By Barry Ritholtz
(Bloomberg View) --Richard Fuld has been in the news recently. A profile in the Financial Times discussed his new wealth and money-management firm, as did a report by Bloomberg News. Collectively, the articles suggest he is testing the waters to find out if people have forgiven and forgotten his personal history.
Some of us have certainly not forgotten. I have long been a critic of Fuld's, pointing out that his management errors helped set up Lehman Brothers Holdings Inc., the company he once ran, for failure. In my book "Bailout Nation," I described how and why he blew the firm’s best opportunity to secure funding during the early days of the financial crisis. In later columns, I noted this error led to a moral-hazard argument that probably derailed a Federal Reserve bailout of the 158-year-old firm. He remains, as I said at one time, the Shaggy of Finance for his unwillingness to accept any responsibility for Lehman’s demise.
While many people deserve a second chance, today’s discussion will be a quick reminder of why he fell so far and so hard. Some have focused on his heavy-handed managerial style and personal shortcomings as contributing factors in the collapse of the storied firm -- and they probably were! But I want to focus on his business judgment and intentional misrepresentations, which were much more important as causative forces in Lehman's meltdown.
One other note: some people blame Lehman for the financial crisis, but that isn't true. The crisis was not caused by Fuld or by Lehman alone. If we look at the top 25 things to blame, the five biggest Wall Street firms -- Lehman, Bear Stearns Cos. (since acquired by JPMorgan Chase & Co.), Merrill Lynch (now part of Bank of America Corp.), Morgan Stanley and Goldman Sachs Group Inc. -- and their leaders fall somewhere in the middle of the pack. Although Lehman was a major contributor to the crisis, and perhaps the worst offender on the list, it was simply one of the first trailers in the park to be destroyed by the tornado.
Although there are many things to criticize about the Fuld era at Lehman, three stand out:
Leverage: Lehman used enormous amounts of leverage to underwrite, create and own securitized subprime mortgages. Initial estimates were that Lehman carried more than 30-to-1 debt to equity. But based on some later estimates, it may have carried debt that was as much as 100 times more than tangible liquid capital.
It was the largest underwriter of subprime and other types of less-than-prime securitized mortgage products. To ensure the firm had a steady stream of mortgages to securitize and resell, Lehman acquired five subprime mortgage lenders, including BNC Mortgage and Aurora Loan Services. When the housing market began to sour, this made the firm’s risk profile and balance sheet even worse.
Buffett’s $3 billion bailout offer: This was a terrible miscalcualtion. Soon after the Bear Stearns's collapse, Fuld began feeling out sources for a capital injection. You may have missed the news story that Warren Buffett’s Berkshire Hathaway Inc. offered to take a stake in Lehman. According to Bloomberg News, Buffett offered to buy preferred shares that would pay a dividend of 9 percent and could be converted to common stock at the then-market price of $40.30. Although this deal may have been pricier than any others, it had two advantages: it was real, and the imprimatur of the world's most respected investor might have guaranteed Lehman’s survival.
Fuld’s rejection eventually sent Buffett and his capital into the arms of Goldman Sachs, where he got a much better deal -- 10 percent on a $5 billion investment -- in a much better company.
I keep coming back to the moral-hazard issue. When the Fed was debating bailing out Lehman, I imagine someone in the room saying: “These guys rejected capital from Buffett -- why should we bail them out if they wouldn’t help themselves?”
Repo 105: The infamous Repo 105 was an accounting gimmick that shifted more than $50 billion in securities to and from Lehman's balance sheet. As we noted before, Lehman would sell short-term repurchase agreements to create the appearance, however temporary, of holding cash on its balance sheet to offset some of its enormous debt. This was done quarterly, just before earnings were released.
By creating a materially misleading picture of the firm’s financial condition in late 2007 and 2008, Lehman’s management and its accountants were engaging in an intentional misrepresentation designed to make the company appear to be in much better shape than it actually was. After the quarterly earnings report, the company then reversed the repos and the cash drained from the balance sheet. It was a giant accounting shell game. Lehman was actually insolvent long before it declared bankruptcy.
It is quite astonishing that no one from Lehman faced any consequences for this egregious accounting impropriety.
Were there others who made such awful business decisions in the run-up to the financial crisis? No doubt. But few were as prominent as Fuld or as lacking in contrition. Just keep that in mind when reading about Fuld's comeback.
This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.
Barry Ritholtz is a Bloomberg View columnist. He founded Ritholtz Wealth Management and was chief executive and director of equity research at FusionIQ, a quantitative research firm. He blogs at the Big Picture and is the author of “Bailout Nation: How Greed and Easy Money Corrupted Wall Street and Shook the World Economy.”
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