Professor/Lecturer Ellmann's Course Materials Page

Lehman and Fuld
economic thought
MBA/MA - Anglo-American University International Finance
ERASMUS - International Finance
MBA - Money and Financial Markets
ERASMUS Money & Banking
M.A. Public Policy Economic Sociology
On the Origin of Facts

From The Sunday Times
December 14, 2008
Exposed: Dick Fuld, the man who brought the world to its knees
Dick Fuld ran Lehman Brothers as if he were at war. He drove the bank hard and ignored the signs of collapse. Andrew Gowers, former editor of the Financial Times, who was working at the heart of the bank as it brought the global economy to the brink of disaster, reveals the inside story

The temperature in the room seemed to drop several degrees as the boss’s voice came on the speaker phone. “I don’t think we’re going bust this afternoon” he said, “but I can’t be 100% sure about that. A lot of strange things are happening . . .”

The four of us gathered in Lehman Brothers’ offices at Canary Wharf looked at each other, our eyes widening. We had just spent the day bashing the phones in a frantic effort to reassure journalists, investors, bankers, anyone who would listen. That was our job as members of Lehman’s communications team.

The bank was fine, we kept saying. It was brimming with cash. Sure, the share price had dropped 48% in New York, but that was a panic reaction to another investment bank’s collapse and nothing to do with us. What’s more, the US authorities had indicated they would not allow another institution to fail.

Yet here was one of Lehman’s top people admitting privately that even he could not be certain that a sudden, precipitous and contagious loss of market confidence would not sweep his firm, its 26,000-plus employees and its 158-year-old name into oblivion.

It was only then that it fully dawned on me just how scarily unpredictable my world had become.

The date was March 17, 2008, the day after Lehman’s smaller New York rival, Bear Stearns, had collapsed into the arms of one of the world’s largest banks, the mighty JP Morgan Chase, in a shotgun marriage that all but wiped out shareholders and cost thousands of highly paid traders their jobs.

On Wall Street blind panic had ensued and its focus was Lehman Brothers.

The market has a phrase for this sort of event: the death spiral. Creditors and trading partners take fright at a falling share price and threaten to cut off credit lines. Alarm is magnified by modern, instant communications. Fear feeds on itself and prophecies of doom become self-fulfilling. Our freewheeling, globally integrated financial markets turn out to be built on sand.

The group of us sitting in Canary Wharf could see the scenario with terrifying clarity that day. The market, cruel and unforgiving, was asking whether Lehman, now the smallest and most vulnerable of the so-called “bulge bracket” of elite global investment banks, was next.

It was. On September 15, Lehman Brothers Holdings filed in New York for chapter 11 bankruptcy protection. An institution with total assets of $639 billion - more than the gross domestic product of Argentina and roughly 10 times the size of Enron when it filed for bankruptcy protection in December 2001 - had gone up in smoke.

This was the largest corporate bankruptcy the world had ever seen. A firm that as recently as February had been worth $42 billion was now worth nothing. We know what happened next. Stock markets plunged and a run on funds and financial institutions brought the global financial system close to collapse. Within days, governments around the world pumped hundreds of billions of dollars into keeping banks and other companies afloat - and the world economy lurched into its worst recession in more than 70 years.

“It is difficult to exaggerate the severity or importance of these events” said Mervyn King, the governor of the Bank of England, a few weeks later. “Not since the beginning of the first world war has our banking system been so close to collapse.”

And we now know we will be living with the consequences for many years to come. As one of the world’s leading investors, Mohamed El-Erian, puts it: “The manner in which Lehman Brothers failed disrupted the smooth functioning of market economies. As a result, virtually every indicator of economic and financial relationships exhibits characteristics of cardiac arrest. The situation will get worse before it gets better.”

How did it come to this? How could an institution as proud and dynamic as Lehman plunge within months from an outward appearance of success to failure on such a colossal scale? And how could the collapse of one financial institution - the smallest of the Wall Street investment banks - bring the world so close to financial Armageddon?

More broadly, how come the collapse took many of the most sophisticated and powerful financial operators in the world so completely by surprise? Why did no one in authority apparently see the global consequences of Lehman’s failure clearly enough to want to avert it? Could it have been averted or should it have been?

Quite apart from their global significance, these questions are of more than casual interest to me and to the thousands of other people who used to work at Lehman Brothers. I am still owed a sum I was promised on leaving the bank in September. I will be lucky to see more than a fraction of it - and that only in several years’ time, once the administrators have finished picking through the wreckage.

LET’S be clear: my part in this seismic story was small. I joined Lehman Brothers in London as head of corporate communications in June 2006 after a long career in financial journalism.

The firm seemed a confident and attractive place as it surfed a wave of easy money. Asset markets were booming; fat profits from slicing and dicing loans - including, crucially, US mortgage loans - and from proprietary trading were being funnelled into building a truly global investment banking empire. Executives were impatient to take what they regarded as their rightful place alongside Goldman Sachs in the vanguard of this modern growth industry.

As I quickly discovered, nobody personified this vaulting ambition more clearly than Dick Fuld, the almost unbearably intense man who had been chairman and chief executive of Lehman since 1993.

In that time - and against considerable odds, including the near failure of the firm in 1998 and the loss of its headquarters in the 9/11 attacks on Manhattan - he had built Lehman Brothers into one of the powerhouses of Wall Street, its annual profits rising year after year from $113m in 1994 to a record $4.2 billion in 2007. Its stock price had multiplied 20-fold.

Fuld had made a lot of people fabulously rich - shareholders, employees and of course himself. In the eight best years he had taken home a cool $300m - funding five residences, his wife Kathy’s passionate interest in modern art and a host of philanthropic activities.

To say he was surrounded with a cult of personality would be an understatement. He was the textbook example of the “command-and-control CEO”. More than that, to many employees and to the outside world, he was Lehman Brothers - his character inextricably intertwined with the firm’s.

Fuld inspired great loyalty and, on occasion, great fear. Those closest to him slaved like courtiers to a medieval monarch, second-guessing his moods and predilections, fretting over minute details of his schedule down to the flower arrangements and insulating him from trouble - from almost anything he might not want to hear.

His ferocity could be intimidating, his eyebrows beetling tight over his hard eyes, his brutally angular brow appearing to contort in rage. He would regularly upbraid colleagues for minor wardrobe malfunc-tions - in Dick’s book, that tended to mean anything other than a dark suit and a white shirt or, in my case, a beard. “Are you off to the country club?” he would grunt dismissively at a senior executive committee member who looked just a tad too casual.

Even when in a relatively upbeat mood he seemed to take pleasure in violent imagery. Lehman was “at war” in the market, he would say. Every day was a battle, employees were troops. At an investment banking conference in London last spring, I saw him astonish several hundred of his managing directors with a blood-curdling threat aimed at investors who were selling Lehman shares short - depressing the price.

“When I find a short-seller, I want to tear his heart out and eat it before his eyes while he’s still alive” the chairman declared. Histrionics, maybe - but with a purpose. Fuld had used this aggression to consolidate his reputation as the most successful chief executive in the banking business and one of the most respected corporate leaders in America. But the style also contained the seeds of disaster. It meant that nobody would or could challenge the boss if his judgment erred or if things started to go wrong.

In good times that did not seem to matter too much. Lehman’s financial record spoke for itself: 55 quarters of unbroken profit, a share price performance second to none in the industry, a dexterity and fleetness of foot that enabled it to scale up rapidly in new markets. But it also bred a fatal complacency.

So when the US mortgage market tanked and the first signs of a credit crunch arrived in July and August 2007, Lehman executives bragged to internal audiences that they were much better placed to weather the storm than, say Bear Stearns, the first competitor to hit real trouble.

When rivals Merrill Lynch, Citigroup and Morgan Stanley wrote off billions and billions in losses on mortgages and corporate loans in their quarterly results, Fuld and his executives congratulated themselves on Lehman’s clever hedging strategies that limited the damage.

Even when Lehman’s own quarterly numbers started to take a real hit, the warning signs were drowned out with celebratory reminders that 2007 had been a record year for profits and with sage assurances about the absolute soundness of the bank’s risk management.

What none of the Fuld team appreciated was that by the beginning of 2008 the world had changed - for Lehman Brothers and for everybody. The unravelling of the US mortgage boom and the contagion of fear this had unleashed in global markets were shaking their business model and their entire raison d’Ítre to the core. THE curious thing was that at some level Dick Fuld knew that trouble was brewing well before the crisis broke. I witnessed him give a fascinating talk about risk at a private lunch with newspaper editors nearly two years ago. With a precision that seems almost uncanny, he virtually prophesied the looming crash.

It was January 2007 and we were in the Swiss mountain resort of Davos where the world’s elite gathers every year for its annual gab-fest, the World Economic Forum. That year’s Davos was an even more raucous party than usual, with the financial markets surging towards their peak and the Masters of the Universe toasting their own power.

Fuld, however, was not in a celebratory mood. He was worried, he told his lunch guests with soft-spoken force, worried that “this could be the year when the markets crack”.

Trouble might come from the US housing market, he said, from the excesses of leveraged finance, or from spiralling oil prices, or a combination of all three. Lehman, true to its tradition of strong risk management and fleet-footed investment decisions, had become more cautious and “taken a bit of money off the table”. The editors went away visibly impressed at the apparent prescience and prudence of Wall Street’s senior statesman.

There was only one problem with this performance. It bore scant resemblance to the reality of how Lehman Brothers was actually being run, or had been run for several years, despite the tendency in Lehman’s largely admiring press coverage to portray Fuld as a hands-on manager with a strong eye for detail and an obsession with risk management.

In truth Fuld had become insulated from the day-to-day realities of the firm and had increasingly delegated operational authority to his number two, a long-standing associate named Joe Gregory.

If Dick was the king, Joe was Cardinal Richelieu. A gregarious sort with a taste for flamboyant displays of wealth - he famously used to fly to work from his out-of-town estate by helicopter and sometimes flew back by seaplane - he was also a ruthless enforcer for the boss. His job was not to encourage debate or intellectual curiosity in subordinates but to bend the bank to Dick Fuld’s will.

If something went wrong, you could be sure that Gregory would be on the telephone in a towering rage. Even very senior executives would dread getting one of those calls. They would describe the experience as analogous to being provided with “a new asshole” and called him Darth Vader behind their hands.

Problematically, Joe Gregory was not a detail man or a risk manager. On the contrary, as Fuld was musing to outsiders about his worries concerning risk, Gregory was doing the precise opposite: actively urging divisional managers to place even more aggressive bets in surging asset markets such as the mortgage business and commercial real estate.

Standing in his way by showing aversion to risk could be fatal to your career. Divisional chiefs who urged caution or tried to rein back on risky bets were swiftly ousted. From the middle of 2007 the leadership of Lehman’s all-important fixed income division became a revolving door, partly as a result of Gregory’s obsession with pushing the envelope. The goal, he would tell subordinates, was to be “number one in the industry by 2012”, no matter what the cost.

And Fuld himself was not consistent. In June 2007, barely four months after his Davos peroration on risk, I joined him in another background discussion with journalists, this time to coincide with Lehman’s business launch in Dubai. His tune could not have been more different.

Think of the hundreds of billions of dollars in oil riches gushing into the Middle East, he said. Add the further hundreds of billions in sovereign wealth funds in emerging nations. Multiply all that by the plentiful liquidity and leverage available on financial markets and you had an almost limitless pool for investment banks like Lehman to swim and prosper in.

At roughly that moment, Lehman was placing some of the riskiest bets it had ever made in the commercial property business. It led a consortium bidding $15 billion for America’s biggest apartment company at the absolute top of the market - a deal signed off by the entire executive committee but subsequently described to me by one of the firm’s executives as “the worst investment Lehman ever made”.

Only a few weeks later, world markets started to experience the phenomenon known as the credit crunch and those investments - illiquid, all but unsaleable - became a millstone dragging Lehman Brothers inexorably towards bankruptcy.

So much for risk management. The Lehman culture had become dangerously complacent and insulated from the outside world. While Fuld talked to clients with legendary assiduity, neither he nor Gregory spent much time talking (still less listening) to investors.

Even within the firm, Fuld’s visits to the trading floor were rare events. So he was shut off from independent sources of information, from challenging questions and from up-to-date views from the front line of Lehman’s daily battle in the markets. He was fed instead with the carefully filtered facts that his inner circle thought he wanted to hear.

Furthermore, the top team was far from united. Here was another point not visible to the outside eye. Lehman liked to propagate the myth that it was “one firm” devotedly working as a team across geographical borders and departmental boundaries to satisfy its clients’ needs. In reality it was as riven with rivalries and competing egos as a gathering of mafia clans. Many suspected that Joe Gregory liked to keep it that way.

One faultline was more troublesome than the rest: the tension between headquarters in New York and Lehman’s European hub in London. In part it was a debate about where in the world the firm should place its bets. Russia? Saudi Arabia? Fuld and Gregory tended to hang back, with Jeremy Isaacs, chief executive for Europe and Asia, pressing on the accelerator.

The rows about whether to go to Moscow were epic and not always very sophisticated. When I asked Fuld at the height of the argument in 2006 what he thought of the Russian market, his brow darkened and he muttered: “Biggest f****** crime syndicate in the world.” Months later, regardless, Lehman opened for business there.

Underlying it all was a classic power struggle, mirroring the rivalry between New York and London as financial centres. Just as London had alarmed New York by overtaking it by some measures, so Lehman’s London team, now responsible for half Lehman’s revenues, sought commensurate recognition and power. As Isaacs became ever more influential in the firm and placed more of his top lieutenants on the global executive committee, the muttering from New York-based rivals became louder and more dangerous.

Everyone knew that the battle to succeed Fuld, whenever he decided to step down, had the potential to be a bloodbath. From his London stronghold, Isaacs reckoned that he had a real shot at the job. In New York, another powerful and ambitious banker was determined to stop him. His name was Bart McDade, a man with a good operating track record but more limited domestic horizons. Both were to play a central role in the events leading to Lehman’s collapse.

Here was a corporate governance structure almost preprogrammed to fail: an overmighty CEO, a top lieutenant eager to please and hungry for risk, an executive team not noted for healthy debate and a power struggle between two key players. Furthermore, the board of directors was packed with nonexecutives of a certain age and woefully lacking in banking expertise. IT is small wonder that Lehman was so ill-equipped to recognise and adjust to the changes in the environment that were dramatically signalled by the collapse of Bear Stearns in March this year.

With hindsight, that was the point at which Fuld and his executive team should have realised the game was up.

What the market was saying - and said again repeatedly in the ensuing countdown to disaster - was that Lehman was overloaded with dodgy assets that it could not sell and underendowed with capital to support its huge balance sheet.

In short, the business was beginning to look like a rickety house built on a perilously thin foundation and unless it took action, to shift “toxic” assets and to raise more capital, confidence in the firm and its management would slide away.

Management’s response was both half-hearted and confused. True, it started out on something resembling a fire sale of distressed assets in a push to shrink the balance sheet and reduce “leverage” - the scale of borrowing. But Fuld and his fellow executives rattled the market by insisting that they did not need more capital, even as they raised some.

To make matters worse, they mounted an increasingly shrill campaign against their critics. One particular hedge fund manager, David Einhorn of Greenlight Capital, had been critical of Lehman’s financial disclosures, thus suggesting to some observers that the bank might have something to hide. Einhorn became an obsession for Fuld and his closest hench-men, who speculated openly about hiring investigators to tail him or search his rubbish bins.

You could say it was a case of shooting the messenger. It was certainly a distraction from the primary business of putting Lehman to rights. But it was typical of the mixture of defiance and paranoia - “us against the world” - with which Fuld drove the firm. I lost count of the number of times I had to listen to senior executives explaining that there was no point in engaging with the press because the press actively wanted Lehman to fail.

Fuld never tired of telling people that Lehman was built to triumph in adversity. That was his understanding of its history and his way of motivating the 26,000 employees at his command. But it also led him and his closest associates latterly to say things that, while obviously sincere and reflecting genuinely held beliefs, had no connection whatsoever with business reality.

This delusion - compounded by the powerful and destructive forces of ambition within the bank - was propelling Lehman towards catastrophe. The death spiral beckoned.