The Lehman Blame Game Gets Rolling

This article is from the archive of The New York Sun before the launch of its new website in 2022. The Sun has neither altered nor updated such articles but will seek to correct any errors, mis-categorizations or other problems introduced during transfer.

The New York Sun

As one Lehman employee put it, “I can’t believe how fast it happened.”

At a gathering this weekend of financial services executives, people universally expressed shock over the rapid demise of Lehman Brothers. Though the fall of Bear Stearns was surprising and worrisome, the company was never viewed as one of the great firms. Lehman was.

Lehman emerged in the past decade as one of the best run and most attractively positioned investment banks, with an especially enviable niche in the fixed income markets. It was unthinkable that the firm would simply go out of business, and that no one would charge in to save it.

How did it happen? The blame game is only just now getting rolling, and certainly much of the coming criticism will be directed squarely at Richard Fuld, Lehman’s chief executive officer. Mr. Fuld’s stature has grown mightily over the years, by dint of longevity (unlike most of his counterparts elsewhere he has been with the firm his entire career), and because in times of stress he has risen to the occasion.

Most notably, after the terrorist attacks of September 11, 2001, Mr. Fuld didn’t hesitate in marching his entire homeless firm uptown and putting them back to work in a midtown hotel. The gutsiness and creativity of the move earned him high marks at a time when the industry, and the nation, was looking for leadership.

Mr. Fuld will be blamed for directing Lehman deep into the real estate swamp, by teaming up with Tishman Speyer to buy the giant Archstone-Smith Trust last fall when the bloom was already fading on the real estate rose, and by heavily backing SunCal Companies, a large real estate developer.

The Archstone investment followed in the wake of Blackstone’s $39 billion purchase of Sam Zell’s Equity Office Property Trust in February 2007. Lehman and its partners purchased the nation’s no. 2 developer of apartment units for more than $15 billion. The deal closed last October, well into the downturn in real estate markets. While Blackstone, operating in a more user-friendly marketplace, was able to shed many of the Office Equity properties to reduce debt, Lehman was not so fortunate.

As the heads of major banks gathered over the weekend to try to save Lehman, the company’s exposure to so-called toxic real estate assets was far from certain. Estimates of bad loans in the sector stretched from $30 billion to $80 billion. The breadth of the range brings home the second criticism that will be laid at Mr. Fuld’s feet. According to a report out by Oppenheimer Fund’s Meredith Whitney, the company reported “highly illiquid assets” at the end of the third quarter of about $65 billion. This figure compares to total net assets of $311 billion.

Though the firm was clearly caught up in the subprime morass, Lehman minimized its problem. The firm actually reported earnings for the first quarter, throwing in a washcloth, as it were, while others were chucking in entire beach towels.

Perhaps because senior management actually believed the sugar-coated version of their balance sheet destruction being handed out to investors, Mr. Fuld also refused to sell assets, and ultimately the company, at prices that would have corroded book value but that might have bailed out the firm. The final straw was his apparent intransigence with Korea Development Bank; the two managements engaged in long-running conversations but ultimately failed to agree on a price.

The lack of transparency and inadequate measures to address declining capital were prime reasons why the stock collapsed last week, and why it is now in bankruptcy. Ironically, Lehman was not facing a liquidity crisis. The company had access to the Fed window opened to investment banks in March directly following the failure of Bear. That facility was meant to ward off a run on the banks and to provide short-term emergency cash. Cash was not the issue, and consequently Lehman apparently never did access that safety net.

Ultimately it was the drop in the company’s share price last week that brought the firm to ruin. Though there were bad debts on the balance sheet, there were also saleable assets, such as Neuberger Berman, a top-notch investment management firm worth around $8 billion.

Confidence became the issue, and the yardstick for investors’ loss of confidence was Lehman’s stock price. As a consequence, some blame will flow to the chairman of the Securities and Exchange Commission, Christopher Cox. Some will say that Mr. Cox’ rescinding of the rule that made naked short selling more difficult allowed aggressive traders to drive Lehman’s stock down into insolvency territory.

Immediately following the lifting of the rule requiring that short sellers borrow shares in advance with which to replace those sold, the financials plummeted by over 10% in just two days. For the weeks in which the ruling was in effect, financials gained ground.

Some may blame the Wall Street titans who failed to come together to protect one of their own. The precedent was established when Long Term Capital Management threatened Wall Street with a systemic collapse. At that time the leading firms (with the glaring and long-remembered absence of Bear) gathered and indeed bailed out those exposed to the ruined fund.

This time, they were hampered by their own problems. Indeed, while the mullahs of Wall Street were putting their heads together to salvage Lehman, Merrill Lynch’s CEO, John Thain, was actually working the room to find a buyer for his firm. We can perhaps blame Mr. Thain for self-interest, but we can’t fault him for lacking agility.

While all these factors and people contributed to the collapse of Lehman, in my opinion, there is another reason the firm went under. First, Wall Street, and Main Street, too, gets into trouble when they cook up instruments so complex that they cannot be easily understood, or valued. When the SIV/CDO parade began, the sheer complexity and ingenuity of the structures caused delight among those who admire financial engineering. But, most people, even inside the firms that were gleefully scooping up these instruments, had no idea what they were buying. The same was true with the trades put on by Long Term Capital Management. Only Nobel-winning mathematicians could figure them out. That’s a fact.

peek10021@aol.com


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