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The lessons of Lehman for other banks

Robert Peston | 11:05 UK time, Thursday, 18 March 2010

Lest we forget, Lehman Bros was regarded as one of the world's most sophisticated, well-managed investment banks, just a year or so before it went belly-up.

Investors loved the stock, valuing the bank at more than $30bn as late as January 2008. Financial institutions, including the world's most lauded banks and hedge funds, lent it hundreds of billions of dollars. Regulators trusted that it had the appropriate systems to control the risks it was taking.

Lehman Brothers sign

But it turns out that those at the top of the bank were - to an extent - flying blind about the risks being taken by Lehman. And so too, therefore, were US and British regulators.

That is the inescapable conclusion of the 400-page valuation section of the recent report on the collapse of Lehman by the examiner for the New York bankruptcy court.

That section hasn't as yet received much media attention, because it is much less sexy than the examiner's finding that Lehman shunted $50bn of assets off its published balance sheet, to exaggerate its financial strength, using the highly questionable Repo 105 technique (see my earlier note on this).

And, to be clear, the examiner does not believe that Lehman deliberately understated losses on its loans and investments in a way that could lead to substantial damages claims by creditors.

But his report tells a disturbing story of a bank with $700bn of assets and 900,000 derivative positions woefully ill-equipped to assess whether the values that its traders were putting on their deals were the correct values.

And before I quote one or two choice passages from the report, I will state the bloomin' obvious - which is that trusting the valuations of traders, whose enormous bonuses depend on whether their investment and dealing positions are showing a loss or profit, is as sensible as trusting a bunch of five-year-olds not to eat the sweeties in a chocolate factory.

Now Lehman did have a so-called Product Control Group whose job was to assess the valuations or "marks" put on assets by the assorted business desks. This is what the examiner says about the capability of the Product Control Group in respect of its checks on the prices claimed for collateralised debt obligations, those toxic bonds made out of home loans:

"The Product Control Group did not appear to have sufficient resources to price test Lehman's CDO positions comprehensively. Second, while the CDO product controllers were able to effectively verify the prices of many positions using trade data and third-party prices, they did not have the same level of quantitative sophistication as many of the desk personnel who developed models to price CDOs...
 
"The effectiveness of the Product Control Group was also limited because it did not have the technical sophistication to develop complex models for pricing CDOs, as did certain of the desk personnel (commonly referred to as 'quants') they were charged with monitoring."

Or to put it another way, in the absence of reliable market prices the Product Control Group lacked the intellectual tools to challenge the prices put on CDOs by those who created them.

This is profoundly shocking, and not just for what it says about woeful risk controls at Lehman.

It calls into question the assurances given by those who run all the world's big investment banks that they have reliable techniques to control the risks taken by their employees.

The point is that the bosses of Barclays, Goldman, Morgan Stanley, JP Morgan and so on have never claimed that they personally understand each and every one of the millions of investments that are on their respective balance sheets. Nor could they ever do so. The size and complexity of their businesses would baffle an X-Men style mutant superhero with a brain the size of a planet.

But they do claim that they have highly skilled risk controllers who vet their traders' and bankers' valuations on their behalf. So the really important question raised by the Lehman report is whether these extant banks' respective risk controllers and product control groups are a cut above Lehmans'.

What was the practical consequence of the physical and intellectual under-resourcing of the team that was supposed to keep Lehman's bankers and traders on the straight and narrow?

Well, on one measure some half of Lehman's CDO portfolio was unreviewed in May 2008. Bizarre mistakes were made, such as using a lower discount rate to value tranches of CDO that were intrinsically more risky. And on one securitisation called CEAGO, the court examiner valued one tranche of bonds at 3% of the price put on them by Lehman's Product Control Group.

Here's the important point. We pay money to be passengers in planes not because we have a detailed understanding of all those complex computer and engineering systems that keep planes in the air, but because we are confident that the airlines and manufacturers have that understanding.

The corollary for banks like Lehman is that they are given licences to trade because they are trusted to keep a firm grip on the high complicated risks they are running. The examiner's report should make us ponder whether we've been a bit too trusting, not just in Lehman's case but for all those global mega investment banks.

Comments

  • Comment number 1.

    So why didnt the regulator spot that there was insufficent 'tallent' put to controling the risk? Is it not common sense that one of the first areas you check out is this audit function? Not least because in a highly profit focused company it may be seen as an unnecessary cost and so under resourced.

  • Comment number 2.

    So the chairmen and directors of banks don't really know what is going on? I would at the least the managers of the departments would have a clue, after all they sign off the big bonuses don't they?
    And the banks (in general) portray themselves as being in control and, to borrow the word, prudent.

    Any real world business that was run like this would have been closed down long ago with jail time for all concerned.
    Sorry but this does point out that banks are not safe with my money, I am off to spend up ......

  • Comment number 3.

    None of this surprises me in the least.

    I was once (about 15 years ago)involved in the audit of a major bank (not in the UK). I certainly didn't understand what I was meant to do and I don't think any of my colleagues understood what they were meant to do either. This was treated as normal, they claimed they never knew what they were meant to be doing but it all led to good career opportunities.

    No doubt internal risk control people are usually in the same mess as external ones.

    My experiences have always led me to believe that in most large organisations self and competitive audit regulation is a joke. If governments want things properly regulated they need a national audit and compliance office that actually does the company audits, rather than relying on commercial operations to do them. Until some government owned set up is created expect very little of the regulators.

  • Comment number 4.

    Basically Robert all outside people have had the wool pulled over their eyes.

    All these banks have been telling us they have robust measures in place when its not the case,in my view that is being criminally negligent and people should be jailed, but we would have to build a new jail just for the supposed auditors, like MP's and their expenses, they were all at it, and we need to put in place a mechanism to prevent it happening again.The worrying thing for me is , i dont see that happening.

  • Comment number 5.

    'But it turns out that those at the top of the bank were - to an extent - flying blind about the risks being taken by Lehman. And so too, therefore, were US and British regulators.

    That is the inescapable conclusion of the 400-page valuation section of the recent report on the collapse of Lehman by the examiner for the New York bankruptcy court.

    That section hasn't as yet received much media attention,'


    The problem is that lots of people with vested interests will 'invest' heavily in order to play the reality of what this amounts to down.
    It will be subtly done too.

    Too many people with too much invested won't want to change the system if it costs them dearly, and it would.

  • Comment number 6.

    RP - it's not just the banks. Every CEO I have worked for hasn't really got a clue what really goes on in their business. If they are lucky, nothing happens on their watch. Even if it does, they shrug and take the pay off. Until we have auditors with the force of law behind them able to stand up to these ego maniacs, t'will ever be thus.

  • Comment number 7.

    Most people who deal with the more complex products would admit that assessing risk on them is often akin to guesswork (many of them depend on more than 3 independant variables).
    In addition to this spending days (or months) assessing the risk on a product doesn't drive the bottom line greatly.
    The best thing to do would be to rubber stamp such products with a "risk unknown" stamp.
    If we could ensure the consequences of taking such risks only affected the shareholders and customers of that institution this wouldn't be a problem.
    We need to create far smaller institutions and then we can let the girls and boys play with their unstable toys.

  • Comment number 8.

    "We pay money to be passengers in planes not because we have a detailed understanding of all those complex computer and engineering systems that keep planes in the air, but because we are confident that the airlines and manufacturers have that understanding."

    And yet, planes still crash.....

    But we also need to understand that the ethos of management now in all sectors and in both public and private sector, is that committees are formed, working groups meet and so there is no one person to take responsibility should anything go wrong. Instead we hear the most annoying phrase of modern times 'Lessons must be learnt"

    So the management ethos needs to change, not necessarily the control points, in public and private sectors so people a) have control and b) accept the responsibility of that control

  • Comment number 9.

    The entire 'investment bank' side of the global financial system is toxic. Separation now.

  • Comment number 10.

    I don't buy the suggestion (made here and everywhere else) that they didn't know what they are doing. I don't believe "under-resourcing of the team that was supposed to keep Lehman's bankers and traders on the straight and narrow" is not a mistake.

    With the amount of money those in position of decision make in bonuses it's not hard to believe they will close an eye when they are about to see something that will affect that bonus. The personal risk they take is tiny compared to what they could benefit.

  • Comment number 11.

    Nearly every big bank collapse seems to have at it's core either a mispricing of risk or not even knowing about it (Think Barings) To some extent it's theoretical, each individual trade either wins or it doesn't. What perhaps is needed is a standard valuation of exposure and these to be calculated with some form of external auditing. That could be simple headline figure in management accounts. It would help keep perspective

    It would at least give boards information on which to make decisiuons

  • Comment number 12.

    'Or to put it another way, in the absence of reliable market prices the Product Control Group lacked the intellectual tools to challenge the prices put on CDOs by those who created them.

    This is profoundly shocking, and not just for what it says about woeful risk controls at Lehman.

    It calls into question the assurances given by those who run all the world's big investment banks that they have reliable techniques to control the risks taken by their employees.'


    It does indeed, and I for one don't believe that this can have escaped your experienced notice before now. So as 'profoundly shocking' is unlikely to be you being ironic, I don't find your choice of words credible.

    This point about strategic intentional opacity through apposite deployment of staff in order to facilitate 'Planned Chaos' (deregulation/economic anarchism) and plausible deniability, has been raised over and over and over again as being endemic.

    Why has it so often been met with protestation, rage, derision or most recently, censorship? Do those concerned resort to legal threats?

  • Comment number 13.

    Regulators trusted that it had the appropriate systems to control the risks it was taking.
    I make no apology for emphasising Ernst and Young’s actions here.
    E+Y's role was not to trust but to audit and give an opinion whether Lehman’s management had the appropriate systems to control, were in place.
    Why, in the annual report of Lehman’s did E+Y come to the opinion that the use of repo 105 wasn't even relevant to mention anywhere? To get things in perspective there were around 30 pages of notes to the financial statements of Lehman’s including sections for accounting policies used and off balance sheet items. E+Y clearly were very aware that the classification of "sale" would not have been accepted in the country where the accounts were published but did not mention this.
    Why did E+Y not even mention the use of Repo 105 in the accounts of the UK company which was the tool for these window dressing activities and even more significant to this company’s accounts and audit.
    Why did the experts in Auditing seem at best to be looking in the other direction rather than seeing that the extent of rep 105 amounted to 50bn dollars of off balance sheet accounting?
    Why did the experts in giving an opinion on adequate controls used by management not even CDO's were too complex to actually value or that the business plan of short term borrowing against long term lending had an inherent risk potentially of terminal proportions
    How did the detailed practice of using a UK company and a UK legal opinion letter to a UK company to carry out theses window dressing come about by management in the USA? Why did Lehman’s management seem of the opinion that E+Y would accept not detailing this activity?

    Why did E+Y seem give such reliance on a letter clearly to a UK company to the world wide group

    Did E+Y, who earned at least 100's of millions in "advice" to Lehman’s play any part in Lehman’s management decision to carry out these activities.
    Why did E+Y’s management seem to feel that a sentence along the lines of “accounts were prepared in accordance with generally accepted accounting practice” would be sufficient to exonerate them in this matter?
    In "Fairness" to E+Y it seems that none of the other big 4 audit companies have even gone as far to say that E+Y have big questions to answer here
    I reiterate that allowing:
    relationships between auditors and company’s to develop, auditors to audit their own company's advice and services, secrecy to the discussions between auditors and their clients, having auditors earn huge multi million / (billion)$ fees from their client and the incentive to keep these fees going all have very clear potential conflicts of interest to say the very least

  • Comment number 14.

    1. jan 'So why didnt the regulator spot that there was insufficent 'tallent' put to controling the risk?'

    Probably because they (the SEC) like us didn't have enough talent - by design?

    Why does this happen? It's a very long, elaborate, population dumbing down story, of right-wing (anarchistic) promotion of equalitarianism, plus furious rage if one dares to point out the fallacies and their consequences - as for some, those consequences are exactly what they wanted in order to make easy money.

  • Comment number 15.

    > The point is that the bosses of Barclays, Goldman, Morgan Stanley, JP Morgan
    > and so on have never claimed that they personally understand each and
    > every one of the millions of investments that are on their
    > respective balance sheets. Nor could they ever do so. The size and
    > complexity of their businesses would baffle an X-Men style mutant
    > superhero with a brain the size of a planet.

    And those bosses are not rocket scientists, after all, but just feeble-minded money-men. That's why we have to break them up, to the point where mere bankers can grasp the entirety of their business.

    Break them up now, and pin personal liability firmly on the money men. Never again will they come this close to doing us all in. The perps still have to get used to it – the good old days are dead and gone.

  • Comment number 16.

    There is a reason that explosives are regulated. If bankers have a tendency toward dishonesty we should not allow systems to be used that are not understood by the regulators. It seems a bit odd that the governments hestitate to regulate this industry that has caused such global problems and burdened the taxpayers with future debt and current buedgetary problems and shortfalls.
    For Lehman it was clearly a decision of wrong doing that was knowingly supported by the leadership...some might view this as criminal. Looking at the other institutions that operated in a similar fashion would be instructive as well as there are certainly indications that this was an industry wide collusion. The banks argue that they will reform themselves, although they have said that before. They fail to admit or take responsbility for what they have done. The governments are weak and unwilling to protect the investments of the people in exchange for contributions to political campaigns. Had bankers gone to jail their attitude might be more accomodating.

  • Comment number 17.

    Robert,

    What a great post.
    Thanks

    But one question ?

    How could the auditors sign off the accounts if the accounts did not have a proper basis in reality ?

    Looks like an extreme and sanctionable failure by the auditors.

    As your post implies, this leaves us with the question of how many current banks, and as importantly their auditors, are still running with the same gross failing ?



  • Comment number 18.

    Yes Robert, your last 2 paragraphs could apply to many banks.
    Slightly off-topic, but the very interesting BBC2 programme "Requiem for Detroit" showed what can happen when "big management" gets it wrong.
    US car manufacturers stubbornly insisting on turning out "gas guzzlers", when the US people wanted more fuel-efficient cars, and so turned to European and Japanese imports.
    Much of Detroit is now a ghost town,....unemployment, crime, cocaine and arson finished it off.....and much is being turned into "urban farms".
    Bank directors should take note.....were they trying to do to the UK what happened in Detroit?
    They nearly succeeded.
    Lehmans may well have been chosen by the US government to act as an example to all the other banks.....in other words, get your act together, public bail-out is not absolutely guaranteed.

  • Comment number 19.

    Looks as if we must add incompetence to greed. The current and future management of banks are and will continue to be motivated by the extraordinary wealth that a few years in the hot seat can bring - both salaries/bonuses and pay offs/pensions. That is why banks and finance institutions need suppervision and governance needs to be legally enforcable so that serious misdemeanors can and do result in personal liability and/or prison.

  • Comment number 20.

    Always, the answer is that those who are insiders in positions of power use that power only for self-aggrandisement. This is a feature of society. It is the rich who get richer and the poor that pays.

    Specifically the nature of regulatory permission to trade is that to be able to make vast profits out of the rest of us first you need the permission from some regulatory body to trade and without it you can't start. This is the cause of the Lehman and the banking crisis and collapse. If anyone could trade then the market would be dynamic with banks going bust left right and centre, but there would be a market. There is no market in banking it is a rigged cartel at best and an appalling monopoly at worst.

    PS Thinking of setting up a bank myself, again! Borrow at zero interest lend 10 to 20 times the capital at 18 percent (no-mortgage holders need apply) seems a sure thing to me.

  • Comment number 21.

    @jan (#1)
    "So why didnt the regulator spot that there was insufficent 'tallent' put to controling the risk? "

    The trouble is that the underresourcing and lack of talent described by Robert within Lehmans applied in spades to the FSA. They paid peanuts and got monkeys, as anyone who was any good could get a much better salary working for a bank's risk department.

    There were some good people at the BoE who had a fair idea of what was going on, but since Brown stripped them of their regulatory powers all the BoE could do was make grumpy noises. The FSA had the power, but no inclination to use it because they couldn't see that there was a problem.

  • Comment number 22.

    This comment was removed because the moderators found it broke the house rules. Explain.

  • Comment number 23.

    "Lest we forget, Lehman Bros was regarded as one of the world's most sophisticated, well-managed investment banks, just a year or so before it went belly-up."

    Errr...maybe by the meeeja, but not by anyone who actually worked in the City, it wasn't. LB was always known as the most dodgy, corner-cutting bank (after Bear went).

  • Comment number 24.

    Lessons for the public are

    "Where there is money there will be incompetence, arrogance, greed and fraud".

    "They will do to you and your society and your country what they will never do to themselves."

    "They will do for themselves which they will not do for you and at your expense."

  • Comment number 25.

    5. At 11:52am on 18 Mar 2010, Statist wrote:
    The problem is that lots of people with vested interests will 'invest' heavily in order to play the reality of what this amounts to down.

    Statist how did you make that loverly link ?

  • Comment number 26.

    Thursday. Banking.

  • Comment number 27.

    6. MonkeyTallyTops 'Every CEO I have worked for hasn't really got a clue what really goes on in their business. If they are lucky, nothing happens on their watch. Even if it does, they shrug and take the pay off. Until we have auditors with the force of law behind them able to stand up to these ego maniacs, t'will ever be thus.'

    But electorates across the liberal-democracies (including the USA colonies of Japan and S. Korea) do not want this. This is statism that you are tacitly referring to, and the electorates of these countries have been educated not to vote in that direction for decades (it is reinforced by subtle propaganda all the time once they leave formal education). The bogeyman was the USSR, and before that it was Germany. That's why we have the mess that we have today. Those who rise to high positions are the least likely to do so in any statist regime, i.e they are anarchists. This does not mean that they intend to behave so, they just naturally find themselves in these sinecures because of their talents and dispositions. That's why so many people are so cynical, not that they fully understand why either!

  • Comment number 28.

    So Robert, we are expected to trust bankers and financiers?
    What's the word that springs to mind - "Enron" - or am I mistaken? Haven't they just produced a musical based on this company?
    Which is about the best you can say for the financial control of these companies.
    Well, at least the story of financial control in this country and elsewhere will entertain future generations. They will be laughing their 'socks off' (that is assuming that they can afford cinema seats in the future).

  • Comment number 29.

    Which is why The Volker Rule (or Glass-Steagal by another name) is needed ASAP, together with leverage limits across the financial industry.

    It's simple really, isn't it? So where is it? And where's the public CDS exchange? They don't want it, these banksters, do they? So it isn't happening is it?

    I think you guys in the media really need to start shouting about this now, Robert.

  • Comment number 30.

    "Still, the tale has a happy ending. Lehman Brothers eventually went belly up. ... The name of Lehman Brothers was for ever struck from the business cards of Wall Street." Liars Poker

    One of the previous times Lehman Brothers went bust. This quote was from 1984.

  • Comment number 31.

    18. stevewo 'Much of Detroit is now a ghost town,....unemployment, crime, cocaine and arson finished it off.....and much is being turned into "urban farms".'

    Unsurprisingly, as that was all on the cards long before the public ever began to pay attention.

    Sadly, most people still don't want to know (to the best of my knowledge), and even when they do, most expect someone else to be able to do something about it, even though, in practice, they've actually been arguing (and voting) for 'freedom' (the very opposite) for decades.

    People eh? Queer creatures.

  • Comment number 32.

    Regulators trusted that they had the appropriate systems to control the risks that were being taken. How do Regulators regulate when there is no Banking Regulation in the United States. Do they just give their opinions?
    When you understate losses, surely you are trying to keep your head above water & not even thinking about substantial damage to anyone or anything. I'm surprised the Report (in this specific area) did not call a spade a spade.
    Don’t you remember The Federal Reserve Bank holding an emergency meeting one FRIDAY NIGHT to discuss the future of Lehman Brothers Holdings Inc. Timothy Geithner was there and so was Henry Paulson. From out of this (somehow) came: TOO BIG TO FAIL!
    The Wall Street Journal:
    "The meeting began at 6 pm but precise details about what was discussed could not be learned. The meeting appeared similar to one a decade ago when the New York Fed pulled together top Wall Street executives to prevent the collapse of hedge fund - Long-Term Capital Management.”
    When Long-Term failed, Wall Street feared it would cause a financial domino effect. When LTCM could not raise capital, Goldman Sachs, AIG, and Berkshire Hathaway offered some kind of assistance, the details of which I no longer recollect, and it doesn’t matter because the Federal Reserve Bank organized a bailout of over 3.5B to avoid a wider collapse. This intervention taken by the Feds was unfortunate because it encouraged financial institutions to get even RISKIER under the assumption that the Federal Reserve would bail them out. This was a “moral hazard”.
    Trusting Lehman to control its own risk is like telling a doctor to operate on himself. As for the Product Control Group lacking the intellectual tools to challenge the prices put on various investment products, I can’t accept that. I (me) - a lowly, ordinary person - can follow a default swap; I don’t like doing it. It’s convoluted; it gives me a headache, but my point is - if I can follow this twisted accounting and tell you it’s not worth the paper it’s written on, don’t try to tell me the billion-dollar boys at Goldman or Lehman don’t have the intellectual tools.
    1. Investment banks must never be married to deposit banks. This is financial incest.
    2. All banks need regulations, operating rules, but especially Investment banks need tight regulation because too often they run on one rule only - Greed. These rules should come from the central financial authority for the country of operation and the individual applications should be subjected to audit.
    Barclays, Goldman, Morgan Stanley, JP Morgan and so on may claim they couldn’t possibly understand the bets being placed. This is tantamount to allowing someone to perform surgery on a patient when the “someone” has no medical qualifications. Give me a break – these big bail-out boys knew exactly what they were doing, knew exactly what they were hiding... and they did it very well – right through to the public bail-outs.
    If they had highly skilled risk controllers why did Lehman fail?
    If the group was under-resourced, whose fault was that?
    I love your example of the review (and remember I am not a certified accountant):
    “Bizarre mistakes were made, such as using a lower discount rate to value tranches of CDO that were intrinsically more risky. And on one securitisation called CEAGO, the court examiner valued one tranche of bonds at 3% of the price put on them by Lehman's Product Control Group.”
    This cannot be a mistake! This cannot be due to misunderstanding!!
    Think about it: one tranche of bonds: actual value about 3% of the price put on them by Lehman's Product Control Group. This has got to be intentional. The Control Group missed the mark by 97%!!
    The examiner's report should make countries with non-existent regulation (like the USA) want to put in Banking Regulation toute suite. So, after all this time, after all the world's financial suffering, has the United States implemented any Banking Regulation?
    NOPE, but I hear something is making its way through Congress...

  • Comment number 33.

    Robert, great post, and seriously worrisome.

    Imagine the (multi-billion quid) premier league being refereed by someone who doesn't even understand the rules of the game? All hell would break loose. But banks see non-comprehending referees as a divine right, and they've just put several hundred goals past our 'rest of the world' team.

    There's obviously no off-side rule in finance, nor how may players they can put on the field, nor a clause preventing the blind from arbitrating.

    It would be funny if it hadn't ruined millions of lives.

  • Comment number 34.

    20. John_from_Hendon 'Always, the answer is that those who are insiders in positions of power use that power only for self-aggrandisement. This is a feature of society. It is the rich who get richer and the poor that pays.'

    Always? Do you have any evidence for that in The People's Republic of China or Iran, or are you just thinking about the Liberal-Democracies? I ask because I suspect it's a structural/systemic issue, and it's that which makes it so hard to deal with. Many of those concerned don't, I suspect, see themselves doing anything 'wrong'. It may be venal in many people's eyes, but as Irwin Stelzer rightly said (on a Newsnight special on the Credit Crunch as I recall) it's legal, and hence, by implication (and he didn't say this bit) it's a structural problem, and one which won't be changed easily in the current system, given that it is this way by evolution/design. :-(

    I reckon the Chinese know this, and I wouldn't be surprised if the rest of the SCO isn't a player too,

  • Comment number 35.

    RP wrote: "But it turns out that those at the top of the bank were - to an extent - flying blind about the risks being taken by Lehman. And so too, therefore, were US and British regulators."

    I am not sure I buy into this analysis. Surely the Board's job is to manage and measure the overall business. They can't know each and every deal (witness the Baring's debacle) but they should surely know the overall risk position of the organisation.

    In 2008 Lehman Bros $25 billion of capital was supporting $700 billion of Assets - a gearing of 28:1. Why did this not sound some alarm bells with not only the Regulators but also the Auditors E&Y?



  • Comment number 36.

    Undoubtedly we suspected this all along - but when such matters are brought out into the light of day, it really does make one realise how we as a people - that's all of us in the UK here at least - have handed over control of "our" money system to these guys, and the extent to which we are getting ripped off.

    The connection between the deceptions these guys are perpetrating and the enormous amounts of money they make from their crimes, and what if any impact it makes to the average man in the street may seem difficult to establish, but it is undoubtedly there.

    It is insidious, and affects just about everything, making ordinary products more expensive than they really are, increasing the cost of companies investing in things that actually benefit their customers, reducing the returns made by ordinary people on their pension contributions, increasing financing costs to productive companies, lowering the effective interest rate paid to savers, increasing the overall cost of ordinary mortgages.... the list goes on.

    It's only the very first step of the solution to break these guys up into smaller units.

    But which political party is going to have the guts to do something about this?

    Brown and Darling are terrified of the City and are basically patsies pretending to do something significant when in reality they just want to leave things as they are, and for the 'whole awful problem just to go away....'.

    Cameron obviously cannot do anything serious given Michael Ashcrofts presence as a non-dom and the fact that Michael Spencer has such close connections with all these investment banks.

    We need to hear from Vince Cable....

  • Comment number 37.

    "Lest we forget, Lehman Bros was regarded as one of the world's most sophisticated, well-managed investment banks"

    ...and yet they invested a small fortune in LTCM

    What is your definition of 'well-managed' Robert?

    "Investors loved the stock, valuing the bank at more than $30bn as late as January 2008"

    Proving exactly what investors know....

    "But it turns out that those at the top of the bank were - to an extent - flying blind about the risks being taken by Lehman. And so too, therefore, were US and British regulators."

    Flying blind - or turning a blind eye? Dick Fuld remembered LTCM as he was there at the time - so why did he think investing in CDO's was any different. Didn't the element of 'money for no risk' start alarm bells ringing?
    I'm sure they're all very sorry - but they cannot use the excuse of "I didn't know sir" - they all knew perfectly well.

    "
    « Previous | Main
    The lessons of Lehman for other banks

    Robert Peston | 11:05 UK time, Thursday, 18 March 2010

    Lest we forget, Lehman Bros was regarded as one of the world's most sophisticated, well-managed investment banks, just a year or so before it went belly-up.

    Investors loved the stock, valuing the bank at more than $30bn as late as January 2008. Financial institutions, including the world's most lauded banks and hedge funds, lent it hundreds of billions of dollars. Regulators trusted that it had the appropriate systems to control the risks it was taking.

    Lehman Brothers sign

    But it turns out that those at the top of the bank were - to an extent - flying blind about the risks being taken by Lehman. And so too, therefore, were US and British regulators.

    That is the inescapable conclusion of the 400-page valuation section of the recent report on the collapse of Lehman by the examiner for the New York bankruptcy court.

    That section hasn't as yet received much media attention, because it is much less sexy than the examiner's finding that Lehman shunted $50bn of assets off its published balance sheet, to exaggerate its financial strength, using the highly questionable Repo 105 technique (see my earlier note on this).

    "And, to be clear, the examiner does not believe that Lehman deliberately understated losses on its loans and investments in a way that could lead to substantial damages claims by creditors."

    Oh I bet he doesn't - I mean you wouldn't want to suggest that banking was full of crooks now would you?

    "which is that trusting the valuations of traders, whose enormous bonuses depend on whether their investment and dealing positions are showing a loss or profit, is as sensible as trusting a bunch of five-year-olds not to eat the sweeties in a chocolate factory."

    Except children aged 5 won't eat the sweets if you tell them not to - but banks cry about their maturity and their ability to regulate themselves. In this case 5 year old children would have been better in charge.

    "Or to put it another way, in the absence of reliable market prices the Product Control Group lacked the intellectual tools to challenge the prices put on CDOs by those who created them."

    Oh surprise surprise, the banks suggest a self regulatory body - and then fills it with ill-equipped dullards who are easily bamboozled by the front office.
    It's the same method by which Wall street chooses the Federal reserve chairman. A 'don't rock the boat' man who will happily ignore the most obvious signs of impending doom in order to maintain a quiet life.

    ...now remind me again - the solution to all our banking problems?? - oh yes, a new regualtor with new equipment and shiny new offices.

    A complete waste of taxpayer money.

    "This is profoundly shocking, and not just for what it says about woeful risk controls at Lehman."

    ...but Robert - are you not experienced in the City? How can you have worked here and not realise that risk management is a joke? It's simply box ticking (or maybe a box ticking!):

    FSA: Have you got a risk department
    BANK: Yes sir!
    FSA: Good, then we'll not look into this any further...

    "But they do claim that they have highly skilled risk controllers who vet their traders' and bankers' valuations on their behalf."

    ...who strangely get paid a fraction of those same traders mmmmmm - how good did you say they were again? - not really shown by their status now is it?

    "The examiner's report should make us ponder whether we've been a bit too trusting, not just in Lehman's case but for all those global mega investment banks."

    WHAT???? - You're pondering that NOW???

    Where have you been for the last 3 years? Are you the same Robert Peston Business editor?

    It's interesting that the 'major players' admit they have no idea about where everything is invested - is that an argument for much, much smaller banks? It seems this is an admission that bigger is uglier and more stupid.

    Never mind, lets hope Jamie Dimon is able to do something about California defaulting - because unlike Greece, JPM has an (in)vested interest there.
    As the Governor said - "Hasta la vista baby"

  • Comment number 38.

    Excellent and very informant post from Robert - shame you then spoil it by the following piece of inanity

    "Bizarre mistakes were made... And on one securitisation called CEAGO, the court examiner valued one tranche of bonds at 3% of the price put on them by Lehman's Product Control Group.
    "

    The Lehman Product control group no doubt valued them when the LB entered into the bonds and should have revalued them regularly but what was the time gap between the last value done by the PCG and the court valuer. The point is that both valuations may well be completely accurate and correct at the time the valuations were made. If the bonds were lower level bonds in a tiered structure and therefore subject to high risk of principal default on, for example the American property market declining, it may well have been entirely correct to value them at face value in say May 2008 but by December would be valueless. I am sure you have heard of the concept of investments may go down in value as well as up.

    Please try harder

    (B+) from you economics teacher

  • Comment number 39.

    Sometime planes crash, it doesn't mean that all engineers are a bunch of feckless, money grabbing charlatans.

    Every day we get out of bed we take calculated risks, almost every decision we make requires an acceptance that the outcome may not be as we expect but we have to make those decisions else we never get out of bed.

    When you made the decision to break the story on Northern Rock, what was your motivation, what risk assessment did you carry out on the potential consequences of your actions, did you care how your actions might impact on other people or were you blinded by self interest and a potential career defining 15 mins of fame?

  • Comment number 40.

    3. At 11:36am on 18 Mar 2010, TimBJones

    ...and I have been on the other end of such audits.

    It's not difficult to fool the auditors and the bank is always willing to assist in the disguising of clear risks. Failure means....well you have to improve for next year.

    I remember one problem which was picked up 3 years in a row before it was finally resolved - there was no consequence to failing the item in question.

    ...and as for portfolio risk - well you find me a risk manager who hasn't been told to 'get back in his box' by one of the 'masters of the universe' who arrogantly swagger around with their 'I earned £600 Billion for this company last year' attitude.....and yet did not lift a finger to do so.

    From the top to the bottom, we're all culpable - it's just that some are more aware of their influence than others.

    However stupidity is not an excuse for abject failure.

  • Comment number 41.

    9. At 12:00pm on 18 Mar 2010, the_fatcat wrote:

    "The entire 'investment bank' side of the global financial system is toxic. Separation now."

    The only practical solution for a toxic infection is amputation. Cut off banking and allow it to die away from the body (Economy).

    Seperating it now is too late - the debt has already infected Government balance sheets and they will be next to wither and die.

  • Comment number 42.

    26. At 1:37pm on 18 Mar 2010, superseasideman wrote:

    "Thursday. Banking."

    This isn't banking - this is CRIME

  • Comment number 43.

    I remember at school we played this game where we pretended that something really important was written on a piece of paper and sold it on under the strict condition it was kept secret, the message was, "you are a mug. To stop being a mug you need to sell this on for more money"
    stupid i know but it was a bit of fun at the time

  • Comment number 44.

    You can bypass the media and go straight to the u-tube truth.

    Find the rest of this series showing how bad it really is in the US - and not one mention by any British MSM.

    http://www.youtube.com/watch?v=kin61s3dAZo

    This really is the greatest depression.

  • Comment number 45.

    25. Alesha Soba 'Statist how did you make that loverly link ?'

    On a Windows machine, right click on the time of the post you wish to link to in order to copy the short-cut, and then ctrl V to paste it in as a link (or embed it if you wish) in your post.

  • Comment number 46.

    #21 So you are saying that the politicians had no idea what they were doing either! That figures.

    Im available for any of these high powered well paid jobs, no idea about banking or politics so superbly qualified.

  • Comment number 47.

    Maybe Lehmans (ex)staff should take a tour of their destructive wake.

    Detroit perhaps?

    http://www.youtube.com/watch?v=QgnIAUepGUQ&feature=PlayList&p=D74672EB4ACE4679&playnext=1&playnext_from=PL&index=4

  • Comment number 48.

    RP " the court examiner valued it at 3% "

    So he was intelectually capable of the valuation.

    Are the bonuses paid on the basis of an internal valuation of 97$ more than actual?

    Do the credit rating agencies have enough intelectual capacity to give a true rating?

    Despite a warning in 2002 from Warren Buffett about derivatives the system went over a cliff and even now we are on the same course so it will all happen again.


  • Comment number 49.

    39. At 3:50pm on 18 Mar 2010, FearandLoathing wrote:

    "When you made the decision to break the story on Northern Rock, what was your motivation, what risk assessment did you carry out on the potential consequences of your actions, did you care how your actions might impact on other people or were you blinded by self interest and a potential career defining 15 mins of fame? "

    Oh that's rich - so Robert caused the crash in your world did he? I suppose if he had kept quiet the LIBOR would have quietly subsided and everyone would have gone back to business as usual....

    Yeah right - maybe in Disneyworld but not in the real world.

    Blaming Robert is like the MP's who blame the media for their expenses debacle - sure the media are irritating by going on about it all the time but it was your actions which have allowed them to do that!

    ...just as it was the actions of the NR board which led to it's downfall - and not Robert.

  • Comment number 50.

    You should all look at the link at 44.

  • Comment number 51.

    Having worked in three of the clearers and also trained as an auditor I have some appreciation of finance. Firstly Mr P. you seem to feel that those at the top do not need to understand their business fully. I would suggest if they cannot they should not be doing business. I do not read financial papers all the time however I believe I can follow the intricacies reasonably well - certainly well enough to see what is bogus.

    And then again people paid on results have ALWAYS been suspect parts of any organisation.

    However fundamental to this is that the risk reward equation is absurd and the only way to cure this is jail/gaol sentences for those with the power to put matters right - that is the top board. Now to prevent legal shenanigans I suggest that an arbitrary rough justice of "should have known" be adequate for conviction from a "Star Chamber". I am sure that all of a sudden odd financial instruments will die a very quick death. Rather like Admiral Byng there should be examples made.

  • Comment number 52.

    Didn't one of the top bankers spend his time playing golf, partaking of dope and with no experience of banking was given his job because he, like the top-dog interviewing him was a fanatical bridge player? And wasnt the risk executive, Paul Moore, at one of the UK banks forced out because he was telling it as it is?

    I don't think this is a banking problem - it's a management problem common to probably every industry. I've seen it time and again, and I bet most of us have. We've all watched the people who play the game, smooth talking and charming their way around but yet have no fundamental understanding at all of what they are really supposed to be doing in the work place climb higher and while they do so destroy the very company they work for out of sheer incompetence. Woe to him with the job if identifying and insisting the internal problems are dealt with.

    In my book it is a dishonest method of running businesses. Running a bank in such a way is just as dangerous as running a pharmaceutical company so poorly. If the drug companies face such stringent regulations and monitoring, then why not the banks?

  • Comment number 53.

    42. writingsonthewall 'This isn't banking - this is CRIME'

    What's the offence?

    You need to tone it down and recognize that this is essentially a ubiquitous structural problem within liberal-democracy. It's venal, but not illegal. Putting people into positions which over stretch their resources so they can't curb other people's financially productive behaviour could be seen by some as very good management if the returns are good, and, prima facie, the company satisfies inspectors/auditors in terms of compliance regulations.

    Remember this, and this and this?

    If you roll back the state, there's a price to pay, and it will be the public which pays here, not our politicians/bankers etc. They only take responsibility when there's credit involved!

  • Comment number 54.

    From the above linked June 2005 BBC article on the FSA and Blair's letter:

    'There is growing scrutiny of how the FSA investigates cases of misconduct and mis-selling by the 30,000 financial services companies and 100,000 industry professionals it regulates.
    ...
    The FSA is charged with protecting consumers

    Gripes are expected to range from the escalating costs of complying with regulation to what some regard as inappropriate and unproductive guidelines which have no clear benefit to consumers.
    ...
    The FSA says it is addressing concerns about red tape, trying to identify what costs are solely attributable to FSA statutes, seeking to eliminate obsolete guidelines and finding alternatives to regulation.

    "We are totally committed to the deregulatory agenda," an FSA spokesman told the BBC.

    "We would be very concerned if there was any evidence that our regulation was harming businesses."


    And just to put those figurs above in context, this is form the Time sin 2007:

    "The Financial Service Authority (FSA) is set to slash staff numbers.

    The move is designed to free up cash to attract higher-quality personnel but has raised concerns that the City watchdog will lack resources to fight market abuse.

    About 30 per cent of the organisation’s 200 enforcement staff will leave this year, Margaret Cole, the head of enforcement, said.

    The move is expected to lead to a net 20 per cent decrease in headcount at the key unit."


    The Times August 2007

    Does everyone get the picture?

  • Comment number 55.

    Re. post No 10: I fully agree.
    J. von Neumann wrote before WWWII that he does not believe in ‘stupidity of stock exchange boys’.

  • Comment number 56.

    Thank you Statist. I think I’ve got it. You’re a day at the beach

  • Comment number 57.

    No I haven't. How do you get to rename the link ?
    I managed to do it in the WP but when I copied it into the post area, no link.

  • Comment number 58.

    Calling them Investment Banks is where the problem lies. Investment is about lending money to businesses, whether to increase the profitability of the business or to take it over (or merge) to create something even more successful. It has an honourable (if not perfact) history and we would all be poorer without such activity. Money was the lubricant that enabled other businesses (manufacturing or service) to flourish. Lending money to people on benefit or sums equal to 5x income is just plain stupid. To be successful all you have to do is to decide whether the risk associated with the investment is sound.

    This rather old fashioned view of money has been taken over (excuse the pun) by the illusionists. They have created another way of regarding money. This way has created Blaine Banks - named after the illusionist. In Blaine Banks these 'talented' bankers take a sum of money, do something very clever and lo and behold the money appears (repeat APPEARS) to have doubled! They need to do these very clever tricks because they weren't doing their investment job properly.

    The excuse that CEOs (or even regulators)cannot be expected to understand all these tricks may have some validity. However any parent whose child suddenly has a new iPod would be deeply suspicious and will be more concerned than those charged with financial checks and balances appear to have been. I suppose they did not want to appear to be too thick to understand these money doubling tricks. When we watch David Blaine we know it is a con and wonder how he did it. When it comes to Bankers we are conned not only by the result of the trick, but also that it is for real. Correction: most of us were never conned, but the regulators were.

  • Comment number 59.

    Possibly a more serious issue that is being, mostly, overlooked is that the Federal Reserve Bank failed to report that Lehman's consistently failed their stress tests thus conniving to deceive the public, investors et al. Who can trust the Fed as a regulator going forward. avenews.org.uk

  • Comment number 60.

    Re: 27 Statist. You suggest I am tacitly referring to statism in my original post. My understanding of this term (but correct me if I'm wrong) is that statism is about taking economic power to the state at the expense of individual economic freedoms. If this is correct, then I think you're misinterpreting what I said.

    What I was driving at was that we need to empower auditors more so that they can become the effective checks and balances that they currently are not. The only way I can see this happening is via some form of authority and corresponding sanction through law. This has to be greater than the current regime of (possibly ex-USA) rare commercial penalties for auditors and miscreant Boards. I don’t think that this impinges upon individual economic freedoms. In fact, if confidence is based more upon actualité rather than perception, I suggest it could actually promulgate such.

    Always interesting to see how others interpret your words, isn’t it?

  • Comment number 61.

    posts 37,49,421

  • Comment number 62.

    Check out "Smile or Die" by Barbara Ehrenreich - she makes a pretty good case that these guys were "flying blind" because they chose to, and shot any messenger that might have given them a less "positive" appreciation of the risks they were taking.

  • Comment number 63.

    60. 'What I was driving at was that we need to empower auditors more so that they can become the effective checks and balances that they currently are not. The only way I can see this happening is via some form of authority and corresponding sanction through law. This has to be greater than the current regime of (possibly ex-USA) rare commercial penalties for auditors and miscreant Boards. I don’t think that this impinges upon individual economic freedoms. In fact, if confidence is based more upon actualité rather than perception, I suggest it could actually promulgate such.

    Always interesting to see how others interpret your words, isn’t it?'

    I know what you were driving at, I was trying to make it clearer for you.

    Liberal-demcoracy is anarchistic, i.e. it rolls back the state (regulation) in the interest of greater freedom for the individual (business). Once one starts asking for more regulation/auditing one is asking for more statism. Simple.

    Clearer?

    You will find many people out there playing very deceptive games with words to push this continuum one way or the other. We live in an anarchistic liberal-democracy. The Chinese do not.

    Look up Masters of The Universe, Newsnight, September 19 2007.

  • Comment number 64.

    62. dinosaur 'she makes a pretty good case that these guys were "flying blind" because they chose to, and shot any messenger that might have given them a less "positive" appreciation of the risks they were taking.'

    It can't be proven can it? That's the problem. People will just feign lack of awareness of the consequences of their action. The reality is that we judge people by the consequences of their actions, by commission and omission. It's just that latter is much harder to identify, so here it has been deployed most skillfully.

    It happens. End of story. It will continue to happen until the system changes dramatically. Will that happen? Do pigs fly?

    I reckon it will take a major collapse before this changes. Our demographics are taking us that way.

    Mr Peston, Ms Flanders etc are not listening to the right people because they are too enamoured by/indebted to the celebrity culture in my view :-(

  • Comment number 65.

    re 61 - getting a little worried about the moderators - there I was just about to agree with WOTW and half the post disappears. Anyway absolutely agree with WOTW's posts on this subject.
    Sorry.
    TM StH

  • Comment number 66.

    The last commentator opined "I reckon it will take a major collapse before this changes." True, too true in fact.. The problem is, we'll inevitably have another collapse and then another mess up followed by another disaster... And why is that you may rightfully ask? Well unfortunately, the entire way that money is created in a fiat fractional reserve banking system, to be euphemistic about it, is highly suspect in and of itself!! I mean, think about it, we have a system wherein if someone deposits £1 into his Bank of Joe Bloggs account, bam! kazaam! and the bank, using just this £1, can create - OUT OF NOTHING! - £10!, £15! - whatever the fraction is at the time and then LEND OUT the said £10 or £15 on the back of this £1! Amazing... What though, in my opinion, is even more galling is that absolutely no attempt is ever made to educate the public as to how currency is created, of how it comes into being, of how dodgy and dubious our entire debt based money system actually is.

    Concurring with the older comment, a disaster is probably needed before something is done. But,, please please please can something be done to remove and kill this dodgy fiat currency dragon rather than merely give a hair cut or a new set of clothes to hide its ugly exterior.

    Change in the very fundamental way that we create money is required. We have to learn and analyse this monster that we, as a society, have created, we have to understand how money comes about and also educate others. Once there is a critical mass of people in the know,, then hopefully, hopefully, we can then consider thinking up a better way of creating money - otherwise - disaster will follow disaster - its only natural - its in the very nature of the beast - it is in its nature to bellow fire regularly! I mean, can you really ask a dragon to refrain from squirting jets of flame everywhere and sincerely hope that it will permenantly desist? Cos if you do, you need a lobotomy my friend!

  • Comment number 67.

    63 Eat yourheart out Tom Woolfe!

  • Comment number 68.

  • Comment number 69.

    The confidence in banks has never been that high as the need connected to their services. The share prices fluctuate continuously, which does not necessary mean a collapse, instead, a critical point, which can be recovered in time. In the history of banks many have been collapsing and recovering on a regular basis, but only few of them disappeared. As long as we can still get financial aids from them to manage our lives the most important matter is not trust but utility.

    See MoneySupermarket

  • Comment number 70.

    The trust in banks and financial institutions is always fluctuating. Not only world leading banks have difficulties in management and understanding, but small, local banks and institutions also. Everyone should understand this and act wisely. Not the trust we have in these banks is leading us to them, but the desperate need of financial aids and rates, the will to make a fortune from the small existing amounts. Not only Lehman and its so-called Product Control Group have difficulties, but all the banks in the world. Problems can come, there is no need to panic; Credit crunch is an everyday situation, this is not the greatest problem. More important is how a monopole financial institute, a well-managed investment bank reacts, acts and solves such problems and minimizes the risk of apparition of these kinds of problems in the future.
    To survive we need money. When we need money, we need to invest in something profitable. This is a fact. And as long as making an investment is one of the most promising and effective source of major income we will need banks and have to face risks and dangers connected to them.

    See: [Unsuitable/Broken URL removed by Moderator]

 

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