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10/14/2010

Book Review: A Colossal Failure of Common Sense


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A Colossal Failure of Common Sense

Two thousand and eight was the annus horribilis that changed Wall Street and Main Street. Among all the historic, previously unimaginable, and stunningly painful events, it is perhaps the collapse of  Lehman Brothers that stands out the most. Lehman, the fourth-largestinvestment bank in the US, failed and filed for bankruptcy in September 2008. Prior to filing, the company held more than $600 billion in assets, making this the largest bankruptcy ever.

Why did Lehman collapse? Was it too small to bail out? Was the severity of the crisis poorly understood? Was Lehman unsalvageable? What could have been done differently to avoid the collapse? In A Colossal Failure of Common Sense, Lawrence G. McDonald, a former vice president of distressed debt trading at the firm, seeks to answer these and other questions by providing a personal account of the road to the collapse. The contributions of cowriter Patrick Robinson, a best-selling author of thrillers, lend a sense of excitement.

In McDonald’s account, the characters at Lehman are cast in either black or white: they either contributed to the failure of Lehman (e.g., chairman and CEO Richard S. Fuld and COO Joseph Gregory) or were dedicated employees with professional pride, determination, exceptional talent, and a strong work ethic (e.g., the guys on the trading floor). Fuld is described as a Machiavellian operator, who became completely detached from the daily activities of his firm over time, communicating through a select group of loyal subordinates and plotting strategies to elevate Lehman to the level of the larger investment banks he envied. Fuld and Gregory aggressively pursued a leverage-fueled expansion spree into real estate–related assets and highly risky, very sophisticated financial products. Commercial real estate and securitization were the focus of their strategy.

To fulfill its ever-increasing appetite for mortgages to be securitized, Lehman relied on its pipeline from BNC Mortgage, its California subsidiary. The book’s thinly veiled suggestion is that Lehman’s profits (and management’s outsized bonuses) depended on “bodybuilders,” the West Coast brokers who sold mortgages to consumers—whether the purchasers needed one, understood what a mortgage was, were able to repay a mortgage, or existed at all. Even when the losses in the mortgage portfolio were rapidly accumulating, the actual leverage of Lehman was astronomical, and increasingly louder alarm bells were ringing in the corridors, Fuld and the firm’s top management were not ready to reduce the outsized risks the firm was taking. The successful coup d’état to unseat some of top management just prolonged the inevitable. Once the genies of entitlement, unmitigated risk taking, poor corporate stewardship, senseless growth, unethical behavior, and unabated greed were out of the bottle, nothing and nobody could put them back.

Throughout the book, McDonald and Robinson describe the intricacies of modern finance and the financial meltdown in an easily accessible way and in the style of a good thriller. All of the tension, pressure, and nervous aggression that characterize the trading desk come alive. The authors provide a nontechnical explanation of why large banks failed and needed government support.

In the vein of Michael Lewis’s Liar’s Poker, the book provides insight into the corporate psychology, culture, and value system of Lehman. Highly enlightening are the stories that describe the daily work on the trading floor. What A Colossal Failure of Common Sense does not provide is the personal perspectives of Fuld and all those at the top of Lehman’s management who made the decisions that later proved disastrous and ultimately sealed Lehman’s fate. As long as their side of the story is not told, the tale of Lehman’s route to ruin remains one-sided. Because this book is nothing short of an indictment of Fuld, Lehman’s board, and some of its senior management team, their version of events needs to be told.

–Peter Went, PhD, CFA, is a senior researcher at the GARP (Global Association of Risk Professionals) Research Center. He coauthored Foundations of Banking Risk: An Overview of Banking, Banking Risks and Risk-Based Banking Regulation (Wiley 2009).

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