Living the Lehman episode
I joined Lehman only a few months ago and hence cannot really claim to have been a real Lehman boy, or one of the "bruddas". In fact I moved to Lehman because I thought my former employer had a higher chance of suffering the very fate that eventually...
I joined Lehman only a few months ago and hence cannot really claim to have been a real Lehman boy, or one of the "bruddas". In fact I moved to Lehman because I thought my former employer had a higher chance of suffering the very fate that eventually fell upon Lehman! But my short stint at the firm proved to be a very brief, but sharp, adventure: an experience to carry for many years to come.
My aim here is not to solicit any pity for what has befallen Lehman and its employees, or for that matter to be apologetic for the banking industry in general. Lehman employees were well rewarded for the risk they were taking (in investment banking you learn to prepare for the worst: firings come when you least expect them, and this was one I certainly wasn't expecting).
And yet compared to my previous employers, I quickly learned that the Lehman experience was the investment banking experience par excellence. People came to Lehman straight out of university and gradually made their way up the ranks. Staff turnover was relatively low and people really felt they were part of something special. Richard (Dick) Fuld himself started off in the lower ranks of the firm 40 years ago and moved up the ladder to become CEO and for a brief period of time one of the richest men in America. Investment bankers do not generally tend to stick around with the same employer for more than say five years in general; at Lehman, a10-year tenure was very common.
I feel I am giving as unbiased and honest an opinion as possible by saying that the fate that Lehman suffered could have befallen any other bank (Lehman was not really a bank but a pure broker-dealer, i.e. we didn't take deposits and make loans, but we bought "risk" in the form of say bonds or mortgages with the intent of selling them on to someone else, making a profit in the process). What happened to Lehman was a problem with the system, i.e. the financial architecture of the Western world, and the events since have proved this.
Lehman made money by exploiting the magic that is leverage. For every $1 of capital, we borrowed $9 more from investors (the figures are just used for the sake of the argument) and then bought $10 worth of assets. A normal commercial bank has capital and deposits on the liability side of the balance sheet, and loans on the asset side. An investment bank (IB) has capital and wholesale funding (in the form of bonds, for example, as the many Lehman bondholders discovered to their cost) on the liabilities side, and let's call them "quasi-loans" on the asset side. Therefore on paper, the difference between say a Lehman and an RBS (to use a prime example of a commerical bank) was minimal.
Lehman had a series of issues to solve as the credit crunch began to unfold (but honestly, who didn't?). To start off, the firm's balance sheet was leveraged up to 30 times by some estimates (this was way above average and where we started off on a wrong footing). What this means, going back to the previous argument, is that the firm had $30 of assets for every $1 of capital! If we look at it from another perspective, this means that if the firm loses $1 on the value of its assets, it becomes insolvent. Given that $1 reflects just a 3.33% per cent decline in the value of the $30-asset, one can quickly understand what little price deterioration it takes to cause some serious problems to shareholders of this highly-leveraged firm. Leverage works miracles on the upside, but can be a nightmare on the downside.
But Lehman had another problem, again common to many banks to some extent. Lehman's balance sheet was saddled with Commercial Mortgage-Backed Securities (CMBS) and other types of Asset-Backed Securities (ABS) which tend to be very illiquid and therefore hard to sell (yet no less liquid than the more-traditional mortgages and loans that sit on a normal commercial bank's balance sheet). To make matters worse, the subprime crisis in the US meant that default rates on many of these securities were rising rapidly.
Hence Lehman's big issue was highly-illiquid, increasingly problematic ABS positions on the Asset side, whereas on the Liability side (funding) a heavy dependency on wholesale money markets. But so was most of the European banking industry, for example, where deposit-to-loan rates are sometimes as low as 50-60 per cent, meaning that the remaining gap is filled by wholesale funding (of the short and highly-volatile type). Which is why European governments have had to scramble to lend huge sums of money to many of their banks to fill that funding gap (Maltese note here: Maltese banks have deposit-to-loan ratios of over 100 per cent; the minister is not kidding you when he says that local banks are on a more solid footing).
When I joined Lehman in March, the firm had already foreseen that the credit crunch required a strong and determined response from management. Leverage levels were decreasing dramatically as the firm scrambled to sell off assets in bulk, sometimes at very low prices. On the funding (liability) side of the balance sheet, Lehman stunned the market in April by raising $4 billion in new equity investments and then went on to launch a series of 5, 10 and 30-year bond issues to ensure the firm had long-term funding. The firm had cash balances of over $40 billion, and capital ratios well above those considered safe (again, who didn't?). Therefore despite its many issues (allegedly excess leverage ratios and a huge appetite for risk-taking), Lehman did more than many in trying to address these issues, and the numbers showed we were succeeding.
Yet the market smelt blood in the banking world, and the investment banking industry was an obvious target. The Bear Stearns collapse in March had already caused lots of pain to Lehman and others in the form of much higher funding costs. Hedge funds started short-selling our bonds (selling them without actually owning them to buy them back cheaper) and this caused panic among our bond investors. In essence, what this meant was that the cost of our funding (the equivalent of deposits for commercial banks) was getting more expensive by the day.
What followed is now history. As we went into that infamous weekend in mid-September, we (and much of the rest of the financial world) were convinced that the US authorities would eventually have to chip in and save us. The problems we had were not Lehman-specific, but system-wide. But US Treasury Secretary Henry Paulson wanted to send a message to the markets: that the banks had to bear the cost of their decisions. That decision led to the carnage of the past weeks and Mr Paulson quickly swallowed his words and went on to bail out first AIG and then the rest of the country's banking industry.
The rest of the world quickly followed in his example and put together what history will probably remember as the biggest bailout the world has ever seen. And all because Mr Paulson, a genius of a banker but still a member of the Goldman family (that other infamous investment banking "brotherhood") decided it was not worth saving his arch-rivals. Most now agree that decision was the wrong one.
Lehman left behind it an estimated $600 billion in debts, something which will prove very hard to recover. Some sceptics will argue that the picture I have painted proves that we were nothing more than a hedge fund in a bank's skin, and that such an outcome should never be allowed again. Yet we were also masters at our job of advising clients on all kinds of corporate finance matters, at re-allocating risks from those who wanted to offload it to those who could afford to take it on.
We (like the rest of the banking system) played a pivotal role in ensuring the continued efficient allocation of capital within the financial system, which we all agree is the key to economic success. The system collapsed because the price of money (interest rates and the availability of credit) had become so cheap, basically free! This created obvious distortions which fed the excesses; excesses lead to bubble... and bubbles lead to disasters. Lehman may have been that one disaster too many.
Mr Sultana was, until a few years ago, a regular contributor in the local press with columns discussing contemporary topics in local and international finance and economics. Now London-based and after a number of years working in investment banking, he shares some thoughts on the collapse of Lehman Brothers - his employer until September's tragic events.
My aim here is not to solicit any pity for what has befallen Lehman and its employees, or for that matter to be apologetic for the banking industry in general. Lehman employees were well rewarded for the risk they were taking (in investment banking you learn to prepare for the worst: firings come when you least expect them, and this was one I certainly wasn't expecting).
And yet compared to my previous employers, I quickly learned that the Lehman experience was the investment banking experience par excellence. People came to Lehman straight out of university and gradually made their way up the ranks. Staff turnover was relatively low and people really felt they were part of something special. Richard (Dick) Fuld himself started off in the lower ranks of the firm 40 years ago and moved up the ladder to become CEO and for a brief period of time one of the richest men in America. Investment bankers do not generally tend to stick around with the same employer for more than say five years in general; at Lehman, a10-year tenure was very common.
I feel I am giving as unbiased and honest an opinion as possible by saying that the fate that Lehman suffered could have befallen any other bank (Lehman was not really a bank but a pure broker-dealer, i.e. we didn't take deposits and make loans, but we bought "risk" in the form of say bonds or mortgages with the intent of selling them on to someone else, making a profit in the process). What happened to Lehman was a problem with the system, i.e. the financial architecture of the Western world, and the events since have proved this.
Lehman made money by exploiting the magic that is leverage. For every $1 of capital, we borrowed $9 more from investors (the figures are just used for the sake of the argument) and then bought $10 worth of assets. A normal commercial bank has capital and deposits on the liability side of the balance sheet, and loans on the asset side. An investment bank (IB) has capital and wholesale funding (in the form of bonds, for example, as the many Lehman bondholders discovered to their cost) on the liabilities side, and let's call them "quasi-loans" on the asset side. Therefore on paper, the difference between say a Lehman and an RBS (to use a prime example of a commerical bank) was minimal.
Lehman had a series of issues to solve as the credit crunch began to unfold (but honestly, who didn't?). To start off, the firm's balance sheet was leveraged up to 30 times by some estimates (this was way above average and where we started off on a wrong footing). What this means, going back to the previous argument, is that the firm had $30 of assets for every $1 of capital! If we look at it from another perspective, this means that if the firm loses $1 on the value of its assets, it becomes insolvent. Given that $1 reflects just a 3.33% per cent decline in the value of the $30-asset, one can quickly understand what little price deterioration it takes to cause some serious problems to shareholders of this highly-leveraged firm. Leverage works miracles on the upside, but can be a nightmare on the downside.
But Lehman had another problem, again common to many banks to some extent. Lehman's balance sheet was saddled with Commercial Mortgage-Backed Securities (CMBS) and other types of Asset-Backed Securities (ABS) which tend to be very illiquid and therefore hard to sell (yet no less liquid than the more-traditional mortgages and loans that sit on a normal commercial bank's balance sheet). To make matters worse, the subprime crisis in the US meant that default rates on many of these securities were rising rapidly.
Hence Lehman's big issue was highly-illiquid, increasingly problematic ABS positions on the Asset side, whereas on the Liability side (funding) a heavy dependency on wholesale money markets. But so was most of the European banking industry, for example, where deposit-to-loan rates are sometimes as low as 50-60 per cent, meaning that the remaining gap is filled by wholesale funding (of the short and highly-volatile type). Which is why European governments have had to scramble to lend huge sums of money to many of their banks to fill that funding gap (Maltese note here: Maltese banks have deposit-to-loan ratios of over 100 per cent; the minister is not kidding you when he says that local banks are on a more solid footing).
When I joined Lehman in March, the firm had already foreseen that the credit crunch required a strong and determined response from management. Leverage levels were decreasing dramatically as the firm scrambled to sell off assets in bulk, sometimes at very low prices. On the funding (liability) side of the balance sheet, Lehman stunned the market in April by raising $4 billion in new equity investments and then went on to launch a series of 5, 10 and 30-year bond issues to ensure the firm had long-term funding. The firm had cash balances of over $40 billion, and capital ratios well above those considered safe (again, who didn't?). Therefore despite its many issues (allegedly excess leverage ratios and a huge appetite for risk-taking), Lehman did more than many in trying to address these issues, and the numbers showed we were succeeding.
Yet the market smelt blood in the banking world, and the investment banking industry was an obvious target. The Bear Stearns collapse in March had already caused lots of pain to Lehman and others in the form of much higher funding costs. Hedge funds started short-selling our bonds (selling them without actually owning them to buy them back cheaper) and this caused panic among our bond investors. In essence, what this meant was that the cost of our funding (the equivalent of deposits for commercial banks) was getting more expensive by the day.
What followed is now history. As we went into that infamous weekend in mid-September, we (and much of the rest of the financial world) were convinced that the US authorities would eventually have to chip in and save us. The problems we had were not Lehman-specific, but system-wide. But US Treasury Secretary Henry Paulson wanted to send a message to the markets: that the banks had to bear the cost of their decisions. That decision led to the carnage of the past weeks and Mr Paulson quickly swallowed his words and went on to bail out first AIG and then the rest of the country's banking industry.
The rest of the world quickly followed in his example and put together what history will probably remember as the biggest bailout the world has ever seen. And all because Mr Paulson, a genius of a banker but still a member of the Goldman family (that other infamous investment banking "brotherhood") decided it was not worth saving his arch-rivals. Most now agree that decision was the wrong one.
Lehman left behind it an estimated $600 billion in debts, something which will prove very hard to recover. Some sceptics will argue that the picture I have painted proves that we were nothing more than a hedge fund in a bank's skin, and that such an outcome should never be allowed again. Yet we were also masters at our job of advising clients on all kinds of corporate finance matters, at re-allocating risks from those who wanted to offload it to those who could afford to take it on.
We (like the rest of the banking system) played a pivotal role in ensuring the continued efficient allocation of capital within the financial system, which we all agree is the key to economic success. The system collapsed because the price of money (interest rates and the availability of credit) had become so cheap, basically free! This created obvious distortions which fed the excesses; excesses lead to bubble... and bubbles lead to disasters. Lehman may have been that one disaster too many.
Mr Sultana was, until a few years ago, a regular contributor in the local press with columns discussing contemporary topics in local and international finance and economics. Now London-based and after a number of years working in investment banking, he shares some thoughts on the collapse of Lehman Brothers - his employer until September's tragic events.