The Lehman Fiasco

Coffee with Costa - Pavement Philosopher

The Lehman Fiasco

Many corporate executives and bankers will say that this is not the time to apportion blame. They argue that now is the time for cool heads and calm nerves to prevail. They are partly correct. I disagree however about the blame part. Usually I’d say that blame is a pointless and counter-productive exercise best left to failed politicians and lame duck presidents. The blame game is something politicians of all persuasions play so very well and in most cases the finger pointing gets them nowhere except that the public or taxpayers always somehow get fingered.

The lame duck Bush Administration says that legislators in the US Senate and House of Congress need to set aside their petty ideological differences and show bi-partisan solidarity to steer the USA through the worst financial meltdown in its history. As the US Senate and Congress deliberate over a new amended version of US Treasury Secretary Hank Paulson’s $700 billion rescue package, the rest of the world watches the unfolding crisis with a combination of horror and loathing. The contagion and resultant panic spreads throughout the world. The Paulson package is primarily aimed at preventing financial markets from imploding. Some commentators benignly call it an “economic stabilization plan.” How did all this come about? Quite simply it’s a twisted and grotesque morality tale of reckless and irresponsible lending and spending. It’s a story about monumental human greed and stupidity and all the major US and several European, commercial and investment banks are guilty.

Now, I am not an economist, nor a financial or banking expert. US politicians refer to the current financial crisis as a mess. It’s not a mess. A mess is what your disobedient dog leaves behind on your front porch. It’s a full blown bloody catastrophe and nobody really knows how and where it will eventually pan out. Probably with a future Israeli strike against nuclear installations in Iran that will push the price of petroleum and gold to stratospheric levels and make South Africa the safe haven and crime friendly country of choice for unemployed investment bankers.

The way I have tried to explain this catastrophe to myself, is as follows: The geniuses working at the banks created off-balance sheet structures called “Structured Investment Vehicles” to park certain dodgy loans, sub-prime mortgages and other debt. They then borrowed money to fund these SIV’s hoping to trade and gain on the higher long term interest rates that this commercial paper attracted. These SIV’s were sold to institutional investors and pension fund administrators all over the world as AAA rated securities. Investment bankers were handsomely rewarded for taking exorbitant risks with other people’s money. Eventually the risky bets went bad, someone smelt a rat and decided to stop buying these securities so the banks had to take back this paper and put all this debt back onto their balance sheets. Part of the anticipated rescue plan is to now quarantine this toxic debt, take it off the balance sheets again so that banks can stop hoarding their precious cash in order to protect their balance sheets and start lending to each other again. The machine has overheated and seized and needs to be oiled again. Hence an initial sub-prime crisis that started last year with losses or write downs that will eventually top $1 trillion has now become a global credit crunch which will leave a trail of devastation, suffering and hardship for years to come.

The analysts on Bloomberg and CNBC say that the credit markets are frozen. Freezing things is usually a good and useful process, frequently necessary to preserve things. I freeze my fish fingers and my aching muscles. Walt Disney was frozen. The markets are not frozen. They’re constipated! Now on a less alarmist note, and before we slit our collective wrists, lets be positive for a moment. Humanity is resilient and survived for centuries by bartering goods. We may for a while need to behave like Roman legionnaires and pay each other with bags of salt but hopefully this crisis too shall pass like laxative, the sun will rise tomorrow, dogs will bark, the parade will march on by and the next US President will inherit a poisoned chalice.

In the case of the executives at Lehman Brothers, I’d say that blame is both necessary and appropriate. But blame is not enough. The board of directors and executive team of Lehman Brothers need to be named, blamed, shamed and publicly punished. Under the misguided stewardship of CEO Richard Fuld, Jr, the Lehman management team violated their corporate responsibilities and fiduciary relationships. Lehman Brothers filed for bankruptcy last week after amassing debts of close to $400 billion. This is a staggering sum of money for one company and it’s no wonder that the US Fed refused to bail them out. Firstly the sum and losses involved were too big even for the Federal Reserve and US Treasury to stomach, standing at more than half of the proposed bail-out plan currently on the table. Secondly reports say that Lehman is being investigated by the FBI and facing possible fraud charges because large cash transfers and transactions allegedly took place prior to them declaring bankruptcy. Thirdly Lehman is implicated on the street as being one of the leading Wall Street outfits who were partly responsible for hyping up the oil price and creating a highly speculative oil bubble that had absolutely nothing to do with supply and demand considerations. Is it not therefore possible and highly likely that Lehman were using the spiking oil price tactic to try to trade away some of their mind boggling losses.

Dozens of hedge fund and money management firms that worked closely with Lehman’s prime brokerage unit are now themselves also folding. A stockbroker friend who knows the Wall Street financial world intimately and has in the past visited several dealing rooms in New York investment banks; told me that Lehman’s gearing ratio was 39. That means that for every dollar in cash or assets they held, they were carrying or exposed to $39 of debt. As they say in the USA, do the math. They had $10 billion in cash or assets which they felt justified them to expose their many private and institutional investors to toxic debt of more than $390 billion. Leverage or extreme gearing had obviously worked for them in the past so the thinking was why not turn up the amplifier to max levels, leverage to the full to make as much money as possible as quickly as possible. Usually banks are only allowed to lend 12 times their capital base to investors and consumers and even that sounds crazy to me. Clearly shortcuts and their carefully considered and well-worked formulas applied to a high risk, high reward, gambling mentality, didn’t work for Lehman Brothers. To put it plainly they took wild bets that went sour and regulatory rules failed dismally to protect investors because they allowed the London unit of Lehman, which handled billions of dollars in global transactions, to borrow more money than the norm. They no doubt had high powered teams of PhD’s and MBA’s advising them on how to do this and get away with it. Had they consulted the owner of the Greek café on the corner or the proprietor of any township spaza shop, they would have told them that the numbers would never tally. They needed a valuable but simple lesson in basic arithmetic.

I have no doubt in my mind that generous salary and bonus packages running into hundreds of millions of dollars, were paid to Lehman executives in 2007. Mid and low level employees who desperately need the work, investors and pensioners will unfortunately pay the price again for these obscene and immoral corporate excesses. In my jaundiced opinion, this calls for a new category of crime. Along with the existing war crimes and crimes against humanity that we know so well, we need a category called “serious or gross economic crimes against humanity.” Now that Thabo is officially jobless, we can persuade him to take up a new post as Ambassador Plenipotentiary at Large otherwise to be known as the Chief Trouble-Avoidance Induna. He will be reassigned by the ANC to lobby the UN to seat the new Gross Economic Crimes Court otherwise to be known as GECCO near the Cradle of Mankind in Krugersdorp. Julius Malaka will undergo intensive cross-cultural sensitivity training and then be appointed as the chief usher of this international tribunal and the wives of prominent Zulu politicians will be awarded the food and beverage, catering and cafeteria contract for life.

Now the burning question on everyone’s lips is how do we boost liquidity in the US financial system without invading China? I’m buggered if I know. More importantly how do we encourage a future cycle of virtuous behaviour without reading Aristotle’s Nichomachean Ethics? Do regulatory rules and codes of ethics work? How should they be enforced? Can ethics and morality be codified? Rather than talk about the “lender of last resort” and the “moral hazard” of bailouts, should we revert to old fashioned basic concepts like fear, responsibility for ones actions, consequences, justice and retribution? President Lyndon B. Johnson once said that if you can’t win their hearts and minds, you grab them by the balls.

Following the crusty Texans advice we could start by re-commissioning our Scorpions or Brazils notorious BOPE Elite Squad and instruct them to seize and arrest the Lehman Brothers executives and dispatch them to Iraq and Afghanistan forthwith wearing ankle irons and orange overalls, where they will collect body parts for several years after the daily bomb attacks. Then we could hand them over to Hezbollah for redeployment and reorientation as they see fit. My innovative financial advisors and certain trustworthy actuaries that work at Alexander Forbes tell me that we can structure and package, shop corner pavement bet taking in Soweto, on their life expectancy probabilities and chances of survival, into a “guaranteed high yield body bag investment vehicle” and sell it to the Reykjavik Municipal Pension Fund.

Hold onto your seats and any Krugerrands if you have any.

Cheers
Costas Ayiotis

Reflections and observations from the pavement.
2 October 2008
Pretoria