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<TABLE border=0 cellSpacing=0 cellPadding=0 width=452><TBODY><TR><TD vAlign=top width=452 colSpan=2>Published September 12, 2009
</TD></TR><TR><TD vAlign=top width=452 colSpan=2>Lehman debacle - and the lessons not learnt
By VIKRAM KHANNA
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ON Wall Street, they call it 9/15 - a financial version of 9/11. It was the day Lehman Brothers collapsed.
As we know, all hell broke loose after that. The global financial system went into cardiac arrest. Banks stopped trusting even each other - let alone regular borrowers - and credit markets seized up. As trade finance ran dry, global trade collapsed.
Terrified investors sent stock and bond markets into free-fall. Speculations began on who would be next. Which once-mighty financial institutions would follow Lehman and Bear Stearns to the grave?
There was a long list of candidates, on both sides of the Atlantic - Citigroup, Washington Mutual, Wachovia, RBS, Lloyds, HBOS and others. And then there was AIG, the insurance behemoth that had hundreds of billions of dollars in liabilities related to credit default swaps that it had insured, in a radical and reckless departure from its conventional insurance business. If AIG crumbled, more big Wall Street firms and banks, including Goldman Sachs and Morgan Stanley, would be at risk.
In the event, some weak banks were swallowed by stronger rivals that were still standing, but most of the others were bailed out by their governments. AIG received the biggest bailout of all.
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</TD></TR></TBODY></TABLE>But for reasons still not entirely clear, Lehman was allowed to perish. The merits of the decision by the US authorities to permit this to happen (they claimed they were legally hamstrung) will be long debated. Some have described it as one of the worst blunders in Federal Reserve history - an error of monumental proportions that, in the words of Janet Yellen, president of the Federal Reserve Bank of San Francisco, caused a 'quantum jump' in the magnitude of the financial crisis. Others - such as Washington Post columnist Steven Pearlstein - have argued, somewhat perversely, that the Lehman collapse was beneficial to the extent that it sped up the process by which the imprudence of bankers (of which Lehman was a textbook example) was brought to light, and also accelerated the dramatic global policy response that saved the world from a second Great Depression.
But what has been learned from the Lehman collapse and its aftermath, and more importantly, what has been done about it?
One key lesson is surely that no financial institution is too big to fail operationally. It's a mistake to think institutions are safe merely because they are large; in fact, a case can be made that, in some circumstances, the opposite is more likely to be true.
Giant institutions are more difficult to tightly manage. Frequently, it was the actions of just one or two relatively small, badly supervised divisions within large organisations - like AIG's financial products group or UBS's US-based investment banking group - that were sufficient to bring the entire institution to its knees.
Soon after the Lehman collapse, US Senator Bernie Sanders suggested that 'if a company is too big to fail, it is too big to exist' - and he had a point. But there has as yet been no regulation, no effort, to address the issue of size. The counterpoint is that what we need is not limits on size, but appropriate regulation and regulatory institutions.
Sounds good, but - and this is another key lesson from the crisis - regulatory institutions are prone to capture by financial industry interests. During good times, bankers were easily able to get regulations relaxed so they could take on more risk and more leverage.
Moreover, what often went wrong was not that regulatory institutions were inappropriate or insufficient in number, but that they failed to act. The most dramatic example? The Securities and Exchange Commission (SEC) - the chief US regulator - failed to uncover Bernard Madoff's US$50 billion Ponzi scheme (another high point of the crisis) despite receiving multiple complaints from different sources over 16 years that Madoff was running a scam. The lesson here is that relying more on regulatory discretion than on tougher rules can be systemically dangerous.
Regulators were also caught napping when it came to policing so-called financial innovation. Securitisation - the packaging of debt securities into parcels that could be sold to third parties or moved off balance sheets - was assumed to be unambiguously beneficial in that it allowed risks to be mitigated.
We now know that securitisation can also magnify risks when concentrated in one asset class, such as mortgages. The crisis showed dramatically how far behind the curve regulators were when it came to policing financial products. Little has been done to change this.
Finally, and perhaps at the bottom of it all, were the perverse incentives created by compensation systems prevailing in the financial industry. At Lehman and elsewhere, bankers were paid humongous bonuses on the basis of short-term results - a perfect recipe for reckless risk-taking.
Post-Lehman, the mega-bonus culture is alive and well. And while some European politicians are trying to rein it in, as yet there is nothing to prevent banks from returning to their bad old ways.
While the financial crisis has not passed, the sense of it has perhaps passed too soon. A lot has been learned, but little has been done. Or perhaps there is truth in the saying, 'to learn something and not act on it is actually to not learn it'.
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<TABLE border=0 cellSpacing=0 cellPadding=0 width=452><TBODY><TR><TD vAlign=top width=452 colSpan=2>Published September 12, 2009
</TD></TR><TR><TD vAlign=top width=452 colSpan=2>Lehman debacle - and the lessons not learnt
By VIKRAM KHANNA
<TABLE class=storyLinks border=0 cellSpacing=4 cellPadding=1 width=136 align=right><TBODY><TR class=font10><TD width=20 align=right>
</TD><TD>Email this article</TD></TR><TR class=font10><TD width=20 align=right>
</TD><TD>Print article </TD></TR><TR class=font10><TD width=20 align=right>
</TD><TD>Feedback</TD></TR></TBODY></TABLE>ON Wall Street, they call it 9/15 - a financial version of 9/11. It was the day Lehman Brothers collapsed.
As we know, all hell broke loose after that. The global financial system went into cardiac arrest. Banks stopped trusting even each other - let alone regular borrowers - and credit markets seized up. As trade finance ran dry, global trade collapsed.
Terrified investors sent stock and bond markets into free-fall. Speculations began on who would be next. Which once-mighty financial institutions would follow Lehman and Bear Stearns to the grave?
There was a long list of candidates, on both sides of the Atlantic - Citigroup, Washington Mutual, Wachovia, RBS, Lloyds, HBOS and others. And then there was AIG, the insurance behemoth that had hundreds of billions of dollars in liabilities related to credit default swaps that it had insured, in a radical and reckless departure from its conventional insurance business. If AIG crumbled, more big Wall Street firms and banks, including Goldman Sachs and Morgan Stanley, would be at risk.
In the event, some weak banks were swallowed by stronger rivals that were still standing, but most of the others were bailed out by their governments. AIG received the biggest bailout of all.
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But what has been learned from the Lehman collapse and its aftermath, and more importantly, what has been done about it?
One key lesson is surely that no financial institution is too big to fail operationally. It's a mistake to think institutions are safe merely because they are large; in fact, a case can be made that, in some circumstances, the opposite is more likely to be true.
Giant institutions are more difficult to tightly manage. Frequently, it was the actions of just one or two relatively small, badly supervised divisions within large organisations - like AIG's financial products group or UBS's US-based investment banking group - that were sufficient to bring the entire institution to its knees.
Soon after the Lehman collapse, US Senator Bernie Sanders suggested that 'if a company is too big to fail, it is too big to exist' - and he had a point. But there has as yet been no regulation, no effort, to address the issue of size. The counterpoint is that what we need is not limits on size, but appropriate regulation and regulatory institutions.
Sounds good, but - and this is another key lesson from the crisis - regulatory institutions are prone to capture by financial industry interests. During good times, bankers were easily able to get regulations relaxed so they could take on more risk and more leverage.
Moreover, what often went wrong was not that regulatory institutions were inappropriate or insufficient in number, but that they failed to act. The most dramatic example? The Securities and Exchange Commission (SEC) - the chief US regulator - failed to uncover Bernard Madoff's US$50 billion Ponzi scheme (another high point of the crisis) despite receiving multiple complaints from different sources over 16 years that Madoff was running a scam. The lesson here is that relying more on regulatory discretion than on tougher rules can be systemically dangerous.
Regulators were also caught napping when it came to policing so-called financial innovation. Securitisation - the packaging of debt securities into parcels that could be sold to third parties or moved off balance sheets - was assumed to be unambiguously beneficial in that it allowed risks to be mitigated.
We now know that securitisation can also magnify risks when concentrated in one asset class, such as mortgages. The crisis showed dramatically how far behind the curve regulators were when it came to policing financial products. Little has been done to change this.
Finally, and perhaps at the bottom of it all, were the perverse incentives created by compensation systems prevailing in the financial industry. At Lehman and elsewhere, bankers were paid humongous bonuses on the basis of short-term results - a perfect recipe for reckless risk-taking.
Post-Lehman, the mega-bonus culture is alive and well. And while some European politicians are trying to rein it in, as yet there is nothing to prevent banks from returning to their bad old ways.
While the financial crisis has not passed, the sense of it has perhaps passed too soon. A lot has been learned, but little has been done. Or perhaps there is truth in the saying, 'to learn something and not act on it is actually to not learn it'.
</TD></TR></TBODY></TABLE>
