The purpose of this book is to explain the fundamental causes of the bank's failure, including the inadequacy of the regulatory and supervisory framework. For some, it was the repeal of the Glass-Steagall Act that was the overriding cause, not just of the collapse of Lehman Brothers, but of the financial crisis as a whole. The argument of this book is that the cause is partly to be found both in weak and ineffective regulation and also in a programme of regulation and supervision that was simply not fit for the purpose. Lehman Brothers certainly contributed to its own demise. When the company pursued its more aggressive policies to increase its profits and its market share, it moved away from purchasing residential real estate loans, even when these were subprime, and packaging them into mortgage backed securities, which were then sold on. From 2006 onwards, its more aggressive strategy focused on commercial real estate, leveraged loans and private equity. Its move into commercial real estate increased the levels of risk for the company, with increasingly illiquid assets. Dick Fuld, the chairman and CEO, and his senior management, ignored the increased risks, choosing to rely on over-valuations of the firm's assets.
One of the continuing puzzles is why Lehman Brothers was allowed to fail. The main players in that decision, Henry Paulson, Timothy Geithner and Chairman Bernanke, have generally claimed that the Federal Reserve did not have the legal powers to rescue Lehman Brothers in the absence of a buyer for the company. This explanation was always difficult to reconcile with the decision to bail out AIG two days later.
That is not the only issue to be considered. The failure of Lehman Brothers has many facets, and each of those is examined in the second part of the book. Much has been said about the ‘destruction of value’ in the financial press and academic analyses. Trillions of dollars ‘disappeared’ through plummeting asset prices and, as some would argue, the crisis entailed not the destruction of ‘real’ value but the exposure of fictitious or virtual capital and artificial value. The appointed examiner for the bankruptcy proceedings stated that ‘valuation is central to the question of Lehman's solvency’. That was the conclusion of his Report, which is over 2,200 pages, based on collecting over five million documents. An analysis of some of the key elements in the Report, as well as other documents and reports, leads to the conclusion that this is indeed the case.
However, this opens up the questions about what is meant by value when it comes to valuing assets and how that value is to be measured and explained. In Chapter 7 it is argued that the valuation of Lehman's real estate assets was problematic to say the least, as the regulators did not require the investment banks to adopt a recognized methodology of valuation, and that Lehman's own methods were flawed. Chapter 8 spells out the recognized methodologies and procedures for valuation that were available at the time and which, in effect, Lehman chose to either ignore or not apply in any rigorous way. Fuld and his team ignored the risks involved; his board was not in a position to monitor the risks involved in his aggressive ‘real estate’ programme and did not do so.
The underlying question is: what is meant by value in the context of a market? A brief look at contemporary theories of value suggests that they provide an inadequate explanation of the way in which assets are priced by the market, and especially the role of trust. The collapse of Lehman Brothers destroyed confidence, which is why the markets froze. There is no intrinsic or enduring value in any asset. Its value, and hence its price, is simply what the market will pay at any one time.
This is the second in my series of books on the financial crisis. The first was Fannie Mae and Freddie Mac: Turning the American Dream into a Nightmare. The distinctiveness of my approach is to describe the role of the major institutions in the events leading up to the crisis. Lehman Brothers has a specific role in that. It was the collapse of Lehman Brothers which, though not the sole cause of the crisis, was the trigger for it. The next book will examine the role of leading financial institutions and the regulators in the financial crisis and its aftermath.
Mayer Lehman Brothers' long history began with three brothers,
immigrants from Germany, setting up a small shop in Alabama, selling
groceries and dry goods to local cotton farmers. Their business soon evolved
into cotton trading. Dick Fuld made a series of acquisitions, designed to
lessen Lehman's dependence on fixed-income trading, and focus attention
on mergers and acquisitions, investment banking and raising capital. He
began the process of restructuring the company so that it consisted of three
major operating units: investment banking, equities and fixed income. He
refocused the company's activities on high-margin business such as
mergers and acquisitions, bringing in experienced senior staff to manage the
business. The description of the company's activities reflected both
the move away from fixed income trading, and Fuld's ambitions for
This chapter examines the regulation of the Big Five investment banks in the
context of the changes which took place in the structure of banking after
the repeal of the Gramm-Leach-Bliley Act 1999 (GLBA). It also examines the
introduction of the European Union's Consolidated Supervision Directive
in 2004. The Act did not 'repeal' the Glass-Steagall Act in its
entirety, but only repealed sections 20 and 32, which prohibited member
banks from affiliating with organizations dealing in securities. The Federal
Reserve became the 'umbrella' supervisor for any Financial Holding
Company owning a bank; under its 'streamlined supervision' remit,
the Federal Reserve was limited in its day-to-day authority to oversee
functionally regulated non-banking subsidiaries of the holding companies.
Though the Securities and Exchange Commission had adequate tools and
statutory backing for taking on the consolidated supervision of the Big Five
investment banks, its inability to carry out effective supervision was
On 10 September 2008, Dick Fuld presented what would be the firm's last
earnings report, announcing the loss of $3.9bn, the second quarterly loss
that had increased from the previous quarter's loss of $2.8bn. It also
released some plans and proposed actions, which included the increase in
total stockholders' equity, spin-off of certain commercial real estate
assets, and a potential deal with a Korean sovereign wealth fund. All of the
proposed actions were no more than plans, as opposed to completed deals or
agreements. Just two days after Mayer Lehman filed for Chapter 11, Barclays
announced that it would acquire Lehman Brothers North American investment
banking and capital markets operations and supporting infrastructure. That
included Lehman Brothers' New York headquarters and two data centres,
all for $1.75bn, a price which the New York Times described as a 'fire
sale' and which was much less than Lehman expected.