One morning in June 2005, Michael Gelband, a Lehman Brothers managing director and the firm’s head of global fixed income, gave a presentation to his colleagues about the dark side of the real estate market.
The meeting began just after 6:45 a.m. Each attendee was handed a dossier of about 30 pages. One former executive who was at the meeting, Lawrence G. McDonald, says that it was “as close to a special forces military briefing as any I’d ever attended.”
In his 2009 book, A Colossal Failure of Common Sense: The Inside Story of the Collapse of Lehman Brothers, McDonald recalls that Gelband described the stunning proliferation of “no-doc” mortgages and other toxic loans, sold by commission-driven salesmen and then purchased by Lehman and other Wall Street banks:
He cited the shadow banks, the vast complex network of mortgage brokers that were not really banks at all but managed somehow to insert themselves into the lending process, making an enormous number of mortgages possible while having to borrow the money themselves to do so. He cited outfits such as Countrywide, New Century, HBOS, and NovaStar, among others, and he accused them of creating well over $1 trillion in economic activity that was comprehensively false money and would never be converted into genuine economic power.
Gelband, McDonald writes, predicted that the house of cards could soon collapse — perhaps in 2007 or 2008 — producing serious consequences for the U.S. economy.
After the meeting, Gelband didn’t stop pressing the issue. He used his position on Lehman’s executive committee to try to persuade the firm to pull back from its massive bets on the real estate market.
But warnings from Gelband and others with similar concerns were largely ignored by CEO Richard Fuld and his inner circle, according to McDonald and news accounts citing other former Lehman insiders.
Lehman packaged $52 billion
Through much of 2006, for example, Lehman continued pushing hard on subprime lending, packaging nearly $52 billion in subprime mortgage-backed securities for the year and maintaining its spot as Wall Street’s No. 1 patron of subprime, according to industry tracker Inside Mortgage Finance.
I should note here, as a matter of full disclosure, that I drew on McDonald’s work for my own book on Lehman’s role in the subprime debacle, The Monster, and that McDonald has been an enthusiastic supporter of my book. It’s worth noting, too, though, that McDonald isn’t the only source who claims that higher ups at Lehman had fair warning that they were taking unreasonable risks with the firm’s all-in gamble on commercial and residential real estate.
New York magazine says that in late 2006, as the first cracks in the real estate market began appearing, Gelband met with Fuld and told him: “The world is changing. We have to rethink our business model.” Fuld brushed Gelband off, New York says, telling him: “You’re too conservative.”
Andrew Gowers, the former communications director for Lehman in the UK, told The Observer of London that Lehman execs pushed aside risk managers in a headlong effort to catch up to rival Goldman Sachs. “It was quite hard to stand in the way,” Gowers said. Lehman had good risk managers, “but the prevailing atmosphere was for fast growth and special fast-track treatment for what we now know were toxic deals.”
Fuld’s foot on accelerator, not brake pedal
Larry McCarthy, former head of distressed debt trading at Lehman, told Reuters that he quit the firm after repeatedly warning that the firm was too leveraged on borrowed money and that the real-estate market couldn’t keep going up forever. When Lehman’s risk committee was urging the company to “hit the brake pedal,” McCarthy claimed, Fuld was “hitting the accelerator.”
“Other than six or seven people, no one really knew him,” McCarthy said. “It was like he was in his own world on the 31st floor. He was never in touch with the troops. In my four years there, he never came down to the trading floor. Not once.”
In an interview with a Reuters reporter who tracked him down last year at his vacation home in Idaho, Fuld denied that he’d ignored warnings about Lehman’s risks: “What, do people think I'm an idiot, that suddenly I woke up two months before and suddenly things were a problem? No. No, the signs were there.” As for the suggestion that he isolated himself, Fuld said: “I left my office, I left my office plenty.” (I tried to arrange an interview with Fuld in late 2009 through his attorney, Patricia Hynes. In an e-mail reply, she told me, “Mr. Fuld is not doing any interviews.”)
In testimony and in unscripted moments, Fuld has continued to maintain that he is a scapegoat and victim of events that were beyond his control.
Around the time of the first anniversary of Lehman’s collapse, Fuld told Reuters: “They're looking for someone to dump on right now, and that's me.” Later, he added: “I do believe at the end of the day that the good guys do win. I do believe that.”