Lehman Lessons (Part 1)

It’s been five years. Have we learned anything?

Five years ago Lehman Brothers filed for Chapter 11 in the largest bankruptcy filing ever. The bank was insolvent, and couldn’t meet the huge demands for funds coming from customers, lenders, and investors. In the aftermath of its bankruptcy, the global financial infrastructure was stressed almost to the breaking point. There was a real risk that hundreds of millions of workers worldwide could see their paychecks bounce.

Congressional inquiries and more than 300 books have identified dozens of villains–overleveraged homeowners, syndicated subprime mortgages, conflicted ratings agencies and regulators–but three fatal flaws stand out: too many illiquid assets funded by too much short-term debt without enough capital to back them up in an opaque, globally interconnected financial system. The failure of a critical node in that web meant that the entire network almost failed.

It’s no good saying that greed caused the financial crisis; that’s like saying that gravity caused a plane crash. The condition is necessary but not sufficient. Rather, an over-levered system didn’t–and still doesn’t–have enough cushion to deal with a significant asset-price shock.

Some say it couldn’t happen again. After all, the world looks pretty benign right now. But it always does until it doesn’t.

Douglas R. Tengdin, CFA

Chief Investment Officer

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