or Citi, or any number of other firms, but the dam had to be broken, because we were just delaying the inevitable. That 44-to-1 leverage Lehman had taken on was not going to be rectified by a temporary government inflow. The credit markets needed to hit the fan, and hit the fan they did. I believe that a combination of government leaders not understanding the full gravity of what the trickle down effect would be, and a basic understanding of the inevitability of it all, is a far more
plausible explanation of Treasury’s letting Lehman fall than any personal grudge or contempt.
I do believe that Lehman Brothers is a company that deserved to go. The employees and bankers and traders who represented the honor and nobility of the company did not deserve the painful outcome, but somehow, some way, the rest of Wall Street began raising equity, deleveraging assets, and finding financial partners, after the subprime mess and Bear Stearns blow-up of March. Lehman did not. When one sees a train coming, and stays on the track, we have no right to be surprised when they get hit. Sadly, the train hit much more than just Lehman Brothers. A sad tale, indeed,
McDonald has written a fine book here, the real merit of which is his analysis of the dysfunctional pathology of leadership that brought this company down. But the few times that he waxes and wanes ideologically, he does make some critical errors, one of which I am duty-bound to correct. He starts off the book by blaming the economic collapse of 2008 on the repeal of the 1933 Glass-Steagall Act (a bipartisan repeal that took place in 1999). This lame and baseless accusation has gotten a little traction (thankfully, just a little) in the mass media as well. If the Republicans were still in leadership, Phil Gramm’s authorship of this repeal would surely lead to it being blamed in a much higher profile manner. But since Gramm is lost from the public scene, and Bill Clinton and Robert Rubin are mostly off limits, this explanation for the financial calamity we endured does not have the political legs some wish it would. However, McDonald teases readers by claiming early on that the repeal of Glass-Steagall led to a co-mingling of bank depositor funds with risky mortgage assets, and he knew back in 1999 that this was going to be a bad thing. He basically skips over this for the remaining 350 pages, and that is a good thing for one simple reason: it is patently absurd, and completely false. Glass Steagall was an effective act in the sense that it forced financial consumers to visit a plethora of financial experts to receive a comprehensive financial plan. It did a good job at keeping a modern financial system from working for middle class people. But its repeal did not “open the door” for this mess, as this mess had absolutely nothing to do with bank depositor funds. What is shocking and disappointing is that McDonald knows this … Lehman did not lever up its client deposit accounts 44-to-1. Rather, it leveraged up its own balance sheet 44-to-1. Prior to the 1999 repeal of Glass-Steagall, banks were still allowed to lend out $10 for every $1 they brought in. And that ratio still applies today. The balance sheet leverage Wall Street put on in the 2000’s had nothing to do with this legislation. It may be rhetorically effective, but as McDonald ought to know from the case of Drexel Burnham Lambert, and Kidder Peabody, and too many others to count, Wall Street has never needed bank depositor funds to blow itself up. Both pre-1999, and post-1999, Wall Street is plenty capable of doing that on its own! Glass-Steagall was in need of “modernization” last decade, because consumers were asking for it. Nothing that has happened in this calamity has changed that fundamental fact. Certainly not the psychotic dealings of Richard Fuld and Lehman Brothers …
w itself up. Both pre-1999, and post-1999, Wall Street is plenty capable of doing that on its own! Glass-Steagall was in need of “modernization” last decade, because consumers were asking for it. Nothing that has happened in this calamity has changed that fundamental fact. Certainly not the psychotic dealings of Richard Fuld and Lehman Brothers …