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
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