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The Dick Fuld Denial

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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Richard Fuld, the former chief executive officer of Lehman Brothers, is the Shaggy of finance. On the cause of the financial crisis and the collapse of Lehman Brothers, his claim is, "It wasn’t me."

Seven years after he drove the 158-year old firm he ran with an iron fist into bankruptcy, he has reappeared to accept blame for, well, absolutely nothing. Fuld seems to believe himself blameless for either his role in the crisis or the collapse of Lehman. Speaking at a penny stock event, Fuld is still confused about the differences between ownership and control. He made the bizarre claim that “Regardless of what you heard about Lehman Brothers’ risk management, I had 27,000 risk managers because they all owned a piece of the firm.”

As if an employee e-mail to Fuld would have changed the firm’s direction: Imagine “Hi Dick, I own 10,000 shares of Lehman. Please divest all of our risky derivatives and securitized subprime mortgages because I think we're going to take losses on them.” For the man known as “The Gorilla” to make such an assertion is beyond absurd.

Before we take a closer look at Fuld, a preface: The crisis was not caused by Fuld or by Lehman Brothers alone. If we look at the top 25 things to blame, the five biggest Wall Street firms (Bear Stearns, Lehman Brothers, Merrill Lynch, Morgan Stanley, and Goldman Sachs) and their CEOs all fall somewhere in the middle of the list.

Keep also in mind that causation is a complex matter, and that finance is an intricate, interconnected system. There were many, many forces at work that led to the collapse. However, this complexity doesn't excuse bad actions, poor judgment, and terrible decision-making. I’ve spilled too many pixels explaining why Lehman crashed and burned, but for those of you who may have forgotten:

Wild Overleverage: Lehman Brothers lacked sufficient capital. It used an excessive amount of leverage -- about 40-to-1 debt to equity -- to chase profit in all manner of exotic mortgage-backed securities.

Had it stayed with a more modest leverage ratio of, say, 12-to-1, it would have had a stronger capital cushion. There would have been less underwriting activity, smaller gains in proprietary holdings and lower risk. The downside of having a de minimus capital structure is when bad investments are made, there is almost no room for error and no buffer to absorb losses.

Why 12-to-1? Lehman Brothers was among a group of five banks that asked for -- and received -- a waiver of the 1975 net capitalization rule. This led the Securities and Exchange Commission to issue what became known as the Bear Stearns exemption. The rule, which still applied to all other investment firms except the five listed above, displaced the older ratio of 12-to-1.

Hence, this was a very conscious risk-management decision made at the highest levels of the bank.

Bad Modeling Assumptions: When you are jacked up at 40-to-1 leverage, your investment models better be perfect. Lehman’s models were decidedly not. Among the false assumptions in these models were: a) residential real estate never loses value; b) the derivatives market is always liquid, with ready buyers available; c) the risk of borrowing short and lending long can be readily managed. Even as substantial evidence was piling up that these assumptions were false, they were ignored by management.

Excessive Real Estate Exposure: Lehman wasn't the only securitizer of subprime mortgages -- ground zero for the financial crisis -- but it was among the biggest. By 2004, Lehman Brothers was originating $40 billion a year in mortgages to feed its collateralized-debt obligation machine. As journalist Roger Lowenstein has pointed out, it was for a time much more lucrative than just selling stocks to investors and underwriting plain vanilla bonds.

Reliance on Ratings: Here is an interesting conundrum: Lehman’s securitized products were highly dependent on the ratings of Moody’s and Standard & Poor's. However, Lehman was also one of the prime purveyors of credit-rating payola -- it participated in the conflict-ridden practice in which issuers pay raters to grade the quality of the debt sold by the payer. If both parties to this arrangement didn't know the credit ratings were worthless, they sure should have.

CDO Ownership: Lehman kept the senior-most layers of the CDOs it created for itself, but bought credit default swaps on them for safety. Consider that Lehman's managers weren't confident enough in the models that forecast the solvency of those tranches, yet they used the same models to determine that American International Group was a creditworthy counterparty to insure them. When the music stopped, Lehman ended up holding lots of what turned out to be junk paper. That’s why Lehman collapsed, and it was apparent (at least to me) back in June 2008 it was in trouble.

Repo 105: Has Dick Fuld really forgotten about this accounting maneuver? On a quarterly basis, Lehman would sell short-term repurchase agreements to create the temporary appearance of cash on its balance sheet to offset some of its towering debt. This made the company look much less leveraged than it actually was. After the quarterly earnings report, the company then reversed the repurchase agreements and the cash drained from the balance sheet. It was a giant sham transaction.

Fuld’s claim that Fannie Mae, Freddie Mac and other so-called government-sponsored entities caused the crisis has been thoroughly, repeatedly, utterly debunked. The sort of revisionism we see from Fuld is no surprise, given his brand of delusion.

You don't need to take my word on any of this; read the Chapter 11 bankruptcy report on Lehman Brothers. It is an embarrassment of riches of the many follies of Lehman Brothers in general and the man who ran the company.

It's rather stunning that Fuld, who led Lehman from 1994 until its 2008 collapse, refuses to accept any responsibility for its failure. Even former Federal Reserve Chairman Alan Greenspan has admitted error for his role in the financial crisis; that Fuld will not is deeply revealing.

The rock 'n' roller in me wants to suggest Dick Fuld give a listen to Led Zeppelin. To help him start accepting some responsibility, I suggest Step 1 begins with the classic rock tune: "Nobody’s Fault But Mine." 

For further reading on Lehman and the financial crisis:

Understanding Lehman & AIG 

The Backstory to Bailout Nation

Bear Stearns, Lehman Execs Kept Billions

Lehman News Round Up  

10 Things You May Not Have Known About Lehman Brothers

The False Crisis Narrative Persists 

This column does not necessarily reflect the opinion of Bloomberg View's editorial board or Bloomberg LP, its owners and investors.

To contact the author on this story:
Barry L Ritholtz at britholtz3@bloomberg.net

To contact the editor on this story:
James Greiff at jgreiff@bloomberg.net