3 Years After Lehman, We’ve Learned Nothing

by Jeff Reeves | September 14, 2011 8:31 pm

On Sept. 15, 2008, the world learned a debt-riddled Lehman Brothers would be no more. The Dow dropped more than 500 points that day, and a month later the index was off about 25%.

And that was only the beginning.

The corporate carnage that followed doesn’t deserve rehashing, since nearly every investor has a personal point of outrage. There was a death sentence for dividends, including a 68% cut[1] in General Electric (NYSE:GE[2]). There was the race to the bottom in the entire financial sector, with American International Group (NYSE:AIG[3]) plunging 90% in seven trading days that fall. The list goes on.

Three years removed from one of the most market-moving events in the history of Wall Street, a casual observer might think that the chaos after Lehman redefined how the global economy functions. By now, we should have made meaningful progress at fixing this mess and protecting against future abuses, right?

Don’t fool yourself. Our global economy is hardly safer or stronger, the key players in the financial crisis have walked away without consequence, and our politicians have seemingly learned nothing from deep losses we’re still trying to gain back.

Fat Cats Still Getting Away With It

One of the most galling facts about Lehman’s bankruptcy was that it was preventable. I’m not talking about how the company should have refused to lever up 20 or 30 times over on subprime mortgage investments. I refer to the lack of a simple handshake between a buyer and Lehman Brothers’ fat cat CEO Dick Fuld.

Fuld stubbornly refused offers[4] up until the very end, either out of ego or a naïve conviction that his company was worth more than suitors were offering. Those potential investors that could have saved the company included Barclays (NYSE:BCS[5]), the state-run Korea Development Bank and even the saintly Warren Buffett.

According to now-famous reports, Buffett apparently told Dick Fuld that if he was going to plow a few billion into the bank, he wanted Lehman executives to invest under the same terms. Fuld refused. Understandably, Buffett wanted nothing to do with a company where management didn’t have the same skin in the game — and he took his funds instead to Goldman Sachs (NYSE:GS[6]), where he made a lucrative $5 billion buy-in.

And that’s just one story. As put by fellow banker William Smith, CEO of Smith Asset Management in New York, “Dick Fuld really blew it. How many opportunities did he have to sell Lehman?”

Smith should know. He started his career in 1991 at then-named Shearson Lehman Brothers before starting his own firm.

The epilogue to this tale is even more outrageous. Dick Fuld walked away with upward of $484 million in salary, bonuses and stock options earned from 2000 to the 2008 collapse of Lehman — though in Congressional hearings[7], he lamented that because of Lehman’s demise, his actual holdings were “only” $350 million. That included a $22 million bonus in March, just six months before the company disappeared forever.

Yet no civil or criminal penalties have been levied against Fuld and his ilk. In fact, just this week Lehman executives had the audacity to petition a bankruptcy judge to release $90 million[8] in insurance funds from the defunct bank so they can settle fraud allegations brought by investors.

That’s right — Fuld walks away with hundreds of millions of dollars while driving Lehman into the ground, but he wants a judge to pick through the wreckage of the bankrupt company to satisfy investors who lost everything — protecting his own personal pocketbook in the process.

It’s sickening. It’s unjust. And unfortunately, because Fuld got away with this, it surely will happen again.

Greece Could Be Lehman 2.0

In 2007, the idea of a 150-year-old investment bank worth $60 billion one day and worth zero 19 months later seemed patently absurd. But it happened. And more recently, bankruptcy in one-third of the euro zone seemed equally ridiculous. But that’s what we now face.

The so-called PIIGS of the euro zone — Portugal, Ireland, Italy, Greece and Spain — make up 135 million of the currency union’s 300 million residents. The nations also account for roughly $4.5 of the $12.5 billion in nominal GDP for the euro zone, according to recent World Bank figures. All of these nations are facing serious debt trouble, and the sad reality is that “contagion” is more than a buzzword. If one domino falls with Greece defaulting on its debt, the rest could soon follow as panic sets in and credit is refused to the rest of the troubled PIIGS states.

Germany would be stupid to abandon Greece[9] because of this possibility, but that doesn’t mean a Greek default won’t happen.

Consider that credit default swaps on Greek debt were as high as 3,500 basis points last Friday — and that it costs $5.6 million up front and $100,000 annually to insure $10 million of Greek debt for five years. The market clearly sees the threat of a breakdown as very real.

The $50 billion or so in Greek debt on the books at European banks is only the beginning. A chilling effect of bad debt is as bad or worse as the headline losses. Lenders shut down. The flow of money in the global economy slows to a crawl. Trust erodes and uncertainty soars, which only sends us deeper into the cycle.

Sound familiar? That credit freeze is exactly what happened after Lehman. Yes, the brutal reality of the mortgage meltdown had started a slow bleed in early 2008, and the shotgun wedding of Bear Stearns and JPMorgan Chase (NYSE:JPM[10]) was alarming.
But it was semi-orderly, backed by the faith and credit of the government. (For what it’s worth, the market actually rallied after the Bear Stearns sale — in part because the Federal Reserve Bank of New York stepped into the breach to help provide financing for the deal and prevent Bear Stearns from just evaporating. Investors felt like the government had their back).

We need Germany to step into the breach this time. But recent hard-line talk from German prime minister Angela Merkel and growing outrage from beleaguered taxpayers shows Europe may not have learned anything from the crash of Lehman and the resulting credit crisis that followed.

Let’s hope Greece doesn’t turn into a painful sequel to the credit freeze incited by the Lehman Brothers failure.

U.S. Debt and High Unemployment Are Secondary Issues

Lest we point too many fingers at the antics overseas, it’s worth noting that the political behavior in America has been equally irrational. Somehow the tenor of our economic discussion has moved away from a troubled financial system to unemployment and now to government spending.

The issues are very closely related, so it’s understandable how we went down this road. But until we address the root cause and restore healthy lending, we will never fix the jobs or the debt issues.

Conservatives seem to think that the national debt is the defining issue of our time. However, any logical person can see that the economic downturn dramatically ate into tax receipts — and the quickest and most effective fix would be to get the economy running again, not to rewrite the tax code.

The president’s renewed focus on jobs is better for the economy but still misses the point. It’s nice to have more school teachers or construction workers collecting a paycheck, but it’s pointless unless stimulus spending props up mortgages and business lending.

Smaller classroom sizes won’t fix the housing market. A freshly paved road doesn’t pay taxes or hire employees.

In short, the credit crisis will continue as banks suffer under the weight of lingering subprime loans and see sluggish performance in “core” lending to Americans who are using credit wisely and responsibly. Without good debt to offset bad debt, our economy is doomed.

Credit is not evil and has been unfairly maligned in this mess. How soon we forget the 2006 Nobel Peace Prize that was awarded to micro-lending pioneers[11]. Millions of poor Bangladeshi women bettered themselves with loans of as little as $100, using it to buy everything from cows to cell phones in order to start their own businesses. Without responsible use of credit, they never would have had access to a better life.

It’s worth reiterating that this was a peace prize, not a prize for economics. There is no greater example to show the importance of a functional credit market — characterized by both honest lending and responsible borrowing — to raise both the wealth of a nation and the quality of life there.

Americans need loans to start businesses, go to college, buy homes, protect themselves in times of crisis and countless other things. The nation needs to re-learn how to use debt as a tool to build and protect wealth, not destroy it.

Juicing jobs numbers or slashing federal spending is nice. But until our nation and our financial system can generate loans, our economy is no better than it was three years ago when Lehman rocked Wall Street.

Jeff Reeves[12] is editor of InvestorPlace.com. As of this writing, he did not own a position in any of the stocks named here. Follow him on Twitter via @JeffReevesIP and become a fan of InvestorPlace on Facebook.

Endnotes:
  1. 68% cut: http://www.marketwatch.com/story/ge-cut-dividend-10-cents-31
  2. GE: http://studio-5.financialcontent.com/investplace/quote?Symbol=GE
  3. AIG: http://studio-5.financialcontent.com/investplace/quote?Symbol=AIG
  4. stubbornly refused offers: http://www.reuters.com/article/2008/09/14/us-lehman-backstory-idUSN1341059120080914
  5. BCS: http://studio-5.financialcontent.com/investplace/quote?Symbol=BCS
  6. GS: http://studio-5.financialcontent.com/investplace/quote?Symbol=GS
  7. in Congressional hearings: http://abcnews.go.com/Blotter/story?id=5965360&page=1
  8. to release $90 million: http://www.reuters.com/article/2011/08/25/us-lehman-settlement-idUSTRE77O7FP20110825
  9. Germany would be stupid to abandon Greece: http://investorplace.com/2011/09/germany-euro-zone-greece-debt/
  10. JPM: http://studio-5.financialcontent.com/investplace/quote?Symbol=JPM
  11. awarded to micro-lending pioneers: http://news.nationalgeographic.com/news/2006/10/061013-nobel-peace.html
  12. Jeff Reeves: http://investorplace.com/2011/09/save-haven-stocks-ibm-v-vz-mcd-clx/2011/08/2011/08/2011/08/2011/08/hewlett-packard-hp-stock-buyback-autonomy-buyout-hpq/2011/08/author/jeff-reeves/

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