Two years after the collapse of Lehman Brothers, the firm’s former vice president of distressed debt and convertible securities trading, Lawrence McDonald, tells the inside story of the investment bank’s downfall in his book, “The Colossal Failure Of Common Sense.”
McDonald puts the blame squarely on the firm’s top management, including former CEO Richard Fuld, who he claims ignored warnings from traders about the risks posed by unsecured mortgage debts. In an interview with Institutional Investor writer Franziska Scheven, McDonald talks about the gulf between the firm’s traders and senior executives on the 31st floor of Lehman’s New York headquarters, who he says were determined to compete with industry giants like Goldman Sachs.
Institutional Investor: Why did you write the book?
Lawrence McDonald: To expose the few that hurt so many. After Lehman failed, we lost 5 million jobs in the U.S. Credit lines were slashed on credit cards. My brother is a small business owner; he employed about 80 people. After Lehman failed, he only employed 20.
Also, Lehman’s failure really was a colossal failure of common sense. It was a tragedy and never should have happened. To me, the firm was never rotten at the core -- that’s where all the beauty was. It was really rotten at the head. What was going on that 31st floor was just a horrific, irresponsible management of a really great firm.
You say in your book, “If only Chairman Fuld had kept his ear close to the ground on the inner workings of his firm ... the catastrophe might have been avoided. But instead of this, he secluded himself in his palatial offices up there on the 31st floor, remote from the action, dreaming only of accelerating growth, nursing ambitions far removed from reality.” Can you expand on this?
Richard Fuld, up to 2001, was a really wonderful CEO. He led the firm like a fierce tiger. He was a hands-on businessman; a trader and great risk taker. But around the turn of the century, he lost his way in two ways.
One was that Lehman was a midsize bank, like a middleweight fighter, and all of a sudden it was fighting against the big heavyweights. Lehman leveraged its balance sheet to compete against the largest banks in the world and they did so extremely, extremely aggressively to the point of about 40 times leverage. It is like walking into a casino with $100 in your back pockets but you are playing at the tables with $4,000.
The other thing was that he and a lot of his cronies became just about billionaires between 2000 and 2007. They started to spend their time on bizarre things, focusing on risk management instead of focusing on growing the bank in a conservative way. And the biggest thing was that they were really consumed with globalization, opening up offices all over the world in the hottest markets, like Dubai, at the top of the market. They took their eyes off the ball. He was not the same executive, I think, that he was in the ‘80s and ‘90s.
How long did you stay at Lehman?
I started in summer 2004. There was a group of revolutionaries that tried to stop the madness in 2007 and 2008. And one by one by one they were silenced and pushed out of the firm. I was in that camp, so I left the firm in spring 2008.
Why did the revolutionaries leave? Did they see there was going to be a problem?
At Lehman Brothers, those executives on the 31st floor wore brass knuckles. If you crossed that group of people your days were numbered, not by hours, but probably by seconds.
Have you ever met Fuld in person?
No. I sat down with 200 people before writing this book -- CEOs, managing directors that have been with the firm 20 years, 25 years. Very few people met the man. He came down FDR Drive and when he got to around 50th street, his driver would call the front desk. The front desk would hit a button and the elevator in the southeast corner of the building would freeze. A 200-pound security guy would hold that door so nobody could go on it.
In his Congressional testimony, Fuld basically said that no one could have expected Lehman to fail. Do you think he knew what was going on?
No, that is silly. I was on the trading floor in 2006 and 2007. There were people on that floor that had major bets, traders that I respect. We made $2 billion in 2007 on that trading floor. A group of people on the trading floor saw this coming. And Mike Gelband [global head of fixed income] said to highly respected people, “You guys realize this is like going to the electric chair.” But he had to do it for the firm. He knew what he was doing was right. He went to Richard Fuld and said this business has to slow down, we are taking too much. Fuld chose not to side with Gelband. He said, “don’t tell me why we can’t do things, tell me why we can”. But then he did something bizarre. He picked up the phone and put Gelband on the phone with Henry Paulson, the secretary of the Treasury. This is what I will never understand. He did not want to side with Gelband about slowing down the mortgage business, but he thought what Gelband was saying was so important that he should talk to the secretary of the U.S. Treasury. That is really strange. It shows you the confusion in his mind.
What do you think about the Financial Crisis Inquiry Commission? Are they doing a good job?
The commission interviewed me for two hours. I was disappointed with the hearings. I thought they could have been harder on Fuld. I mean, there were high level accounting people at Lehman Brothers in 2007 and 2008 that were pressured to do the wrong thing. We were using Repo 105. It is like liposuction. You are very skinny and losing a lot of weight. And then two weeks later, the person puts the weight right back on. That is what Lehman Brothers was doing with their balance sheet. There were people at Lehman that I have spoken to -- high-level accounting people -- that did not feel comfortable about this. Other Lehman people who were close to that 31st floor pressured them. They were saying, in other words, “Do this. Look the other way, do this REPO 105 and we will get through this, we will live another day.” Investors were really deceived.
Lawrence McDonald was vice president of distressed debt and convertible securities trading at Lehman Brothers until 2008 when he was laid off from this position. He launched his own conulting firm, the McDonald Advisory Group and travels the country and abroad to give speeches and seminars. To find out more about McDonald and his book visit www.lawrencegmcdonald.com
