See also papers in SH Archive Financial Institutions box 1.

Ever wonder what happened in 2008 to cause such a panic in the financial markets and the economies around the world, that some countries are still recovering from, or haven't recovered at all? This is a great book written by one of the VPs at one of the banks at the heart of the collapse and he gives us a great idea on how this all went down, even with warnings from various members on what was going to happen. The author seems a little bitter with the CEO of Lehman, rightly so after he lost his own life savings when the stock tanked because of incompetence, stubbornness and greed by the CEO. Great read for sure! ( )

Great insider perspective of the financial collapse. ( )

Couldnt finish.. keeping aside for time being

Lawrence MacDonald, a former VP at Lehman Brothers, recounts his rise within the broker profession and the precipitous fall of Lehman brothers which he blames almost entirely on just eight people, including Richard Fuld. They were the ones promoting over-leverage and investment in risky investments such as CDOs and CDS's

It's interesting, because intentionally or not, we are given insight into MacDonald's mind and watch the erosion of ethics of his own behavior and that of those around him. No one sets out to destroy a company, yet the shift from interest of the investor to personal self-interest at the expense of the company has the same result. One could see this mind-set reflected in the faces of the Goldman Sachs boys during the recent hearings.

MacDonald got his start as a meat salesman who wanted to move to the big money on Wall Street. He and a friend had a brilliant idea: take prospectuses from companies issuing bonds, put them online and make them available to people with sensible advice about those bonds. Using some clever PR and a savvy programmer, the three of them created a company, Convertabond.com, at the height of the tech boom, that was soon the talk of the financial world. It also pissed off some of the bond traders because they were providing honest and candid advice about bonds. Morgan-Stanley was particularly angry because Convertabond was calling some of their bond releases for the junk they were. So Morgan Stanley bought them out and closed the site to the public. Their website now reads: "For more information on convertible securities, and current offerings, please contact your Morgan Stanley representative." Now, of course, we have congressional investigations revealing emails from both Goldman Sachs and Bear Stearns of employees at the firms disparaging the products they were selling to their clients.

MacDonald talks a lot about corporate culture, big companies filled with people who often don't know their heads from their asses and who's major skill is covering their butt. It's not a pretty picture. Basically a bunch of guys making decisions they know nothing about. After they were bought out, his partner, unable to handle the daily bullshit (meetings to prepare for meetings and hiring consultants to perform tasks requiring months which formerly the two had done in a couple of days,) quit.

The along cam the Commodities Futures Modernization Act and the repeal of Glass-Steagall, two political decisions intended to deregulate the market, but instead laid the groundwork for a repeat of 1929. MacDonald's father predicted it. "It's all crap," he told his son. The bonds which had prevented investment houses who bet with other peoples money from getting access to the funds of banks were cut. That and the CFMA's deregulation of CDOs (collateralized debt obligations,) spelled trouble. His father also saw the signs of a classic bubble. CDO's (basically a form of insurance in case a corporation should go bankrupt) were sold and collected by investment houses earning them and the banks huge fees, but also putting them on the hook for hundreds of billions should a company like CountryWide (see Chain of Blame for more detail) go belly-up. Since Countrywide's entire business plan rested on the assumption that real estate prices would continue to grow, their failure was inevitable.

And not just real estate. MacDonald became concerned when he saw that Cisco had a market capitalization of $500 billion making it the largest in the world. Their P/E ration was 160, or meaning that if they were bought out at current prices, it would take 160 years for the buyer to earn his money back. Remember, this was just before the tech bubble exploded. Soon he was a bear, shorting companies he knew were over extended, ironically using the convertible bonds he had become expert in, to acquire more capital (and debt) in an effort to stay afloat.

Then came Alan Greenspan and cheap money. Consumers embarked on an orgy of borrowing. With interest rates falling below 1%, investors had almost no choice but to not save and to look for high yield bonds. Wall Street was ready to oblige and invention of new ways to securitize debt exploded.

MacDonald describes complex financial instruments in very clear terms. For examples, a CDO, collateralized debt obligation, originated in the sale of a mortgage. The preferred were those with adjustable rates because they were very attractive to the buyer, but promised large rewards a couple of years down the road when the interest rate went to 8% or 9%. The broker could care less whether the homeowner could pay or not because the mortgages were sold to mortgage houses which then packaged them into large bundles; say 1000 mortgages of $300,000 each, or $300,000,000. Lehman Bros. would borrow money on the short-term market to buy the package. It was now a mortgage backed security, a CDO. Lehman would slice this into 300 bonds at $1,000,000 each. The rating agencies who were paid enormous fees to help design the bonds and then give them AAA ratings help t provide assurance to buyers that they were getting solid bonds backed by strong mortgages which would begin paying at 8-9%. At each step along the way, everyone collected fees and made piles of money. Of course, it meant that ultimately the mortgage on a house in California might be owned in part by an Eskimo in Iceland. Original mortgage salesmen soon realized that all they needed was a signature. No one else cared because the mortgages would be traunched up anyway. It didn't matter if the system didn't run smoothly because any complaints would get lost since the hedge funds which bought the CDOs could be on the other side of the world from the mortgagee. Presumably bad mortgages would be spread across a larger number of good loans, evening things out. Real estate had never lost more than 5% of its value in a given year since the depression. The psychology of a bubble says that this time things will be different. They weren't. Housing prices fell and soon the CDOs became junk. But insurance companies (AIG) had been brought into the picture with credit default swaps and now they were on the hook for trillions. And the house of cards fell apart.

MacDonald describes a world and culture that thrived on cheating and lying. Lawyers and accountants making millions a year inventing new "products" (remember Blankheim talking about synthetics in the hearings?) did battle obfuscating the truth as they rang rings around civil service regulators making $120,000 per year. It was an unfair fight.

William Isaac, formerly of the FDIC, in an interview I heard the other day, said that the financial "regulation" being considered is a mere band-aid and that systemic change is needed to avoid periodic economic disasters. Since the repeal of depression era regulations, we had suffered major economic calamities on average about every 10 years. That, he says, has to stop. We now have a situation where six large banks control more than 60% of the nations wealth. Too big to fail?

References: http://www.washingtonpost.com/wp-dyn/content/article/2008/09/26/AR2008092602200....

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[b:Chain of Blame: How Wall Street Caused the Mortgage and Credit Crisis|3461662|Chain of Blame How Wall Street Caused the Mortgage and Credit Crisis|Paul Muolo|http://photo.goodreads.com/books/1266606597s/3461662.jpg|3502941]

[b:House of Cards: A Tale of Hubris and Wretched Excess on Wall Street|5881889|House of Cards A Tale of Hubris and Wretched Excess on Wall Street|William D. Cohan|http://photo.goodreads.com/books/1255635440s/5881889.jpg|6054107]

Given the recent report in the NYTimes detailing how Lehman and its accounting firm (always adhering to those wonderful Generally Accepted Accounting Principles, i.e. help hide everything you can) managed to hide some $50 billion in bad loans from its books, I thought this might be a good time to read this book. If there is any justice in the world Ernest & Young will go the way of Enron's accounting firm, Arthur Anderson. "Charles Perkins, a spokesman for Ernst & Young, said in an e-mailed statement: 'Our last audit of the company was for the fiscal year ending Nov. 30, 2007. Our opinion indicated that Lehman’s financial statements for that year were fairly presented in accordance with Generally Accepted Accounting Principles (GAAP), and we remain of that view.' "

From the report: "Colorable claims exist that Ernst & Young did not meet professional standards, both in investigating Lee's allegations and in connection with its audit and review of Lehman's financial statements."

Reference: http://www.nytimes.com/2010/03/12/business/12lehman.html ( )