If one wants to understand the full complicity of Wall Street in the Great Recession, look no further than the voluminous package of pre-collapse Lehman Brothers documents that have been made available by the law firm Jenner & Block LLP, which has acted as the coroner in the Lehman post-mortem.
Most important, the cache dispels the myth that Dick Fuld, chief executive officer of Lehman Brothers Holdings Inc., and his close associates were unaware of the risks their business faced in 2007 and 2008. That would be bad enough, but the more devastating reality is that Fuld and his sycophants were warned repeatedly but were blinded by their hubris.
The records confirm, yet again, that the “forces-out-of-our-control” argument we hear from Wall Street leaders is bunk. It is the ill-advised behavior of one banker after another, day in and day out, that leads to the sort of devastating financial crisis we are only now emerging from.
For instance, at a Lehman board meeting in September 2007, according to a copy of the presentation in the data cache, Lehman executives presented a clear summary of the brewing crisis. “The initial tremors were felt at the end of 2006,” the board was told, “when the poor loan performance of sub-prime borrowers began to be a cause for concern in the marketplace. This was evidenced by a gradual spread widening in the asset backed index.” The presentation continued: “The market continued to widen as it became apparent that the performance problems in mortgage loans was not going to abate and was no longer limited to the sub-prime market but also affecting the Alt-A product.”
Then the board heard about the problems at two Bear Stearns Asset Management hedge funds that “ran out of liquidity” in June and July 2007 and were forced to shut down, leading to other hedge funds dumping assets into the market “adding additional stress to the market.” By August 2007, the commercial paper market was “facing challenging conditions, with very little liquidity” and “funding for almost any type of mortgage or ABS” -- asset-backed security -- “product dried up.” You can’t say the top Lehman management didn’t understand what was happening in the market.
So did other firms: At Goldman Sachs Group Inc., these “initial tremors” in December 2006 were sufficient to get the firm to make a huge proprietary bet -- referred internally at Goldman as the “Big Short” -- that paid off big-time in 2007 and helped to put the firm in a position to weather the financial crisis a year later.
At Lehman, though, it was business as usual. Management chose to ignore the rising concerns. By Labor Day weekend 2007, Lehman, like Bear Stearns and Citigroup, had been in talks with Citic Group, the leading Chinese investment bank, which wanted to make an investment in a Wall Street firm, a potential lifeline in a crisis. Lehman’s top executives -- Fuld and David Goldfarb, the firm’s chief financial officer -- weren’t interested, at least on the terms that Citic was proposing. If Lehman were to do a deal with Citic, Goldfarb wrote Fuld and others in an e-mail, “This will signal a major sign (which obviously isn’t true and will feed into rimors, etc) and put us in a category of those who needed an infusion to help them out of this market mess.”
Fuld responded with his usual misguided bravado: “Sounds to me like another non-starter. If it’s just about price [and] who is the right partner then tell them NFI.” Goldfarb couldn’t resist piling on. “Agreed 1000 percent,” he wrote back to Fuld. “How do you spell stupidity in Chinese!!!”
Will and Skill
Then the conversation descended into a pathetic display of macho arrogance. “What happened,” Fuld asked Goldfarb, “u didn’t like my sumdum spelling?” Responded Goldfarb, “I love it, better said then I could have. I think Mizuho is the best option for strategic partner. Any potential investor that would consider BS” -- Bear Stearns -- “in the same breath as LB should go fungoo themselves!!!” Fuld replied, “I agree we need some help -- but the Bros always wins!!” Goldfarb agreed. “Absolutely, will and skill always win, and that be us!!!!” Concluded Fuld: “Got it so do u.”
Fuld was well-paid for these insights. Between 2000 and 2007, according to various documents released as part of Fuld’s testimony before Congress, he took out of Lehman some $500 million in cash.
The Jenner & Block trove shows that instead of seeking the capital they so desperately needed, Fuld and Goldfarb believed Lehman was an impenetrable fortress. “During the last downturn” -- 2001-02 -- “the firm outperformed its competitors and established a platform for further growth,” Lehman management told the board in January 2008. “The firm pursued a counter-cyclical strategy, investing in talent while its competitors were in retrenchment mode” and then outperformed the peer group.
The clear message: Lehman would use a similar approach through the 2008 downturn. At the board meeting in January, Lehman management explained that while other Wall Street firms were raising “significant capital” in the “past three months,” for Lehman “aggressive capital raising is not necessary” because the firm “remains strongly capitalized” thanks to capital “generated by earnings.”
Knowing that Lehman would be belly up by the end of September 2008, reading these e-mails and documents is cringe-inducing. Unfortunately, given the lack of leadership we still see on much of Wall Street, they will hardly be the last of their kind.
(William D. Cohan, a former investment banker and the author of “Money and Power: How Goldman Sachs Came to Rule the World,” is a Bloomberg View columnist. The opinions expressed are his own.)
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