Ignoring Risk Management at Lehman Brothers

The court appointed examiner for the Lehman Brothers bankruptcy case issued its final report yesterday.  The report provides some interesting insight into the final months of the firm's existence.  Most notable are the firm's efforts to shift massive exposures off of its balance sheet to prevent credit rating downgrades.  At the same time, the firm ignored its own risk management limits as it continued to pursue a high growth strategy. Here is what the examiner noted in the report.

In 2006, Lehman made the deliberate decision to embark upon an aggressive growth strategy, to take on significantly greater risk, and to substantially increase leverage on its capital. In 2007, as the sub‐prime residential mortgage business progressed from problem to crisis, Lehman was slow to recognize the developing storm and its spillover effect upon commercial real estate and other business lines. Rather than pull back, Lehman made the conscious decision to “double down,” hoping to profit from a counter‐cyclical strategy. As it did so, Lehman significantly and repeatedly exceeded its own internal risk limits and controls.

While many critics like to point the finger at the failure of risk management in the financial crisis of 2008, more evidence is pointing to the fact that it was the failure of management to acknowledge the risks that were made apparent by risk management practices.