How the Fall of Lehman Brothers Really Began

by Inya Ivkovic, MA.

The Black Monday of September 15, 2008, will be, and should be, remembered as the day when the global economy stood on the brink of recession and had little choice but to hurl itself into the abyss. That was the day the U.S. government allowed Lehman Brothers to fail and that was the day that unleashed the Ice Age in the credit and financial markets.

When Richard Fuld was summoned before Congress about a month later to do some explaining, the grilling received from angry congressmen was not just of him, but of the entire Wall Street and the role it played in creating the biggest economic meltdown in more than eight decades — the role it played in not only driving the world into one of the longest recessions ever, but also all but destroying faith in the free market system that made this country great.

Fuld became the face of the usually faceless Wall Street. He was also smartly selected as the poster boy of everything that had gone wrong. He offered explanations galore to pacify angry investors and ordinary people. He exemplified the kind of wild and irresponsible pursuit of self-interest on Wall Street. In a nutshell, Fuld became the face of all the evil that led to the Great Recession.

The transcripts from Fuld’s Congressional hearing read more like a crash course on the post-war world of high finance. Through the unique Lehman lens, the hearing illustrated how financial institutions departed from their core businesses, how financial engineering evolved into designing complex and risky products, how risk models became more and more lax, how esoteric products such as credit default swaps and collateralized debt obligations flooded the market, how “shadow banking system” was created, etc. As the Oracle of Omaha, Warren Buffett, put it, those were the true “weapons of mass financial destruction.” Sadly, but not surprisingly, this momentous shift in capital markets ended on Black Monday a year ago, when Lehman Brothers filed for the largest bankruptcy in history.

Yet, there is something that bothered me about Fuld’s Congressional hearing. By all means, it was good theater. But it came up short on explanations. For instance, the hearing did not explain how the U.S. subprime mortgage mess could mushroom into a global catastrophe. It did not explain how an entire country like Iceland could almost go bankrupt. It did not explain how U.S. automakers ended up in Washington, reduced to beggars. And it certainly did not explain why pension funds from north of Europe all the way down to Australia suddenly could not fund their obligations, dying a slow and painful death in the clutches of massive shortfalls.

We are always rushing somewhere. This time we rushed to the conclusion that Wall Street was the sole architect of the global calamity that brought us almost to the verge of another Great Depression. Certainly, Wall Street aided and abetted the crisis amply. But it did not act alone. It had some powerful accomplices: first and foremost, the Federal Reserve and Washington. Then the list goes on to the over-inflated housing market, banks’ suspicious lending procedures, complete abandonment of the concept of risk, and the flourishing of the shadow banking system. Unfortunately, as Congress rushed to give the angry mob its villain, it also failed to do a harder, but more productive duty — it failed to force America to take a long and hard look at itself and to admit to itself some hard truths.

The American Dream, once beautiful and dreamed by all, now is tarnished, almost reduced to a nightmare after Black Monday. Homeownership was its pillar. It helped America evolve from an agrarian society into an urban one. It became an expression of personal social mobility. It even became an expression of social progress and unity, or at least that is how government policy-makers saw it. And it was the latter that first led to the ascendancy of the subprime mortgage market to stardom in the U.S., and then brought the global economy to a catastrophic bust.

But the subprime mortgage market did not build houses of cards, such as Lehman was. Wall Street may have enabled and perpetuated them, but Wall Street did not create lending assembly lines with little or no control over risk. Certainly, Wall Street securitized debt, toyed with product engineering and sold products to the poorly informed investing community that even its enablers did not understand. But Wall Street did not rate such securities. Wall Street did not pass laws lowering the bar to homeownership. Wall Street was not responsible for disastrous monetary policy of the Federal Reserve and it certainly was not responsible for the Bush administration’s fiscal policies.

Who is responsible, then? Well, if we were to really look in the mirror and be brutally honest with ourselves, the face of Richard Fuld could start looking awfully like each of our own.