Book Review: The Murder of Lehman Brothers by Joseph Tibman

NOTE: This was from my old A&L Enterprises blog – but I thought it was interesting…

Interesting Read – “The Murder of Lehman Brothers”  by Joseph Tibman.  This was a personal account of the “death” of Lehman Brothers – part of the Financial Crisis of 2008.  The author is a former investment banker – written under a false name so he could get another job.  This is not a scholarly work – but a personal account from the inside – of the history and culture of Lehman Brothers.  It was a nice read – as the personal story drew me into the drama of the events of the firm – especially around 9/11 and at the end.

Like other reviews I’m not going to re-iterate the book – but focus on some of the key points of the book. What was most fascinating was how the events of the day looked from the inside of the industry.  To the outside and in hindsight it seems like people were insane but the author gives some reasoning why people felt and acted the way they did.

One interesting point he makes is that the events of 9/11 – the struggle for survival of the company – created a unique culture at Lehman Brothers.  The company struggled many times – but emerged through deft management after many of those struggles.  Those in the firm believed in the firm – believed that any struggle could be overcome with hard work and patience.  I got the hint of a different world that these bankers and traders lived in – one of risk, reward and the thrill of the deal.

The author helped me understand how the whole subprime crisis could have started in the first place.  There were a number of factors:

  1. It is fairly common for mortgages to be sold (many of you have gotten a notice saying a different company has bought your loan) in a package by the original lender to a different party.  If you think about it a mortgage- to a creditor –  is a cash flow – each month you send a check to them – so the value of the mortgage is the future cash flows it produces minus risk.
  2. The Federal Government, through Fannie Mae and Freddie Mac (wow- those names sound strange), encourage this practice – as they buy up the loans – encouraging more lending as the original lender no longer has this loan on their books.
  3. This seemed to work good when borrowers were well qualified – as the default rate (risk) –  was low and well understood.
  4. The Federal Government, to boost the economy, lowered interest rates – which both encouraged more lending and reduced investment opportunities.
  5. So the housing marked heated up and went crazy with expectations of ever increasing value.  Everyone seemed to buy into the crazy idea that housing prices would never go down – just up and up!
  6. As houses got more expensive it was harder to get a loan – so riskier forms of loans became more common – interest only, adjustable rate, etc. – these loans were more risky – but this wasn’t well understood.
  7. So these more risky mortgages were also grouped together and sold -but the big problem was that the risk was drastically underestimated.
    • For some reason people seemed to think (irrationally) that grouping together a group of risky loans together somehow make the whole package not very risky.
    • The ratings agencies did not help here – as they valued these packages of loans practically the same as less risky loans.
    • The government did not challenge this practice either
  8. Here’s where things get interesting – everyone fell in line with underestimated risk.  Nobody really, at least not effectively, questioned this practice.  Everyone bought into it hook line and sinker – the public, investment bankers, traders, investors, the government, etc.
  9. As time went on investments got riskier and more complex – so the returns were higher.
  10. An interesting point was that there is a cascade effect with these exotic, risky investments.  As they yielded higher revenues everyone took notice – and wanted to be part of the party.
  11. We might think – wait – what are the risks here – is it worth it?  These people didn’t – as they we’re going for the deal – and the subsequent compensation.  Even if they made the safe bet (best for the company and the economy in the future) they may be out of a job – as they weren’t bringing in the same revenue as the riskier bets.
  12. Then the companies became even more entangled -as to offset risk they took out hedges and insurance against these investments.  And then these got re-packaged and sold -making the whole thing so complex and difficult to evaluate.
  13. So the risk for the economy was growing – but not so obviously – as these companies were slowly entangling themselves together with complex contracts of transferring risk.

So the whole thing fell apart – real estate stopped wildly gaining value – so the house of cards was brought down.  Commercial real estate also went down – causing another ripple through the economy.  Lehman Brothers had slowly took on more and more risk – but most people in the company didn’t realize it – as it was not well known and dissent was stifled.  So, according to this author, he was shocked at what happened – as he “drank the kool-aid” and believed everything was going to be fine – that things would turn around like they always had.  Another example of group-think – of believing things contrary to reality…

The cost was enormous – good, hard-working people lost their jobs at Lehman Brothers.  The economy itself took a major hit -as investor confidence was shaken.  The long-term costs of this era are difficult to estimate – but they will linger for some time…

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