My Role in the Collapse of Lehman Brothers

People woke up this morning to the news that Lehman Brothers, a Wall Street giant, has filed for Bankruptcy, and Merrill Lynch, and even larger Wall Street giant has agreed to be taken over by Bank of America. Politicians issued statements. Taxpayers sighed a relief that their hard earned tax dollars were not used to bail out Lehman and small investors everywhere wondered what the collapse would do to their retirement accounts.

Some of us, however, have been watching this closely for some time. I worked at Lehman Brothers in the late 80s, and attended meetings with people who are now listed as key players. Over the weekend, I watched the financial newswires with the same fascination that I watched the weather channel as Ike pulled into Texas, or during Katrina a few years ago.

When I worked at Lehman, I worked with mortgaged backed securities, those currently much maligned financial instruments that seem to be at the center of so much of the financial turmoil these days. We calculated the probability of home owners prepaying their mortgages and sliced and diced the cashflows from pools of mortgages to sell off the different pieces at a profit.

Even back then, I wondered if this financial engineering was really making lives better for people other than those getting rich at Lehman and it’s related firms. Friends reassured me that by increasing liquidity in the mortgage market, by creating securities that tailor the risk to people most interested in it, we were making mortgages easier to obtain for more people. We were reducing the price of mortgages.

By the 1990s, I had moved on from Lehman brothers. I watched the bankruptcy of Drexel Burnham from a front row seat at Smith Barney, as I gathered any information I could to help Smith Barney protect itself for the collapse of Drexel. You see, every Wall Street firm trades with every other Wall Street firm. So of the trades can take weeks, or even months to be finally settled. When one firms fails, all the other firms are essentially creditors of the failed firm. On Wall Street, they talk about this in terms of ‘counter-party risk’.

A few years later, I watched Orange County file its bankruptcy. Orange County was one of those buyers gathering up these special financial instruments without fully understanding what they were buying.

That said, I would suggest that none of us fully understand our investments. How many people have their retirement accounts in mutual funds which have invested in Lehman Brothers, or, perhaps more significantly, in Fannie Mae or Freddie Mac? How many people have lost money, not only in terms of their taxpayer dollars being spent to take over Fannie Mae and Freddie Mac, but also in terms of their investments in these mutual funds?

By 2000, I was working at a very large and successful Connecticut based Hedge Fund. I had a great house in Stamford, with a large mortgage. Yet I ended up leaving the hedge fund at the end of 2000, hoping that I would be able to find an equally good, if not better job in 2001. I did some consulting for other hedge funds and for some financial services startup firms that looked especially promising. Yet in September, 2001, the markets became roiled again, and I never did manage to find that next great job.

So, I muddled around, taking jobs where I could find them, and increasing the loans against my house. This is where I get back to my role in collapse of Lehman Brothers. Last year, I tried to sell my house. I knew that the housing market was collapsing, but I hoped I could sell the house and at least break even. My debt on the house at that time, was approximately 65% of what the mortgage companies had assessed the house for when I refinanced. That was also the highest that local realtors said we would be able to get for the house.

So, we placed it on the market, and waited, and hoped. We came very close to selling the house a few times, but deals seemed to always fall apart at the last minute. The most significant was in late July and early August, when a potential buyer went to contract with us. We rented our house in Woodbridge, and looked forward to the difficulties being over. Yet the buyer reneged and we are still fighting over their deposit in the courts.

With us living in a new house, and unable to make payments on the large old house, we sought a few last minute deals before heading into foreclosure. There was a big foreclosure auction, yet no one bid on the property. Later, the house sold for about half of what I had been told it was worth by the mortgage companies. With foreclosure came our bankruptcy, which is also currently in the courts. The bankruptcy affected not only those in the mortgage market, but other credit markets and small businesses as well.

It was not easy filing bankruptcy. Some of our creditors are companies or organizations that we hold in high regard, and I wish there were ways we could have paid them off. Other companies, by the unwillingness to negotiate in ways that might have prevented the foreclosure and bankruptcy from occurring are suffering, in my opinion, from their own stupidity.

So, I have added to the defaults, foreclosures and bankruptcies that are dragging down our financial institutions. Our experiences are but one of many, that when taken together, end up passing on financial difficulties to large Wall Street firms.

It also adds to a cycle. How many of the people that will lose their jobs at Lehman Brothers or at Merrill Lynch, will end up in similar financial difficulties? How many will need to sell their houses at a loss, adding to a further slide in housing prices? From a Wall Street perspective, how much will the debts of Lehman drag down other financial services firms?

So, we continue to see financial difficulties. The politicians will continue to make statements about this. They will most likely be fairly simplistic, because I suspect many politicians don’t really understand the financial markets any better than many of voters. They will be simplistic, because you can’t address the issues of the financial services crisis in sound bites. They will be simplistic because many voters have little idea how interconnected all of the markets, and all of our lives truly are.

Would it have been better if the Government stepped in to cover some of the assets of Lehman brothers? It’s hard to tell. To a certain extent it is happening anyway, as the Federal Reserve and central banks around the world attempt to boost liquidity, including the Fed widening the types of collateral that it accepts for loans to financial services firms. Meanwhile, a large insurance firm, AIG, is reportedly asking the Fed for a $40 billion loan.

So, I will continue to scrape by, as I look for new opportunities. I guess we all will. The thousands of dollars in my bankruptcy pale compared to the billions in the financial markets. Yet, I still hope to get through this okay, and I hope our financial markets will too.

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