Learn­ing the lessons of Lehman Bros 10 years on

It was thought that Lehman Bros could weather any storm, but its ex­po­sure to toxic loans could not be fixed, writes He­len Chan­dler-wilde

The Sunday Telegraph - Money & Business - - Front Page -

It is dif­fi­cult to pin­point the ex­act mo­ment when ev­ery­thing went wrong at Lehman Broth­ers. In the early Nineties, it was a rel­a­tively small bank with earn­ings of $75m. Over the next decade and a half, it ex­panded rapidly. It raised hold­ings of risky sub­prime debt un­til it teetered, like an ele­phant in stilet­tos, own­ing $85bn (£66bn) in mort­gage-backed se­cu­ri­ties, al­most four times its $22.5bn buf­fer against losses of share­holder eq­uity.

One small change in house prices could have felled the firm. But al­though there were warn­ing signs, it was widely thought Lehman could weather any storm. It had sur­vived a se­ries of shocks in emerg­ing markets and the dot­com bub­ble that fol­lowed. It pulled through af­ter 9/11, when its of­fice in the World Trade Cen­tre was de­stroyed and a mem­ber of staff killed.

“There was a lot of con­fi­dence that man­age­ment would work its way out of the prob­lems”, says Andy Sparks, who in 2008 was a man­ag­ing direc­tor in its bond trad­ing divi­sion.

“It was a scrappy firm.”

The first rum­bles of trou­ble

Through­out 2008, clouds gath­ered. House prices stut­tered. In March, Bear Stearns im­ploded af­ter its ex­po­sure to sub­prime mort­gage debt be­came clear. In­vestors won­dered who might be next. Eyes set­tled on Lehman.

Warn­ing signs con­tin­ued. In the sec­ond quar­ter it lost $2.8bn, the first loss in 14 years. Its share price fell 73pc in the first six months of the year. In the fol­low­ing weeks and months, peo­ple started to bat­ten down the hatches.

“There were some in­di­ca­tions in the mar­ket­place that there were is­sues with Lehman” says Chris­tian Lee, who was head of Swap­clear at Lon­don Clear­ing House (LCH), which man­aged the de­fault of Lehman’s swaps port­fo­lios. “Quite a few coun­ter­par­ties were try­ing to put a lot more busi­ness through us be­cause they wanted to off­load risk from their bal­ance sheet.”

Even within Lehman, some de­part­ments were pre­par­ing in case other parts turned bad.

Christoph Schon was a direc­tor in

‘The se­nior man­age­ment were all gone. The glass of­fices were empty. It was a kind of anar­chy’

the POINT in­dex team, cre­at­ing prod­ucts that re­lied on in­puts from the trad­ing desks.

“We had to pre­pare for the case that we might lose the trad­ing desks that sup­ply us with prices”, he says. “We had to have a contin­gency plan.”

De­spite the rum­blings, the ex­tent of the is­sues was kept tightly in­side the top man­age­ment team.

“I was a fairly se­nior per­son but I was un­aware of the dire sit­u­a­tion”, says Sparks. “Man­age­ment did a good job of keep­ing that to a small group.”

Some de­scribed this as typ­i­cal of the in­su­lar team at the top of the bank, led by leg­endary CEO and chair­man Dick Fuld, nick­named “the go­rilla” for his men­ac­ing de­meanour. Un­der his rule, Lehman had grown hugely.

Fuld’s ex­pan­sion strat­egy in­volved buy­ing mort­gage len­ders to pro­vide raw as­sets for repack­ag­ing into mort­gage-backed se­cu­ri­ties (MBS). One was shut in 2007, with the ex­pla­na­tion: “Mar­ket con­di­tions have ne­ces­si­tated a sub­stan­tial re­duc­tion in … re­sources and ca­pac­ity in the sub­prime space.”

“Fuld had too much faith in his own abil­ity to weather the cri­sis”, says Nick Firoozye, a fi­nan­cial an­a­lyt­ics spe­cial­ist who started his bank­ing ca­reer at Lehman Broth­ers.

“It was a close-knit cir­cle around him. They all lived near each other and even com­muted to­gether. They knew each other’s fam­i­lies. When a mem­ber of the se­nior team had an af­fair and di­vorced his wife, they all shunned him be­cause they knew the wife.”

The be­gin­ning of the end

The col­lapse gath­ered speed in early Septem­ber. News emerged that po­ten­tial fund­ing from Korea Devel­op­ment Bank was off.

On Wed­nes­day Sept 10, Lehman posted a $3.9bn third-quar­ter loss af­ter $5.6bn of write downs on toxic mort­gages. This bad news added to a slide in share prices, which in two days had fallen 52pc. The last dregs of con­fi­dence in the bank drained fast.

On Fri­day af­ter­noon, Ti­mothy Gei­th­ner, the pres­i­dent of the New York Fed­eral Re­serve, be­gan to as­sem­ble the bosses of Wall St’s big­gest in­vest­ment banks and fi­nan­cial au­thor­i­ties in Manhattan. They were there for a week­end of make-or-break talks, with a dead­line of Mon­day morn­ing, when markets re­opened. There were two res­cuers in the frame: Bar­clays and Bank of Amer­ica. Bankers at the meet­ing went back­wards and forwards on the chance of a Bar­clays deal, but UK reg­u­la­tors were un­sure.

Ac­cord­ing to Amer­i­can jour­nal­ists, Alis­tair Dar­ling, chan­cel­lor at the time, did not want to bring the “can­cer” of US mort­gage debt to the UK. He was re­port­edly wary of a Bar­clays deal with­out help from the US tax­payer.

Reg­u­la­tion com­pli­cated the Bar­clays deal. It would re­quire a vote by share­hold­ers be­fore markets opened on Mon­day. It was not pos­si­ble – the res­cue fell through.

Bank of Amer­ica also pored over the books, but con­cluded that the out­look was par­lous, and it too would need gov­ern­ment back­ing. It plumped for Mer­rill Lynch in­stead.

Peo­ple out­side the meet­ing lis­tened for clues to what the fu­ture held. Prepa­ra­tions were made for the worst-case sce­nario: Lehman col­laps­ing with­out a white knight.

Lin­klaters, a Lon­don law firm that had worked with Lehman Broth­ers,

re­ceived a phone call on Fri­day, ask­ing for ad­vice.

It be­gan to pre­pare Lehman to file for bank­ruptcy, with a hard dead­line of 8am Mon­day. If a com­pany is in­sol­vent, it is not al­lowed to trade. And with­out in­ter­ven­tion, au­to­mated trades would have been trig­gered as soon as markets opened.

“It would have been tens or hun­dreds of mil­lions of pounds worth of trad­ing that would have hap­pened in a short length of time”, says Euan Clarke, a part­ner who worked on the deal.

Hav­ing just a day and a half to pre­pare was not nor­mal.

“Com­pare it with En­ron, which we’d done a few years ear­lier, we were plan­ning along­side them for six or eight weeks”, says Clarke.

“We got there with about four min­utes to spare – the or­der was fi­nally made at 7.56 in the morn­ing.”

A gi­ant falls

“[On Mon­day] I got dressed as usual in my suit, went to the bus stop and bumped into my neigh­bour”, says Schon.

“He looked at me and said ‘Haven’t you read the news?’ and held his Black­berry out to me.

“I saw the head­line ‘Lehman Broth­ers un­der ad­min­is­tra­tion.’”

When Schon got to the of­fice, se­cu­rity were at the door handing out printed emails say­ing the com­pany was in ad­min­is­tra­tion.

“We were told there is no cash, you might not even get your salary for that month”, he says.

Schon said peo­ple packed up their be­long­ings so quickly that Lehman “had run out of card­board boxes within an hour”.

Else­where, traders fought to stop fi­nan­cial risk spread­ing.

Af­ter the de­fault was an­nounced, Lehman swaps books be­came the prop­erty of LCH. The house gath­ered traders to neu­tralise Lehman po­si­tions – find­ing ex­act op­po­site trades to hedge the books.

“We were part of a very thin red line be­tween a suc­cess­ful res­o­lu­tion and the fi­nan­cial sys­tem star­ing into the abyss”, says Stephen Loosley, who worked on the team.

LCH de­camped to a “dis­as­ter re­cov­ery” suite on the south bank of the Thames, near Water­loo. It had en­hanced se­cu­rity and re­stricted com­mu­ni­ca­tions. Traders had mo­bile phones taken away.

The team worked from six in the morn­ing to 10 at night for the first week, many sleep­ing close to the “bunker” in­stead of go­ing home

“Be pre­pared for a de­fault ev­ery day. You find out where the gaps are when ev­ery­thing’s on fire”, says Loosley.

The bit­ter end

Em­ploy­ees at Lehman in Lon­don were in limbo while the com­pany’s fu­ture was de­cided. Ad­min­is­tra­tors PWC bor­rowed money to pay salaries in the first month, ac­cord­ing to Schon.

Hav­ing stopped mov­ing forward, the firm be­gan to creak. There was no proper man­age­ment. The email sys­tem broke down.

“We were com­ing to the of­fice with ab­so­lutely noth­ing to do, which was sur­real”, says Nik Storon­sky, who was a trader at the time. “You’d look around the of­fice and ev­ery­one would be play­ing the only in­ter­net game that wasn’t blocked – an ad­dic­tive ar­cadestyle game that in­volved shoot­ing down he­li­copters.”

Ju­nior staff were left with­out any lead­er­ship.

“Who you re­ally didn’t see was the se­nior man­age­ment – they were ba­si­cally gone”, says Schon.

“There were glass of­fices at the sides of the trad­ing floor.

“Those were all empty. Peo­ple went into those of­fices and took the comfy chairs for their desks.

“There was a kind of anar­chy in a sense.”

A week later, No­mura bought Lehman’s fixed-in­come op­er­a­tions in Europe, the Mid­dle East, and Africa for $2, sav­ing the ma­jor­ity of jobs.

Bar­clays bought its North Amer­i­can in­vest­ment bank­ing arm, and re­hired some teams in Europe.

“We were rel­a­tively for­tu­nate”, says Schon.

“We were quite early in the whole cri­sis. At that point in time there were still jobs out there.”

Even though many jobs were saved, em­ployee wealth suf­fered.

“We took a se­ri­ous hit to our net worth be­cause we as em­ploy­ees owned 30pc or 40pc of the com­pany”, says Jack Malvey, who was chief global fixed in­come strate­gist at Lehman in 2008.

“If you were close to the top of the firm al­most 60pc of your com­pen­sa­tion could be in pa­per.

“To find out you weren’t go­ing to move to Bar­clays was like – OK, I’ve al­ready been kicked re­ally hard to the ground, this is not a su­per-ad­verse devel­op­ment.”

“Peo­ple like to imag­ine that Lehman em­ploy­ees, the bankers, are the bad guys”, says Clarke.

“A lot of peo­ple just lost their jobs and had friends and col­leagues who lost their jobs.

“The vast ma­jor­ity of them weren’t re­spon­si­ble for the bank’s demise.”

Traders on the New York Stock Ex­change try to ab­sorb the shock of Lehman’s col­lapse on Sept 15 2008. Be­low, a re­dun­dant em­ployee leaves the bank in New York, and pro­test­ers con­front Dick Fuld at the US Congress

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