A Colossal Failure
Lawrence McDonald's "A Colossal Failure of Common Sense" reads like a work of fiction- a real page-turner- but the events that led to the downfall of Lehman Brothers happened in an unreal era not too long ago. I've decided to save some prized passages here:
On fuck-ups:
The trading floor is an arena of instant decisions: all traders
are called to make markets all the time, to price the stock,
price the bonds, buy, sell, or hold. And I'd just make a
mistake. A big one. There was nowhere to turn. No one could
help. My word was my bond. There was no going back.
Which was precisely when Rich Gatward appeared on my left
shoulder, like the angel of death.
"The Calpine trade ... what delta did you do it on?" The equity
trading floor around me suddenly seemed like like the petrified
forest. It always does when Gatward comes over. Everyone stops,
watching for the scene to unfold. I knew only one thing: I'd
shorted only half the stock I should have.
Ah...er...Rich, I did it on a 30, but I probably should have done
it on a 60." "What's this word _probably_ -- what do you mean by
that" "Er..I mean we should have done the trade on a 60 delta..."
"How many shares of stock do you need to sell right now to be
hedged?"
I grappled for the bond calculator on the screen and hit the
buttons as my entire career flashed before my eyes, the way it
does, I believe, when you face instant death.
"Forty-five thousand two hundred, Rich." "Well, don't look at me.
Sell the fucking stock," he snapped.
I could feel every eye on the floor trained on me, and he was not
finished yet. "If you're gonna work on my desk, you don't fly
blind. You'd better know your deltas to the fucking penny."
"You're right. I screwed up, and I'm sorry. It won't happen
again."
"You're goddamned right it won't, becuase if it does we're going
to have a big fucking probllem. Do you understand that?"
"Yes, I do. It was a mistake. It won't happen again. I'm
sorry."
"You'd better be fucking sorry. Right here we're dealing with
the firm's capital. You're on my watch, and I have an eye on
every fucking penny of risk on this desk- and if you have a
problem with that, you can get the fuck out."
And with that he stormed off, back to his desk. It was as if the
entire place could breathe again. People went back to work and
the whole shouting, yelling, tempestuous atmosphere of the
trading floor swiftly resumed business as usual.
On executive presense and decision making
...I twice thought I saw my ultimate boss, Alex Kirk, Lehman's
global head of high-yield and leveraged-loan business, and a huge
power in the land, look just a tad hard-faced at some of the more
optimistic assumptions coming from the guys who walked on water
(the mortgage guys). On anyone else I might not have noticed,
but Alex was a terrific guy of very even temperament, displaying
nerves of steel in all of our trading sorties. He was six feet
tall, had an extremely commanding presence, and was never prone
to unnecessary displays of emotion.
My observation took place at one of our 7AM meetings. The
discussion was about the US real estate market, and I thought I
noticed something. It wasn't a lapse in concentration, because
he was listening intently, no doubt about that. But for just a
split second I thought he might say something, and I sensed it
might be an unfavorable comment. But whatever it was, he reined
himself in and said nothing.
Just before we broke up, to return to the trading floor, I
thought I noticed it again. And once more the subject was
property. But once more our leader refrained from making a
comment, and I never gave it another thought. At least not until
we were outside the room. That was when Alex pulled Larry
McCarthy and me aside and looked at us with a deadly serious
expression.
"This housing market," he snapped, "it's 'roided up." ... "This
whole thing is fucking ridiculous," he confirmed, obviously not
wanting to sugarcoat the issue completely. And then he added,
just for good measure, "This market is on fucking steriods."
The three of us just stood there. And for once Larry was lost for
words. He looked straight at Alex, nodded curtly, and held out
his right hand. I watched them shake. I witnessed an unspoken
bond forged between them. And it was not convertible. We might
as well, all three of us, have cut our thumbs with a bowie knife
and allowed our blood to mingle, because right there outside that
conference room we three had locked our minds into a potential
mutiny. And it was one I think we all sensed might one day save
this organization, which to a man we believed could be heading
for very serious trouble.
Triumph with Delta bonds:
"US Air just made a hostile bid for Delta. At least fifty-five
cents on the dollar for the bonds."
I think I nearly died of happiness. Chills ran up my spine, and
my pulse was racing as I headed up to the trading floor...I was
just running the numbers through my mind, and the key ones were
there we now owned about $750 million worth, face value of the
bonds and we'd bought most of them for well under 25 cents on the
dollar.
...
It was not yet seven o'clock, but by now everyone in the entire
bank knew about the drama, and a lot of them knew we were about
to make a colossal fortune for the firm. The atmosphere was
electric, nothing less, as our group moved into gear, because
trading was expected to start early, maybe around seven-thirty.
The place was packed, and every single eye was on us, especially
me, the market maker. But suddenly there was a shift of focus,
and we turned to the entrace to the trading floor to see Jane
Castle walking in. A huge burst of applause broke out, a
spontaneous cry of joy, just for her. Through all the months,
through all the doubts and all the fears, she'd never wavered in
her valuation of Delta Air Lines, and everyone knew it.
The smile on her face would have lit up Yankee Stadium, and she
walked straight up to me and gave me a sweeping high five that
darn nearly broke my wrist. Moments later Larry came in, wearing
a brand-new suit and looking like the king of the world, and
another burst of applause ripped into the mourning air. When it
died down, he looked over to Joe Beggans, who was about to start
trading the Delta bonds, and, with a huge grin on his face, held
out his hand and shouted, "Gimme the keys, Joe. I'm driving!"
The whole place erupted.
... The rest remains a blur until the moment Larry McCarthy
decided to get out. "Okay, guys. Let's go," he called, and, for
the first time for almost a year, we began to divest ourselves of
the Delta bonds. Larry launched them onto the market with
consummate skill, knowing, of course, that US Air was out there
waiting, begging to buy. By the time he had finished, Lehman had
made a $250 million profit, the larget one-day triumph in the
history of Lehman Brothers bond trading.
Mike Gelband's farewell
The news broke the following morning on the Bloomberg tape, and
Larry McCarthy was not so much shocked as shattered. Mike
Gelband was his linesman, our blocker, the big hitter who was a
huge sponsor of all of our risk and short positions. He'd had
the most phenomenal career, punctuated by success after success.
In a democracy he'd have been swept to power, most certainly by
Larry McCarthy, who regarded him as the most talented guy in the
building. The chairman and his deputy had somehow found a way to
lose him, and that had to rank as one of the most stupid acts
he'd ever seen anyone do- anywhere.
On the day Mike left, May 2 2007, everyone trooped down to the
third floor around eleven to say good-bye. So many people wanted
to shake his hand that a huge receiving line formed. Everyone
owed him something. He was such a big part of our strength and
standing in the corporation. His presense made us count. Some
of the women were in tears as the great Lehman banker moved from
friend to friend. How could anything ever be the same again.
Mike could have saved his job, could have gone on collecting $10
to $20 million a year, every dollar of it earned. But he was not
that kind of guy. Like Larry, Mike was certain we were steaming
toward the iceberg, with a balance sheet he thought was
catastrophically overleveraged. He had to be true not only to
the firm but to himself,and he could not countenance the wishes of
the chairman. And so he walked away from one of the highest
paying jobs on Wall Street, walked away from those enormous
earnings. It took a real man to do that.
He came over to say a last good-bye to Larry, Joe, and me. And
there was a strange silence throughout the trading floor as he
did so. When he finally turned away and walked toward the door,
there was a sustained and heartfelt burst of applause- not the
raucous outpouring that greets a touchdown or a home run, just a
fierce clapping of hands, like the kind that greets a pitcher
when he's finally relieved in the eighth with his team out in
front after a long job, brilliantly done. For the record, he did
turn around one last time and, typically, just smiled and nodded
to his fans. If he'd been wearing a cap, he would have doffed
it- for the good times.
Larry McCarthy's farewell
"I told them I'd heard a lot about Dick Fuld over the years.
He's a former commercial paper trader, but not once, not one time
in all my years here, did I ever see him on the trading floor.
Not even on the day me and the guys had the single most
profitable day in the history of Lehman's fixed-income division-
two hundred fifty million clams, and the guy's a no-show."
It's hard for Captain Cool to show outage. But I could see it on
his face at that moment, just at the memory of that shining day
when we sold the Delta bonds and never even received a note or a
handshake from the head of the corporation.
"I said I just thought it was very odd, that's all- a pretty
unusual way to stay close to your troops."
For the rest of the morning Larry walked around saying his
goodbyes and spending time with the support staff. He told me he
was leaving the building right after lunch, but he didn't mention
precisely what lunch would mean on this day. It turned out he'd
ordered twenty carts of food from the outstanding steakhouse Ben
Benson's. That's where he ate, and that was the food he wanted
for his guys. When fifteen waiters started pushing them in I
thought the A train had veered off its tracks. There were huge
metal trays of prime rib, filets, porterhouses, creamed spinach,
mountains of potatoes. There was enough shrimp and lobster to
feed the population of Martha's Vineyard. Larry had decried, "No
plastic," so there was only the finest cutlery and linen napkins.
The feast cost him around $14,000.
He and I talked quietly while we dined, and he came up with some
true McCarthyisms- "Never tell anyone on Wall Street your
problems, old buddy. Ninety percent of those you tell don't
care, and the other ten percent are glad you have them."
...
There were eighteen rows of people between Larry and the door,
and one by one they stood up and applauded as he walked past,
just as they had with Mike.
Larry never looked back. But just before he reached the glass
doors, he raised a clenched right fist high in the air. And then
he was gone. Something in the soul of Lehman Brothers was gone
with him, and it never came back as we steamed ever onward toward
Larry's iceberg.
The carry trade
For a start, commercial paper is short-term money, loaned out for
thirty to forty days or less. This market is used by the biggest
and best blue-chip companies. Commercial paper is the quickest,
cheapest, and easiest way for them to raise a fast loan that is
not registed by the SEC. As an example, say Bear Stearns goes to
JPMorganChase and requests a $500 million loan for fourteen days.
Question- would you lend Bear Stearns half a billion dollars just
a couple of weeks when they were backing it with AAA-rated
mortgage bonds and willing to pay 5 percent interest? Answer:
probably yes, since that would mean a $959,000 profit.
Now JPMorganChase isn't going to offer up that $500 million to
any old applicant. But Bear Stearns is a highly respected bank,
and they've done something similar many times before. The same
would apply to Lehman, Morgan Stanley, ... or Countrywide. All
of them have always paid back, with the interest, right on time.
But in many cases they paid back with money from another
short-term paper loan they'd borrow from someone else. For banks
with blue-chip lines of credit, it was possible to keep a huge
loan rolling for months and months, paying back with borrowed
money over andover. Simply put, they were taking short-term
borrowed money and investing in longer-term mortgage-backed
securities that paid a higher yield. In Wall Street jargon, this
was known as the "carry trade" or the "positive carry trade."