Book Review
by William A. Hayes
A Colossal Failure of Common Sense: The Inside Story of the Collapse of Lehman Brothers
by Lawrence G. McDonald with Patrick Robinson. Crown Business. 2009.
As a partner in a New York Stock Exchange specialist firm, I became very focused on how to manage a market maker trading firm, not only to make money but also to avoid going over the edge into oblivion. The basics were simple—accurate inventory valuation, liquidity of inventory, ample and reserve capital, constant vigilance, and a commitment to risk management at all levels of the firm. As one of my co-managing partners put it: “We are in the risk management business.” Thus I have been astonished to find out how some of the now gone top Wall Street firms were mismanaged by senior types who received enormous compensation despite ignoring the basics.
One of the best accounts of this is Lawrence McDonald’s book on Lehman Brothers, one of the most venerable names in the business. What makes A Colossal Failure of Common Sense: The Inside Story of the Collapse of Lehman Brothers so striking is the contrast to his trading desk group and the senior management. His trading desk group was aware of the dangers of sub-prime mortgages early on. They shorted Beazer Homes, and also made $500 million on a five-year credit default swap. Meanwhile, Lehman was one of the biggest sub-prime mortgage packagers and distributors. The management leveraged up to the end, eventually reaching a ratio of 44 times liabilities to net worth. Near the end, they spent $1.6 billion on a stock buyback. They adored and were addicted to highly leveraged real estate.
In fairness, there may be another side to the story. The top management has yet to tell its story. In the meantime, read A Colossal Failure of Common Sense to be gripped by a clearly written, detailed, compelling account of the collapse of one of the great names in our business.
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