The lesson from Lehman's failure

飞雪寒冰

The report into Lehman's failure will no doubt prompt much snorting about swindling investment bankers. Some may be tempted to draw parallels with past financial frauds, such as Enron or Madoff. But to do so would miss the wider point about Lehman's collapse.

Lehman was a poorly-managed bank that operated an irresponsible business model. But it was no Enron or Ponzi scheme. Indeed it behaved much as any bank would, if allowed, in a similar situation.

It is worth looking back to the months before Lehman's collapse. After the rescue of Bear Stearns in March 2008, it was clear that investors were losing faith in highly-leveraged investment banks that relied on wholesale funding. This was Lehman in excelsis. As such, it was the next domino in line.

Bosses of banks that are in clear danger of failing have three courses open to them. They can wind the bank up; sell it; or keep trading in the hope of resurrection. Given the crystallisation of losses involved in the first option, only a manager who put integrity above either his own reputation or the shareholders' interest would ever take it. The board of Lehman was stuffed with major shareholders. Unsurprisingly, it opted for option three (only later seeking an outright sale of the bank).

飞雪寒冰

A barely-alive bank is an extremely dangerous thing. The temptation to fudge the figures or lie to prolong life becomes overwhelming. This is why regulators seize banks that are close to failure. But, as a broker-dealer, Lehman was not subject to such regulation: the SEC did not have the tools. In this situation, it is scarcely surprising that Lehman's managers resorted to fudging. The report details how they used a repo transaction to artificially reduce the bank's leverage, knowing the importance that investors placed on this figure. Lehman also misled investors about its access to liquid funds.

飞雪寒冰

If there are lessons to be learned from Lehman, it is not simply that its management succumbed to temptation. The authorities were excessively sanguine about the existence of such a vast and undercapitalised organisation. None of this excuses the conduct of individuals or professional service firms that may have failed in their duties. Anyone who did wrong should be held to account. But the real lesson is that institutions with bank-like characteristics should all be treated like banks and be subject to proper oversight. Whatever the future regulatory world is to be, it should not contain loopholes for another Lehman to exploit.