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.

Fooled by Fuld?

Yesterday, Richard Fuld, CEO of the recently defunct Lehman Brothers, testified before Congress in regards to his role in the demise of his firm.  Here is an excerpt from his prepared testimony.

No one realized the extent and magnitude of these problems, nor how the deterioration of mortgage-backed assets would infect other types of assets and threaten our entire system.  In April 2006, Chairman Bernanke predicted that the housing market “will most likely experience a gradual cooling rather than a sharp slowdown.”  In March 2007, he stated “the impact on the broader economy and financial markets of the problems in the subprime market seems likely to be contained.”  Similarly, Secretary Paulson said in June 2007 that the crisis in the mortgage markets “will not affect the economy overall,” echoing the views of the International Monetary Fund.  And at Lehman Brothers’ annual shareholder meeting, I too said what I absolutely believed to be true at the time – that the worst of the impact to the financial markets was behind us.

How could Mr. Fuld truthfully tell shareholders in April that "the worst was behind us" during a 2nd quarter performance period that would result in a loss to those same shareholders of $2.8 billion?  Also, how can he place blame on those outside his organization for a failure within his own organization?  He added the following later in his testimony.

We exist in a regulatory regime created in a vastly different world for vastly different markets. Some have compared the regulatory and risk management systems of our current markets to trying to run a bullet train on ancient track.

Blaming the system is as weak as it gets.  Call it a lack of accountability or responsibility or simply a lack of integrity.  To me, it sounds like Mr. Fuld tried to fool the market and lost.  Your thoughts?