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RIP Lehman

Created:
17 September 2008
Written by:
Alistair Blair

Times change. In 1958, Lehman Brothers - which had been a premier Wall Street bank for 60 years and was still run by a Mr Lehman - invited the public to buy shares in a mutual fund which it managed. Expected to raise $40m, by the time the offer closed, it had pulled in over $200m. At the time, it was the biggest mutual fund IPO ever.

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Adjusting for inflation, $200m in 1958 is the equivalent of $2bn in 2008, but bearing in mind the subsequent relative growth of the financial sector, one could argue that the issue would have corresponded to something closer to $8bn today. Had Lehman been able to rustle up even half of this sort of money last week, it would probably still have been with us.

There's another angle to this tale of the confidence once commanded by Lehman. The fund, named One William Street after the bank's headquarters, was managed so cautiously that it was committed to keeping a quarter of its resources in cash. One's first impression upon discovering this is to think Lehman's bosses must have been mad (but probably not mad enough to remit the management fee on the cash). Even then, people bought mutual funds to invest in shares, not cash. The second impression is a reflection that in gentler times, and only thirty years after the Wall Street Crash, risk was something people took seriously.

Caution thrown to the wind

This approach to life in the capital markets went out of the window in the go-go years of the sixties, and although there have been some serious upsets since - notably the collapses of Drexel and Long Term Capital Management - the go-go attitude in investment banking has conquered all before it. Mr Robert Lehman's death in office in 1969, plunged his bank into turmoil. It recovered, but shakily. Traders took over the leadership. Lehman fell into the arms of American Express, which held it for 10 years before spinning it off under the leadership of Richard Fuld, a bond trader.

Fourteen apparently tremendous years later, shareholders funds had expanded from $3bn to $22bn (on top of which towered $670bn of "assets"), and the payroll from 9,000 to 25,000. Average pay per employee was $330,000, which adds up to $9bn a year. This included a large proportion in Lehman shares, but these entailed a real cash cost: to accommodate them; Lehman has over the last five years spent $15bn of real money buying its own shares. A slab of that would have helped Lehman survive, too.

Puff. It's dust. Richard Fuld is gone. Barclays is buying pieces, and will probably judge the Lehman name to be worth keeping. Up to half of the Lehman payroll may have sorted out useful futures with Barclays or other buyers within a few weeks. Not everything in Lehman was for the birds. But there was so much toxic rubbish being generated in the mortgage financing and some other arms of the bank that it simply overwhelmed a $22bn balance sheet.

The boil lanced

Although the immediate consequences could be pretty dire - and assuming not too many more Fannies, Freddies or AIGs turn up round the corner with their hands out for $80bn-$100bn a time (in which case Lehman will be the merest footnote) - the demise of Lehman is a good thing, which we shall all be glad of for the next couple of decades. This is because it will make indelible impressions in the minds of everyone likely to get anywhere near running a bank for the next 20 years. The Bear Stearns burnout did not do this. In the first place, Bear Stearns simply wasn't big enough. In the second, it was "rescued" (although it might not have felt like that to its shareholders and employees).

Investment banks cannot be properly restrained by regulators because ingenuity in the creation of new products - no doubt bolstered by cynicism - outruns regulatory talent and resources. This inevitable imbalance has been ratcheted by 50 years of global prosperity, which works with a multiplier effect in the financial services industry. Continuing prosperity justifies an awful lot of what will only later be recognised as rubbish. Investment banks need self-restraint.

The world might be poorer for a couple of years, but I'd bank on prosperity returning soon. In that case, a generation from now, a newly emerging leadership cadre of investment banks, currently in high schools and universities - their minds unetched by Lehman - will design and sell geared-up monstrosities of financial products. But between now and then, we might see a bit less of this irresponsible nonsense. Fingers crossed.

MORE FROM ALISTAIR BLAIR...

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Alistair Blair is a past winner of the Business Writer of the Year Award, and has worked in investment banking and fund management.

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