Business Insight Zone

The bear has come for Lehman.

Richard Fuld is a smart, driven man, and it’s a shame that his long tenure as the head of Lehman Brothers will be forever stained by the 158-year-old house’s bankruptcy. But the stain should endure, since Lehman indisputably bore Fuld’s imprint, and suffered from his decisions.

In this New York Times piece, Joe Nocera aptly summarizes the sort of garden-variety delusion that led to Lehman’s downfall (emphasis added):

[A]fter you get past the mind-numbing complexity of the derivatives that are at the heart of the current crisis, what’s going on is something we are all familiar with: denial. . . .

Last summer, as the credit crisis first gripped Wall Street, Mr. Fuld’s firm . . . concluded that the problems would be short-lived — and that those firms willing to take big risks would be the ones that would reap the big rewards once things calmed down. So Lehman doubled down on mortgage-backed derivatives — not unlike a Florida condo owner buying a second one to flip 18 months ago.

Big mistake. Ever since then, Lehman has had a terrible time admitting the magnitude of its mistake — or properly pricing its securities. As mortgage derivatives became increasingly toxic, they also became increasingly illiquid. So firms were left to set their own “mark-to-market” price. And just like so many homeowners, they kept pricing their securities higher than they should have. . . .

[Hedge fund manager David] Einhorn used to cast Lehman’s mark-to-market pricing as an act of dishonesty. I tend to think it was more like wishful thinking. Either way, the result was the same.

A week ago, even as the government was bailing out Fannie and Freddie, Mr. Fuld went off to seek new capital — something Lehman desperately needed to shore up its decimated balance sheet — from the Korea Development Bank. Why did those talks break down? Because Mr. Fuld wanted more for Lehman than the Koreans thought it was worth. He simply couldn’t face the reality that his firm wasn’t worth what he thought it was.

The rest of Nocera’s article is well worth reading, especially for the way he compares the denial of Fuld et al. to the denial of homeowners across the country who could not bring themselves to admit that their beloved homes could lose value, or that they had erred in taking on too much debt.

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John Thain is a smart, driven man, and it’s to his credit that Merrill Lynch is ending its 94-year independent history in the arms of Bank of America rather than in bankruptcy.

Last year I opined that it would have been better if Merrill had been able to find a new CEO in-house, but that since it couldn’t, Thain looked to be a great fit for the job. By my reading, Thain was able to steer Merrill away from sharing Lehman’s fate because he wasn’t blinded by his own psychological investment in the firm’s history. He was able to come in with clear eyes and take realistic actions that might have been too painful for one of the company’s old hands.

My perspective is informed by this article by Merrill alumnus Henry Blodget. He provides a useful summary of Merrill’s boom-and-bust history under former (short-sighted) CEO Stanley O’Neal, then talks about the job Thain has done since he took the reins at Merrill.

Thain . . . had been dealt a tough hand, but, unlike his compatriots at Bear, Lehman, Fannie, Freddie, and other firms, he played it well. Specifically, instead of blaming skeptics and short-sellers for Merrill’s sagging stock price, Thain focused on strengthening the firm’s balance sheet. Several times over the next few quarters, he swallowed his pride, took more enormous write-offs, and raised even more capital.

Blodget makes a particularly good comparison between Thain and Fuld:

Over at Lehman, meanwhile, CEO Dick Fuld was dealing with the same problems and implementing the same solutions — but always a step behind.

Unlike Thain, Fuld hadn’t been brought in to fix Lehman — he had built it. So, making the aggressive “de-risking” moves Thain was making would have meant dismantling his own aggressive growth and leverage strategy. . . .

Fuld is human, and he made a mistake common to you, me, and everybody else — he wasn’t able to detach himself from his past actions to make the best decision about what should be done now. But Thain kept himself grounded in reality — no matter how bitter it may have been.

Once again, however, Thain played his weak cards wisely: Instead of wasting another precious day explaining to investors why the market was wrong and the firm’s balance sheet was strong, Thain acted. And this time, he fixed Merrill’s problem once and for all.

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As Nocera put it in the opening sentence of his article, the prevailing reaction of denial is “How can this be happening?” Thain asked the much better question: “What can we do now?”

It’s easy to point at Fuld after the fact, because by now we know for certain that Lehman is in shambles. But the same errors — or temptations to err — that beset Fuld affect us all.

This is why the very best decision makers take deliberate steps to protect themselves from their own capacity for foolishness. Would that Fuld had done the same.

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Related:

• Joe Nocera: On Wall Street as on Main Street, a Problem of Denial
• Henry Blodget: The Merrill Miracle: How a company staved off financial doom.
• “Mark-to-model” as a synonym for “wishcasting.”
• Merrill taps the right man.
• Confirmation bias: fight the Procrustean instinct.
  

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(Picture by hill.josh.)

Category: Executives, Finance & Real Estate, The business brain