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0:00
Hello, my name is Pat McConnell.
And in this session,
I'm going to talk about
the topics of strategic risk
in general
and the failure of
Lehman Brothers in particular.
0:11
Bankruptcy of Lehman Brothers
in 2008
was a critical event
in the global financial crisis.
It exposed serious fault lines
in the structure
of the global financial markets
and led to widespread
economic disruption.
But how did Lehman,
a company with over
150 years of experience
as a successful
investment banker,
reach such
a precarious position?
The official examiners report
into Lehman's bankruptcy
by Anton Valukas runs
to some nine volumes
and 2,100 pages
and explains in great details
the events that led up
to the demise of the firm.
0:47
On September 15, 2008,
Lehman Brothers,
successful US investment bank,
filed for bankruptcy
with the largest failure
of a bank in history
to that point
and it precipitated
but did not cause
what became known
as the global financial crisis.
The immediate cause
of Lehman's insolvency
was that the firm
was overly exposed
to the US commercial
and residential
property markets,
and when the housing
bubble burst in 2007,
Lehman Failed.
At the time, Lehman was sitting
on a large warehouse
of securities,
so called Collateralized
Debt Obligations or CDOs,
the value
of which were falling rapidly
as a result of
rating agency downgrades.
However, the bankruptcy,
the examiner concluded
that it was the firm's
flawed strategy
that was the ultimate cause
of the failure.
1:37
The underlying reason
for Lehman's failure
goes back to a change
in the firm's corporate
strategy in 2006
from which the board headed
by the charismatic chairman
and CEO Dick Fuld
decided to shift
what was called a moving
or securitization business
to a storage business,
with the firm making
and holding longer term
riskier investments.
In addition to making fee income
from its traditional investment
banking activity
such as mergers
and acquisitions,
Lehman's management
wanted to use its own capital
to speculate in the markets.
For our purposes, however,
it's sufficient to note that
in 2006 Lehman's management
developed a new strategy
which was fully endorsed
by the Lehman Board.
But this flawed strategy
resulted in the bankruptcy
of Lehman's.
Only two years later in 2008,
Lehman's board fully endorsed
this growth strategy,
which was presented
as a 50% increase
in what was called
the risk appetite limit,
which Lehmans claimed
they needed to compete.
Although the strategy
was without controversy,
inside the firm
the Chief Risk Officer
at the time Madelyn Antoncic
argued for a much lower limit
but was overridden
by senior management,
eventually leading
to her replacement
as Chief Risk Officer.
However, the risks inherent
in this strategy,
so called strategic risks, were
not fully disclosed to the board
nor were they properly
mitigated by management.
