By Arthur Doyle, a former managing director of Lehman Brothers who now manages a hedge fund.
I didn’t come to Joseph Tibman’s The Murder of Lehman Brothers expecting a blow-by-blow insider’s account of the financial meltdown of 2008. That ground has been covered adequately by, among others, Andrew Ross Sorkin in Too Big To Fail.
Frankly, I didn’t really even expect a blow-by-blow of what led Lehman to fail. That may seem a surprisingly low expectation for a book subtitled “An Insider’s Look at the Global Meltdown,” which has been authored by a senior banker who spent his career at the firm. But I myself was a managing director at Lehman Brothers until the summer of 2008, and yet if you asked me to tell you what really happened, I couldn’t.
Of course, plenty of people at Lehman, if you asked them “what happened?” would give you an answer. They’d say, “Paulson hated Fuld’s guts,” or “Fuld ran the company into the wall,” or “Mark Walsh made a bad real estate bet.”
But while each of those statements may be true, none of them, at least to me, really answers the question: “What happened?” Or, at least, what I mean when I ask the question, which is really: “Trace for me the series of events that led a profitable investment banking and trading franchise to become so overleveraged and loaded with bad assets that, at the end, the bankruptcy specialists estimate that it had a negative net worth far in excess of $100 billion. Who OK’d the decisions that led to that outcome? How many people were privy to the bank’s disastrous situation, and what did they do once they learned of it? Who was complicit in the decisions that were made in Lehman’s final months regarding the representation of the company’s financial position to investors, regulators and trading partners, some of which (given the disparity between the firm’s published statements and ultimate worth in liquidation) surely amounted to outright fraud?
I was pretty senior at Lehman, and yet I have no idea how to even begin to answer any of these questions. And neither does Mr. Tibman, who, unlike me, worked in investment banking rather than trading. Nor would I expect him to.
What I did expect to find in Mr. Tibman’s narrative was a human drama, an account of how it felt to work at Lehman as the unthinkable happened. Mr. Tibman, at Lehman since the dark days under ownership by American Express, and through the harrowing days following 9/11, seemed well positioned to tell that story.
Unfortunately, except for a few brief glimpses, that is not the story we get. Tibman, with the innate caution of a veteran I-banker, feels that “maintaining his viability for future employment” requires him to use a pseudonym. It also requires him to omit most of the personal details of the people with whom he worked and what, if anything, he witnessed personally of the events related to Lehman’s fall
Of course, this is Tibman’s prerogative, and you can’t blame a man for trying to avoid pissing off people who might be future employers. But you have to ask yourself… why exactly did Tibman choose to write this book? It certainly wasn’t to settle any scores. With a (very) few exceptions, Tibman treats all the principal characters in the drama with kid gloves. The shots he takes (at Fuld, for being out of touch; at COO Gregory, for being obsessed with growth; at Paulson, for being inconsistent in his bailout strategy) are gentle, and have been, by now, taken by dozens of others. Girl-wonder Erin Callan is revealed to be, though brilliant, perhaps a tad out of her depth as CFO. Gee, d’ya think? More than a year after hedge fund manager David Einhorn turned Callan into mincemeat over discrepancies between statements she made in the March 2008 conference and details which appeared weeks later in the firm’s 10-Q, this hardly counts as news.
Tibman does seem interested in making sure we know that Lehman’s investment banking division was, and I’m paraphrasing here, “totally awesome.” They were smarter and more creative and faster and harder working than everyone else’s investment banking division. And, unlike their competitors, they had high ethical standards. Sure, Tibman knows that he and his colleagues weren’t performing charity work, but “Lehman was not Bear. Bear (were) aggressive, messy bankers without any sort of standard. All investment bankers are whores. But they were the cheapest of streetwalkers…when we poached Bear bankers, well, we had to bring them to heel like junkyard dogs that did not know how to behave.” In contrast, at Lehman, “at least in the context of investment banking, we wanted…to behave with a meaningful semblance of ethics and good corporate citizenship.”
Cue the gag reflex, though I’ve never worked in investment banking so for all I know this could be true. And Tibman seems genuine, on this one subject. In a passage describing that awful weekend when it became clear that Lehman was going to file for bankruptcy, he conveys a sliver of what it must have felt like to walk in his wing-tipped shoes. Speaking to those of us who think of investment bankers as “a hoard of spoiled, greedy assholes,” he asks us to suspend all predispositions and “think only of what it means to be marginalized, a laughed-about underdog…then you experience something of great magnitude, like 9/11…and from that experience a bond develops that propels you with purpose. You (then) succeed beyond all expectation. Once maligned, you are now…surpassing all goals that you have set for yourselves. And then a very few make some very poor decisions, and the glorious landscape that…you have worked at for a very many years simply falls like light timber through a backyard chipper.”
OK, so now that I read the last bit over, it is perhaps a bit more cringe-worthy than it originally seemed, particularly the part about the transformative effect of 9/11 on Lehman’s place in the I-banking Lead Tables. Then again, as Tibman says, if you weren’t there, you couldn’t possibly understand.
My real objection to Mr. Tibman’s line of thinking—and this applies equally to the thinking of Lawrence McDonald, whose book, A Colossal Failure of Common Sense, I reviewed several months ago—is that the idea that Lehman was made up of a great collection of businesses but was ruined by a few stupid actors is nonsense. You cannot separate one part from the whole. Without Lehman’s highly leveraged, hugely risk-taking trading operation, Mr. Tibman’s investment banking business could never have existed—certainly not on the scale it grew to in its last several years of existence. Leaving aside the fact that Lehman’s costly distribution (trading) and research operations was a primary reason Tibman and his friends were able to win so much business, there’s also the fact that without the profits from the trading business (well over $4 billion per year in LEH’s last several years, more than 5x the profits of the investment banking business), the company couldn’t have gone on the spending spree which enabled it to poach top bankers from its competition.
And where did the trading operation’s huge profits come from? Was it from brokerage commissions on stock and bond trades executed on behalf of customers? Ha. Principal transactions (aka “proprietary trading”), that is, trading for the firm’s own account, accounted for nearly 75% of the trading division’s revenues during the firm’s last three full years of operation. Brokerage commissions accounted for just over 12%, while net interest margin accounted for the rest.
So Lehman Brothers, with a $691 billion balance sheet, sitting atop a $22.5 billion capital base (both figures from the 2007 10-K) was essentially running a giant proprietary trading operation with a decent-sized investment banking operation attached. I’ll resist the easy comparison to the Soprano family’s use of Satrialli’s Pork Store to distract attention from where the real action was, but you get the point. You could call Lehman a $22.5 billion hedge fund, except that very few hedge funds of that size (or any size) operate at a leverage ratio of greater than 30-1—and certainly not hedge funds whose balance sheets were loaded with massive, risky and illiquid assets.
So, yes, it is unfortunate that Mssrs. Fuld & Gregory, who were the primary managers of the Lehman hedge fund, made so many bets that turned sour in 2008. But those bets weren’t some afterthought that ruined an otherwise great firm. By 2008 (actually, by several years earlier than 2008), those bets essentially WERE the firm. They were the life blood that generated the revenue for the $9 billion of annual compensation that Lehman paid out to its professionals. And, like any hedge fund, the managers took their cut (49.3% of revenue went toward compensation, typical for Wall Street) every year—but never had to pay any back in years when returns when negative. At least traditional hedge funds have high water marks (provisions that require managers to earn back any losses from prior years for limited partners before paying incentive fees to themselves). On Wall Street, after a bad year, the firm starts fresh. In fact, it pays out billions in bonuses even in a losing year, so as not to “lose talent to the competition.”
It has now been over a year since the Lehman implosion. In the intervening period, the capital markets have come roaring back. Meanwhile, the real economy, though it is getting worse at a slower pace, is still in its worst shape in a generation. The economic and psychic toll on the country from the crisis has been vast. The recapitalization of the financial system, whose costs are being overwhelmingly borne by the public through bailouts as well as by the steepest yield curve in decades, will take years and extract a continued price from consumers and businesses throughout the economy. Despite this, it appears increasingly unlikely as time goes on that any meaningful reform will be instituted to protect the public from what Simon Johnson so aptly refers to as the “rent-seeking behavior of the financial sector.”
Mr. Tibman’s book, like so many of the books written about the crisis in 2009, bears its share of responsibility for this state of affairs. By spinning narratives that deflect attention from the activities and circumstances most responsible for the crisis, and by indulging the human instinct to blame the failure of complex systems on individual bad actors rather than on the rottenness of the whole, we increase the likelihood that similar crises will return sooner and with greater severity than would otherwise be the case.
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Did you skip the chapters that talked about all of those outside Lehman who shared responsibility for what happened. Tibman, in contrast to McDonald didn’t simply blame it on a small group at Lehman. You seem angry.
John,
I read the review before posting it, and I have written over 40 book reviews myself. There is nothing angry in it. Pointing out the all-too-common self congratulatory posture of I-Bankers or the biases of the account is an assessment. This is a simply a mildly critical review.
And the fact that you are reading anger into a post that has none in it would lead one to the conclusion you have a vested interest in Lehman or the book itself.
I second Yves. I might also add that, as a trustee of the Robert Lehman Foundation, which i have been for over 30 years now (I was a Lehman partner 1967-73) that the reviewer’s account absolutely echoes my own reading of the situation. we were in regular contact with Lehman people four or five times a year. They pitched us deals: some we turned down, others we (as well as myself personally) went into. We dealt with people whom we felt were honest and competent. AT NO TIME, up to the very moment of LB’s implosion, did any of these good folk reflect the slightest apprehension about their firm’s viability – and these are people with whom we dealt confidently and confidentially, and in some cases had known for forty years. What happens in these big firms is what the former CEO of one of the great banks once told me: “You spend decades, maybe a century, building a great operation, involving thousands of hard-working people, and one SOB can destroy it!” Lehman was a colossal failure of internal governance, and of the theory that one can trade oneself out of a trading disaster by doing more of the same.
What I did expect to find in Mr. Tibman’s narrative was a human drama, an account of how it felt to work at Lehman as the unthinkable happened…
Unfortunately, except for a few brief glimpses, that is not the story we get. Tibman, with the innate caution of a veteran I-banker, feels that “maintaining his viability for future employment” requires him to use a pseudonym. It also requires him to omit most of the personal details of the people with whom he worked and what, if anything, he witnessed personally of the events related to Lehman’s fall
IOW, these guys are such inveterate and worthless non-value creating parasites that they’re con men even as authors.
Not surprising.
Speaking to those of us who think of investment bankers as “a hoard of spoiled, greedy assholes,” he asks us to suspend all predispositions and “think only of what it means to be marginalized, a laughed-about underdog…then you experience something of great magnitude, like 9/11…and from that experience a bond develops that propels you with purpose. You (then) succeed beyond all expectation. Once maligned, you are now…surpassing all goals that you have set for yourselves. And then a very few make some very poor decisions, and the glorious landscape that…you have worked at for a very many years simply falls like light timber through a backyard chipper.”
So they’re like 9/11 victims. If this cockroach were more prominent we could put that up there with Blankfein’s “we’re doing God’s work.”
And that’s how these criminals really think. Even most mafioso or Columbian cartel members don’t really think of themselves as heroes.
Although, those gangsters aren’t generally celebrated and fellated by the MSM the way these far worse Wall Street gangsters have been and to some extent still are.
My real objection to Mr. Tibman’s line of thinking—and this applies equally to the thinking of Lawrence McDonald, whose book, A Colossal Failure of Common Sense, I reviewed several months ago—is that the idea that Lehman was made up of a great collection of businesses but was ruined by a few stupid actors is nonsense.
That’s correct. The great-or-stupid man theory of history is rarely more than a small piece of the puzzle.
No otherwise sound large structure can be brought down by the stupidity and/or criminality of a few bad apples.
So it follows that no one who understands all this thinks “reform” can ever work so long as these criminal structures remain intact. We know that by definition when politicians seek “reform” here they really want to change nothing.
The only solution is to break up the structures completely and forever.
I suppose all predators serve some useful role in every ecosystem; one fine day before they are hunted to extinction we may discover that Wall Street gangsters will have played some redeeming part in a higher order of human evolution. Still, theirs is a vipers’ nest in the reeking cesspool of a den of thieves, and I’d rather save a pit of puff-adders than these monsters. There is no effective antidote for their venom.
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This commentary is wonderfully insightful:
“And where did the trading operation’s huge profits come from? . . . trading for the firm’s own account, accounted for nearly 75% of the trading division’s revenues during the firm’s last three full years of operation . . . So Lehman Brothers, with a $691 billion balance sheet, sitting atop a $22.5 billion capital base (both figures from the 2007 10-K) was essentially running a giant proprietary trading operation . . . . You could call Lehman a $22.5 billion hedge fund, except that very few hedge funds of that size (or any size) operate at a leverage ratio of greater than 30-1—and certainly not hedge funds whose balance sheets were loaded with massive, risky and illiquid assets . . . . like any hedge fund, the managers took their cut (49.3% of revenue went toward compensation, typical for Wall Street) every year—but never had to pay any back in years when returns when negative. At least traditional hedge funds have high water marks (provisions that require managers to earn back any losses from prior years for limited partners before paying incentive fees to themselves). On Wall Street, after a bad year, the firm starts fresh. In fact, it pays out billions in bonuses even in a losing year, so as not to ‘lose talent to the competition’.”
The one other critical point I’d add is that Lehman (and all other Wall Street firms) grossly abused overnight funding of their highly leveraged operations in order to reduce capital costs. It’s one of those incredibly intelligent and rational financing tactics that works fabulously well in normal times but in regularly-occurring abnormal times (credit crunches cycle through the system about once per decade) raises the “risk of ruin” to a fairly high level, pretty much guaranteeing that if you run the gauntlet often enough, eventually you won’t make it through.
That is an interesting point. It explains why the auction securities in the tax free market started failing. These guys couldn’t get their own financing.
Refreshing straight talk without any wildass hyperbole. I’d like to hear more from Mr. Doyle.
As to the principals in our financial/economic drama, I hope they’re not so out of touch with reality that they fail to realize that it is unlikely that they will escape unscathed from this mess.
One can only hope.
Yves,
A moderately long read over ground that’s well plowed. Why?
Very little of use in this because what’s at issue is inherent fraud in CDS, CDO, CLO etc. As to the real estate, that was a fools bet on there being a greater fool.
As to Paulson, I’m not convinced he actually did wrong. At some point the zombie banks have to be liquidated. Now, that suggests that nationalization would have been the preferred route; however, the liquidation of Lehman seems to progressing. What’s messy about the liquidation is that losses are incurred in that fictitious are being erased.
“A moderately long read over ground that’s well plowed. Why?”
Mr. Doyle’s editorial is extremely well written, a cool and intelligent survey of a mess that frankly needs to be “plowed” until all the weeds are out of the ground. I found Mr. Doyle’s commentary to be truly insightful. Well done! As for the “Why?”, well, because Business As Usual would be a failure to learn, and learning and changing, for the better, is what needs to be done.
Keep plowing!
Damn, I was looking for an answer to the question “How much senior to pretty senior must one be to know the answers the excellent questions: “Trace for me the series of events that led a profitable investment banking and trading franchise to become so over-leveraged and loaded with bad assets that, at the end, the bankruptcy specialists estimate that it had a negative net worth far in excess of $100 billion. Who OK’d the decisions that led to that outcome?” and etc.
On the one hand, Mr Doyle complains that Tibman’s narrative
“deflect[s] attention from the activities and circumstances most responsible for the crisis…”
which presumes the “activities and circumstances” that caused Lehman’s collapse can be isolated, made plain.
But on the other hand, Mr Doyle accuses Tibman of indulging in
“the human instinct to blame the failure of complex systems on individual bad actors rather than on the rottenness of the whole…”
which suggest that Mr Doyle would have liked more attention paid to “the rottenness of the whole” — whatever that is.
Mr Doyle’s reviews are well worth reading. I hope he’ll grace us with more testimony about the “the rottenness of the whole” that he witnessed at Lehman Brothers.
I haven’t commented on a review of my book before. But given the way today’s comments started, for the record, I requested that Mr Doyle review my book because I found an earlier review he wrote insightful. I thought there were also a variety of insights in this review. Beyond that, it’s not for me to review the reviewer. Mr. Doyle, thanks for reading my book and providing your perspective on it.
Quite a sedate reading. We are in a heap of trouble in the US and probably in the world. What happens when you finance more debt than can be paid back by a significant amount, you either lose big or go broke. The entire system was insolvent and it is still bankrupt. Debt can never be paid back, but it can either be carried or it can’t. I can be resold or it can’t. Enter the Fed and the TARP. Maybe LEH was an excuse so they could get some big guns in to save the rest for the time being. The US wasn’t going to war until Pearl Harbor, so maybe LEH was the Pacific fleet.
This mess is like a submerged rock 1 foot below water in a recreational lake. The system couldn’t take a 5% haircut or 10% or whatever so the Fed steps in and buys some mortgages. Now the banks have liquidity, but they are still insolvent. So goes Ponzi finance.
For an answer to the question of what series of decisions let to Lehman’s downfall and who was responsible for it, I suggest the last 10 pages or so of chapter 6 in Too Big to Fail. Here’s the short answer to the question: a bunch of ill-advised real estate investments, a virtual ignorance of risk management by Fuld and his inner circle, and an insular top management team that prized loyalty above all else and didn’t have a very good handle on what was going on in the trenches. There was also a series of fairly dubious personnel decisions (ie Eric Callon as CFO). In the book, a lot of this gets laid at the feet of COO Joe Gregory (appropriately so from what I can tell) but Fuld shares the blame for not holding Gregory accountable for the personnel and risk management decisions that proved fatal. Fuld’s capabilities as an executive are very suspect in this telling of Lehman’s downfall.
At the end of the day, the most remarkable takeaway is how clueless Fuld was about the state of the firm in the spring of 2008. It was clear to people as varied as David Einhorn and Skip McGee, the head of Lehman’s investment banking group, that Lehman had made some bad bets, and needed much better risk control and substantial amounts of capital, but Fuld apparently spent most of his time looking for ways to “screw the shorts” who were the source of all the firm’s problems as far as the reader can tell.
I have not finished the book, so there may be more info that informs these impressions, but given what I know of the firm (I was one of those evil short sellers of Lehman in early 2008) it all rings true.
Great review, as always, and it’s interesting that this subject is still relevant and will be food for thought for a while longer. While I understand the co-dependency between departments you reference (“My real objection to Mr. Tibman’s line of thinking…”), and the fact that highly profitable areas can and do underwrite expansion in others, I can’t agree with your conclusion here. The dirty little secret of financial services businesses (and maybe the ultimate argument for their regulatory restructuring) is that the senior executives of these companies enjoy an absolutely unparalleled and enormous asymetrical control over their balance sheets compared to other types of corporations. Yes, the combined decisions of 4 or 5 “stupid actors”, specific decisions that were absolutely attributable to them, DID bring down LEH (like another small group at MER and another at BS) as they quietly enabled transactions utilizing almost limitless leverage that together would make a even the most monumental “typical” corporate transaction, even an AOL/Time Warner merger, look like an odd lot. They were arrogant, of course, emboldened by previous successes, but also were insulated by group-think, confirmation bias, assorted sycophants, etc., and ultimately, a fundamental lack of imagination as to how Black the Swan could become…in short, bad management. That this happened is as much due to the design of the businesses (especially when governed by inadquate stewards) as opposed to the conventional wisdom that Wall Street is populated by a bunch of greedy crooks who brought us all down. They aren’t and they didn’t, and certainly it isn’t the “rottenness of the whole” either. There are those (unfortunately few) who understood this, had respect for the extreme impact executive suite decisions (including very much the “people” decisions) have on financial companies, like Jamie Dimon, and who’s companies survived and will continue to thrive. No one speaks about JPM as though it’s a rotten business although it’s in essentially the same businesses as all the others. It’s all about effective, informed leadership and rigorous risk management, all very much lacking at LEH.