Lehman Brothers Holdings Inc. built one of Wall Street’s first centralized risk-management desks, and Richard S. Fuld Jr. hired top executives to run it.
Then, at the height of the mortgage mania, the chief executive ignored their advice, choosing instead to pile on ever more leveraged bets.
That’s one reason why Lehman collapsed 158 years after its foundation, writes Mark T. Williams in his brief and lucid book, “Uncontrolled Risk: The Lessons of Lehman Brothers and How Systemic Risk Can Still Bring Down the World Financial System.”
Williams, 46, worked as a risk manager in the 1990s after a stint as a Federal Reserve bank examiner. He now teaches finance at Boston University and trains Wall Street risk managers on the side. In a phone interview, we discussed Lehman’s blunders; the sidelining of its senior risk manager, Madelyn Antoncic; and the failure of its board members, notably former Salomon Brothers Inc. chief economist Henry Kaufman, to rein in Fuld’s gambling.
Onaran: You point out in your book that Lehman was a leader in setting up a good risk-management division and hiring the best risk managers in town, including Antoncic. What went wrong?
Williams: Risk management plays a critical role to counterbalance the pursuit of return by the rest of the firm, but there’s been a structural weakness in how risk managers are treated on Wall Street. That led to the models that failed before the crisis.
Citigroup Inc. is a good example of that. They had a very decentralized risk function, which didn’t work. Lehman had a very centralized one, yet didn’t give the risk function the accountability it needed.
Onaran: Do you see any signs of change? Are risk managers more respected?
Williams: I do. Pain is a powerful agent of change. When you feel amazing pain, you make sure you do the right things to minimize it in the future. Going through the pain of the last crisis, a lot of companies are re-assessing how they view the role of the risk manager. I call this the era of the revenge of the nerds.
But it’s not just a department or a unit within a bank that needs to be better structured. Risk management is a philosophy. It’s a disciplined approach to managing profit-seeking.
‘Harsh on Kaufman’
Onaran: You fault Lehman’s board for sleeping at the switch.
Williams: I’m kind of harsh on Henry Kaufman. He was the perfect board member, with his industry experience and understanding of complex securities. He headed the risk-management committee, yet he still failed in that role.
If you’re making $365,000 a year, that sounds more like you’re being paid for full-time work, not part-time. I really had a problem when I heard that Kaufman met twice a year for such an important committee. Ultimately, if these boards are held accountable legally, then you’ll see them paying attention.
And you might get real professionals on the boards. If you look at Lehman’s board, they were very old; the average age was 75. Dina Merrill was a movie star actress. Why was she there? There was also a Broadway producer on the board. It was a very odd group of people.
Onaran: How about liquidity risk? That wasn’t incorporated into the rest of the risk-management function, was it?
Williams: Exactly. Liquidity is a big risk especially if you’re relying very heavily on overnight borrowing. Lehman was borrowing $180 billion a day on the repo market. Bear Stearns Cos. was knocking on the repo door for about $50 billion every day, assuming it was going to be open for them.
Onaran: Why did the Fed decide not to lend to Lehman from its discount window when its overnight lenders balked? Wouldn’t opening the window to investment banks have prevented such a liquidity crisis? Did the Fed decide Lehman was insolvent and not just illiquid?
Williams: The Fed had more insights into Lehman’s collateral and refused to lend against it. Then a few days later, when Barclays Plc came in and bought Lehman’s U.S. businesses, the Fed accepted that same collateral to lend to Barclays. It wasn’t good enough collateral for Lehman, but it was for Barclays.
The Fed decided Barclays was going to be around, but Lehman wasn’t. So it looks like they decided it was insolvent.
“Uncontrolled Risk” is published by McGraw-Hill (247 pages, $27.95, 19.99 pounds, 23.99 euros). To buy this book in North America, click here.
(Yalman Onaran writes for Bloomberg News. The opinions expressed are his own. This interview was condensed from a longer conversation.)