Review: "A Colossal Failure of Common Sense"

A Colossal Failure of Common Sense, about the collapse of Lehman Brothers as told by an employee, Lawrence McDonald. He was a retail broker who saw the value in bonds (especially convertible bonds) twenty years ago. He went on to create an online clearinghouse for bond information, convertbond, before eventually winding up at Lehman.

Oddly, there were many people in Lehman who were all over the housing bubble, and even shorted homebuilder stocks. Apparently, his department even realized the mess the mortgage department was getting in and tried to short builders and lenders as a hedge. They owned New Century puts!

The incompetence seems to have come partially from the mortgage department, because it was on a roll, but even more from the very top of the company, which doubled down on big purchases and on repurchases of its own stock. Here's how out of touch Dick Fuld was, according to the head of distressed debt trading,

“I told them I’d heard a lot about Dick Fuld over the years. He’s a former commercial paper trader, but not once, not one time in all my years here, did I ever see him on the trading floor. Not even on the day me and the guys had the single most profitable day in the history of Lehman’s fixed - income division — two hundred fifty million clams, and the guy’s a no - show.”

If Dick Fuld had never spoken with the head of distressed debt trading, what exactly was he doing all day. (I think you can get a sense from one other must read Lehman article, Lehman’s Desperate Housewives.) And that guy was smart enough that he had bought a billion dollars worth of protection on Countrywide for 18 basis points!

At the moment right before the crash - early 2007 -  one of the really good distressed analysts quit because there were no distressed bonds. Market top.

It's worth noting that even once this ineptly managed firm woke up and started trying to unload assets, the market had plenty of room to fall.
 
There's a disappointing story where the author and the distressed head are in Las Vegas playing blackjack (stupid), and the distressed guy has a big drawdown. He responds by upping his bet size and playing all the spots at the table, which the author mistakenly thinks gives the player an advantage.

4/5

Tuesday Links

WSJ: "Pimco Takes Bath on Lehman: Losses From Wrong-Way Bet on Investment Bank's Bonds Exceed $3.4 Billion." I think this is a small part of his assets under management, but still. I can't believe people buy bonds in banks and financial companies. They are so highly levered that you get bondlike returns with equitylike risk.

Bloomberg: Frontline Billionaire Bets Tankers Collapsing. Chairman John Fredriksen says the biggest crash in the cost of ships has yet to happen. It will be within “a year or two” that the market “collapses.”

Great Pawlenty speech. "When you deposit a dollar in your bank account, every penny should be forevermore yours and your children’s. Not the federal government’s."

NYT: "The Wal-Mart founder’s descendants are poised to see their stake in the $190 billion company creep above 50 percent, without much fanfare, thanks to the latest $15 billion share buyback program."

Spain Reminds Me of Lehman Brothers

Last week, Spanish prime minister Zapatero said “I should warn those investors who are short selling Spain that they are going to be wrong and will go against their own interests.”

Meanwhile, the yield on the Spanish 10-year government bond is up 25 basis points today. Oops!

Tuesday Reading

Puts are on sale: current implied volatility vs. the 52 week high IV of Dow 30. I have accumulated almost a thousand GE put contracts so I'll never have to work again if we get the next leg down.

Conservative Woodstock Rocks the Capital.

"Every week the FDIC takes over failed banks and every week the assets on the banks balance sheets are written down by 30% overnight. Does this not make eager buyers of bank stocks wonder how assets on bank's balance sheets are being valued?" (Capital Observer)

Why do people say the government "let" Lehman fail? Lehman was a mess. It failed. It's requiring "the biggest real-estate workout department in the U.S." just to oversee the real estate screwups they made.

Geithner cancels Westchester house listing, rents to tenants. Cap rate is around 4% based on his asking price for the house.

Short Interest At Lowest Level Since February 2007

The Market is Now a Zombie Movie

Here is the zombie movie all star cast, roughly in order from most to least outrageous:

General Motors - hovering at a half-billion dollar market cap, even though the stock is worthless.
Lehman Brothers - up 200% on Friday, even though it faces $100 billion in claims.
AIG - up over 5x since beginning of July, even though the CEO admits there is no equity in the company.
FNM - up hugely. But the preferred stock still less than 10 cents.
FRM - same as FNM,
Washington Mutual - up 35% on Friday. Why not buy the holding company notes for 70 cents?