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Lehman Nov 27
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Not So Smart
Nov 27, 2015 | The Economist
...Some clues to Mr Greenspan’s conundrum can be found in a new book* on Lehman Brothers, the American investment bank whose failure precipitated the worst of the crisis, and a recent report** on the collapse of HBOS, a British retail bank, that imploded soon after. Although the two banks had different histories, they made similar...
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Alan Greenspan
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Nov 27, 2015 | The Economist
In 2008, as the financial system was collapsing, Alan Greenspan, the former chairman of the Federal Reserve and champion of free markets, admitted he had been wrong. “I made a mistake in presuming that the self-interests of organisations, specifically banks and others, were such that they were best capable of protecting their own shareholders and their equity in the firms,” he said. In other words: why would bankers destroy their own livelihoods?
Some clues to Mr Greenspan’s conundrum can be found in a new book* on Lehman Brothers, the American investment bank whose failure precipitated the worst of the crisis, and a recent report** on the collapse of HBOS, a British retail bank, that imploded soon after. Although the two banks had different histories, they made similar mistakes.
...Lehman was best known for bond-trading, but moved heavily into property lending. Through a subsidiary called BNC Mortgage it was the 11th-biggest subprime lender in America; it underwrote more mortgage-backed securities than any other Wall Street firm and it made direct investments in property companies.
...Risk-control systems should have saved managers from their mistakes, but didn’t. Lehman had a risk department that employed nearly 400 people, including former regulators; its approach to risk management had been praised by the Securities and Exchange Commission (SEC), an American regulator, in 2005. But the chief risk officer was overruled and risk limits were ignored; some investments in commercial property and private equity were excluded from internal stress tests.
...In neither case did the board control the managers. More than two-thirds of Lehman’s board had no significant recent experience of banking. The report on HBOS said its board lacked “knowledge and experience of banking”. To be fair, recruitment of experienced non-executives might have been difficult; anyone capable of overseeing a modern bank was presumably working for a competitor.
That points to a broader problem. Lehman had over 7,000 legal entities, of which 209 were registered subsidiaries; it had assets of $700 billion. Such a complex organisation was very hard to monitor, let alone control.
A long period of benign economic conditions and rising property values lulled executives at both HBOS and Lehman into a false sense of security. They thought they were brilliant and could handle the cycle; in fact, they had just been lucky. To go back to Mr Greenspan’s error, bankers did focus on their self-interest: they believed that if they didn’t expand their balance-sheets and keep pushing up profits, they would be replaced. They didn’t see the truck coming until it hit them.
For full story: http://www.economist.com/news/finance-and-economics/21679228-why-two-big-banks-failed-not-so-smart
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Alan Greenspan
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