A Colossal Failure of Common Sense

1. A Rocky Road to Wall Street: Drive and Resilience Over Privilege

Son, remember this—it’s not where you start, it’s where you finish.

Overcoming adversity. The author's journey to Wall Street began not from privilege, but from hardship. After his parents' divorce, he moved from an affluent town to a run-down housing project, facing academic struggles and physical threats. This difficult period instilled in him a fierce determination to succeed.

Unconventional path. Lacking connections and attending a less prestigious university, the author faced constant rejection from financial firms. He resorted to creative tactics, including posing as a pizza deliveryman, just to get interviews. This persistence, combined with a strong work ethic, eventually led to a sales job at Merrill Lynch.

Sales experience pays off. Despite starting in frozen foods sales, the author's ability to sell proved valuable. His success in retail brokerage, particularly in acquiring assets, demonstrated the practical skills sought by Wall Street firms, ultimately paving the way for his entry into the industry.

2. Bonds, Dot-Coms, and the Power of Information

Overnight Steve Seefeld and I became world oracles on the convertible bond.

The safety of bonds. Influenced by his father's cautious approach and a friend's expertise, the author developed a strong belief in the relative safety of bonds compared to stocks. Bonds represent debt, offering principal repayment and interest, with bondholders having priority over stockholders in bankruptcy.

ConvertBond.com innovation. Recognizing the difficulty in accessing information about convertible bonds, the author and his friend Steve Seefeld created ConvertBond.com. This website provided a centralized database and analysis, becoming an indispensable resource for institutional investors.

Publicity and acquisition. Strategic publicity efforts, particularly through financial journalist Kate Bohner, propelled ConvertBond.com to prominence. Its influence in the market, including its bond ratings, eventually led Morgan Stanley to acquire the company, bringing the author one step closer to his Wall Street dream.

3. Joining Lehman: A Culture of Fear and an Absent King

Down on the trading floor no one ever saw him, and that represented one hell of a lot of important people, many of whom knew almost nothing about their leader.

Lehman's storied history. Joining Lehman Brothers meant entering an institution with a deep and impressive history, having financed major American companies across various industries for over a century. The firm had a reputation for excellence and attracted top talent.

Remote leadership. The author quickly discovered that CEO Richard S. Fuld Jr. was a distant figure, rarely seen on the trading floor and communicating primarily through a small circle of loyalists. This isolation from the firm's core operations and key personnel was a striking characteristic of his leadership.

Fear and control. Fuld's leadership style was marked by a reputation for temper and a tendency to fire those perceived as threats. This created an atmosphere of fear, where challenging the status quo or being too successful could be detrimental to one's career, hindering open communication and critical assessment.

4. The Mortgage Bonanza: Securitization and the Rise of Risky Debt

This was the Age of the Derivative—the Wall Street neutron that provided atomic power to one of the most reckless housing booms in all of history.

The rise of shadow banks. The housing boom was fueled by mortgage brokers (shadow banks) who originated loans with minimal standards, knowing they could quickly sell them to investment banks. This removed the incentive for careful lending.

Securitization and CDOs. Investment banks like Lehman bought these mortgages, packaged them into securities (CDOs), and sold them to investors worldwide. This process, aided by favorable ratings from agencies like Moody's and S&P, generated massive fees and profits.

Risky lending practices. The pursuit of volume led to increasingly risky mortgages, including:

• NINJA loans (No Income, No Job, No Assets)
• No-doc loans (little or no proof of income)
• Interest-only loans and adjustable-rate mortgages (ARMs) with low initial "teaser" rates

These practices created a bubble based on unsustainable debt and rising property values.

5. Warnings Ignored: The Iceberg Ahead and the Steroid Market

This housing market,” he snapped, “it’s all ‘roided up.”

Internal dissent. Despite the massive profits generated by the mortgage division, key figures within Lehman, including Mike Gelband and Alex Kirk, recognized the inherent risks. They saw the housing market as artificially inflated by excessive leverage and questionable lending.

Prophets unheard. Gelband, as global head of fixed income, presented data showing the unsustainable nature of the boom and the impending wave of mortgage resets. His warnings, and those of others like Kirk and Larry McCarthy, were largely dismissed by the top leadership, who prioritized growth and revenue.

Misplaced confidence. The mortgage division and top executives remained confident, citing historical data that U.S. housing prices had never fallen significantly. They failed to appreciate that the market's structure had fundamentally changed due to securitization and predatory lending, making past performance an unreliable indicator.

6. Shorting Success: Profiting from Corporate Distress

That Jane. That brave, brave little bear had called it.

Distressed debt expertise. The author's team specialized in distressed debt, identifying troubled companies and profiting from their decline or eventual restructuring. This required deep research and a contrarian mindset, often betting against market optimism.

Successful shorts. The team achieved significant profits by shorting companies they identified as vulnerable due to debt, market conditions, or questionable practices, including:

• Calpine (energy company)
• Tower Automotive (auto parts supplier)
• Beazer Homes (home builder)
• New Century (mortgage lender)

Delta Air Lines triumph. A major success came from betting on the recovery of Delta Air Lines bonds after its bankruptcy filing. Relying on analyst Jane Castle's valuation, the team bought bonds cheaply and profited handsomely when a takeover bid materialized, demonstrating the value of their research and nerve.

7. Excessive Leverage and Risky Global Expansion

Lehman was somehow out there buying wildly overpriced skyscrapers with distant views to the friggin’ Eiffel Tower, still buying hedge funds.

Increasing leverage. Under Fuld and Gregory, Lehman's leverage ratio (borrowed money vs. firm's capital) escalated dramatically, reaching over 40:1. This allowed them to take on massive positions but made the firm highly vulnerable to even small declines in asset values.

Aggressive expansion. Driven by a desire to compete with larger banks and rivals like Blackstone, Lehman aggressively acquired assets globally, often at market peaks. This included:

• Commercial real estate (e.g., Coeur Défense in Paris, Archstone-Smith apartments)
• Hedge funds (stakes in numerous funds worldwide)
• Energy companies (Eagle Energy Partners)

Ignoring risk. These acquisitions were often made with borrowed money and involved significant risk, particularly as asset markets began to decline. The leadership seemed focused on growth and prestige, disregarding warnings about overexposure and illiquidity.

8. The Exodus of Talent: Brains Leave as Problems Mount

Something in the soul of Lehman Brothers was gone with him, and it never came back as we steamed ever onward toward Larry’s iceberg.

Departure of key figures. As the firm's direction became increasingly reckless and warnings were ignored, several of Lehman's most talented and respected leaders departed. This included:

• Christine Daley (Head of Distressed Debt Research)
• Mike Gelband (Global Head of Fixed Income)
• Larry McCarthy (Head of Distressed Trading)
• Alex Kirk (Global Head of High-Yield and Leveraged Loan Businesses)

Loss of expertise. These departures stripped Lehman of critical expertise in risk management, distressed assets, and fixed income, precisely the areas needed to navigate the brewing financial storm. Their reasons for leaving often stemmed from frustration with the leadership's unwillingness to heed their warnings.

Demoralized staff. The loss of these respected leaders, coupled with perceived unfairness in bonus distribution and questionable management decisions, significantly impacted morale on the trading floor. The remaining staff felt increasingly vulnerable and concerned about the firm's future.

9. Einhorn's Critique: Questioning Transparency and Valuations

David Einhorn thought there was something rotten going on in the Lehman accounting department.

Public scrutiny. As Lehman's financial health deteriorated, hedge fund manager David Einhorn became a vocal critic, publicly questioning the firm's accounting practices and asset valuations. His detailed presentations highlighted discrepancies and lack of transparency.

Focus on hidden losses. Einhorn specifically pointed to Lehman's large, undisclosed holdings of mortgage-backed securities and commercial real estate, suggesting that the firm was not adequately writing down the value of these assets as the market declined. He questioned how Lehman could report profits while others were reporting losses.

Credibility challenged. Einhorn's persistent and well-researched critiques, amplified by media appearances, severely damaged Lehman's credibility in the eyes of investors and analysts. This public pressure contributed to the decline in Lehman's stock price and increased scrutiny of its balance sheet.

10. The Coup: Power Shifts as Crisis Deepens

Bart McDade, who was already standing, walked around the table and moved his papers to the place occupied for so long by the reclusive CEO.

Growing discontent. As losses mounted and Einhorn's critiques gained traction, discontent among Lehman's senior managing directors intensified. They recognized that the firm's leadership was failing to address the crisis effectively and was jeopardizing the company's survival.

Secret meeting. A group of key division heads, led by Tom Humphrey, held a secret dinner to discuss the firm's future. They concluded that a change in leadership was necessary to restore confidence and steer the firm away from disaster.

Gregory's ouster. Bart McDade, a respected figure within the firm, confronted Dick Fuld with the group's findings. Faced with a united front from his key executives, Fuld was forced to agree to the removal of his long-time president, Joe Gregory, marking a significant shift in power.

11. The Commercial Paper Freeze and Bear Stearns' Collapse

The commercial paper market had frozen on them.

Liquidity crisis. The subprime crisis triggered a freeze in the commercial paper market, the short-term lending market vital for investment banks. Banks became reluctant to lend to each other or to firms heavily exposed to risky assets, fearing counterparty risk.

Bear Stearns' vulnerability. Bear Stearns, heavily invested in subprime mortgages and highly leveraged, was particularly vulnerable to this freeze. Unable to secure short-term funding, the firm faced a liquidity crisis and a rapid loss of confidence from investors and lenders.

Government intervention. On the verge of bankruptcy, Bear Stearns was acquired by JPMorganChase in a deal brokered and financially supported by the Federal Reserve. This unprecedented government intervention highlighted the systemic risk posed by the crisis and sent shockwaves through Wall Street.

12. A Colossal Failure of Common Sense at the Top

Most people who attended that meeting regarded Fuld as a slightly pathetic, out-of-touch, confused old guy who was in office past his time, struggling with a 1970s playbook in a 2008 game.

Ignoring expertise. The core failure at Lehman stemmed from the top leadership's consistent disregard for the warnings and expertise of their most capable executives. Fuld and Gregory sidelined or drove out those who challenged their optimistic, growth-focused strategy.

Misplaced priorities. The leadership prioritized aggressive expansion, prestige projects, and personal enrichment (through large bonuses and stock buybacks) over prudent risk management and balance sheet health. They failed to adapt to the changing market landscape and the inherent dangers of modern financial products.

Lack of transparency and accountability. The firm's opaque accounting practices, particularly regarding off-balance-sheet assets and asset valuations, masked the true extent of its exposure. This lack of transparency, coupled with a culture that stifled dissent, prevented timely corrective action and ultimately contributed to the firm's downfall.

Last updated: May 17, 2025