So what went wrong at Lehman? (Part 1)

A wide variety of factors contributed to the downfall of Lehman, these include firm specific factors such as an inherently flawed and unsustainable business model as well as economy wide factors.

One central factor was risk and in particular risk management. When Lehman changed to an aggressive growth strategy the amount of risk skyrocketed but managers at Lehman disregarded nearly all risk controls. An employee at Lehman summed up Lehman’s view on risk with the following quote:

“the majority of the trading business’s focus is on revenues, with balance sheet, risk limit, capital or cost implications being a secondary concern” (Valukas, 2010:52)

An example of the complete disregard of risk limits at Lehman occurred in 2007 when Lehman increased their risk appetite limit several times throughout the year from $2.3bn to $4bn (Valukas, 2010). Lehman explained this rise as a change in calculation but it seems unlikely that such a large rise was down to a calculation change. As well as disregarding risk limits Lehman ignored the advice of some of their risk management team as well as external risk specialists. One of those who communicated their concerns was Lehman’s Chief Risk Officer Madelyn Antoncic who was subsequently reassigned (*FCIR, 2011).

Another factor that played a role was irrational exuberance (see post 1 for definition) and arrogance among Lehman’s employees. Senior staff at Lehman believed Lehman was infallible. This arrogance is displayed in emails from late 2007 between two top executives Fuld and Goldfarb when Fuld describes the firm’s position:

“I agree we need some help – but the Bros always wins!!” (Cohan, 2012)

This arrogant persona led to Fuld, once nicknamed the Gorilla of Wall Street, being demonised post Lehman’s collapse (see picture below). He was named on the '25 people to blame for the financial crisis' list by Times magazine (2009) and is described in press as greedy and a symbol of failure (Freeman, 2011). 

(The Demon Fuld: Google Images, 2013)

In my next post I will examine the role of financial innovation, balance sheet manipulation and disclosure in Lehman’s collapse.

*FCIR: Financial Crisis Inquiry Report

Bibliography

1.      Cohan, W. (2012). Lehman E-Mails Show Wall Street Arrogance Led to the Fall. Available: http://www.bloomberg.com/news/2012-05-06/lehman-e-mails-show-wall-street-arrogance-led-to-the-fall.html. Last accessed 3rd Feb 2013.

2.      Financial Crisis Inquiry Report (FCIR), 2011

3.      Freeman, J. (2009). Banking On a Rescue. Available: http://online.wsj.com/article/SB10001424052970204251404574342350506568022.html. Last accessed 12th Feb 2013.

4.      Sender, H et al. (2008). Broken brothers: How brinkmanship was not enough to save Lehman. Available: http://www.ft.com/cms/s/0/d9792572-8358-11dd-907e-000077b07658.html#axzz2KizR1ukN. Last accessed 12th Feb 2013.

5.      Time Lists. (2009). 25 People to Blame for the Financial Crisis. Available: http://www.time.com/time/specials/packages/article/0,28804,1877351_1878509_1878508,00.html. Last accessed 12th Feb 2013.

6.      Valukas, A. (2010) LEHMAN BROTHERS HOLDINGS INC. CHAPTER 11 PROCEEDINGS EXAMINER REPORT. Jenner & Block, Volumes: 1-9.