Blow by Blow: A Short History of the Battle for Lehman Brothers

The recent battle over Lehman Brothers will someday make for an interesting case study. With trading in Lehman likely to settle down in the wake of their earnings release and conference call, it is time to review the episode, and hopefully learn something from it.

Bear Stearns kicked off the de-leveraging process on Wall Street a year ago when its credit based hedge funds imploded. Merrill Lynch grabbed collateral from the fund, and attempted to liquidate it, but met with little success. Wall Street was beginning to grind to a halt by the end of June.

Much of my focus at the time was with the situation and Bear, and the power struggle that was likely to ensue. Richard Marin, head of Bear's Asset Management operation was shown the door quicker than I would have imagined-certainly his personal blog did not help his case, given Bear's stringent compliance policies regarding electronic communication.

Warren Spector was next to go; Jimmy Cayne was quick to place blame, and brutally dispatched his heir apparent as he consolidated his grip on the firm. Wall Street was a mess in the heat of the summer, but a "V" bottom ensued, and perhaps some investors had bought the party line from Wall Street chieftains, who tried to reassure investors that it was all good.

By mid-September Hedgistan was buzzing about FAS 157, and it was clear that the brokers would have accounting issues to deal with, but very few analysts were up to speed on issues such as Level 3 assets. The financial blogosphere was asleep at the wheel, at least until Nouriel Roubini highlighted the issue in early November, and all hell broke loose. But as fate would have it, Erin Callan assumed the CFO role at Lehman on September 20th, just as the Street was coming to grips with the issue.

Lehman was a likely target for the hedge funds ire, too much mortgage business and not much in the way of commodities, which is about the only profitable engine on Wall Street in June 2008. David Einhorn was sharpening his knives a month later, after digging through the brokers, and began harping on Lehman’s Level “3” assets, which scared the hell out of longs who were asleep at the wheel, and it brought in piggybacking shorts who embraced the thesis.

The wind was at Einhorn’s back,and the rout was on as the markets nearly imploded in mid-January, thanks, in part, to a rogue trader at SocGen by the name of Jerome Kerviel. The issues at Lehman festered until March 18th, when Lehman’s stock made an extraordinary intra-day move that seemingly reassured the Street that its problems were manageable. Callan reportedly high-fived the Lehman trading desks in the wake of the call, and went on CNBC after the close to cement her legend as the most exciting thing to hit the SellSide since Sallie Krawcheck.

The stock levitated in the $40’s until Lehman filed their 10-Q, which seemed to contain inconsistencies with what Lehman reported on the conference call. The shorts had lost the chance to break the company and the stock on March 18th, but now the hunt was back on, as Einhorn sharpened his pencil and dug in like a tick.

In my mind Erin gained credibility in this interview, in which she admitted Wall Street’s brokerage firms would be under the gun for quite some time, and I had surmised her words were aimed at her rivals, in an attempt to cap their upside, capping any competitive advantage vis a vis Lehman and their cost of capital.

April 11th

April and early May passed somewhat uneventfully for Lehman. Einhorn had at least one conversation with Callan to confirm the facts as he saw them, and wanted to fact check going into his presentation on at the annual Ira W. Sohn Investment Research conference, which, along with the bi-annual Value Investing Congress, is the largest “idea dinner” in the world. Surely a great opportunity for bulls and bears to pitch their favorite ideas. Given that hedge fund managers seemingly relish a dollar made short more than one made long, short ideas are always a highlight of he confab. Yes, making money short makes you feel very clever, and is twice as nice.

Einhorn clearly had a strong hand, a created a dustup in which many fingers were pointed, but many key assumptions were lost in the growing storm. Was Einhorn calling for Lehman to go to zero? Are they cooking the books? The whole thing took on a life of its own.

Meanwhile, Callan was being celebrated far and wide. Portfolio Magazine ran with the ball while Einhorn continued to fume that Lehman’s management was getting a free pass with a razzle dazzle show reminiscent of Magic Johnson’s no-look passes in the mid-80’s. It was showtime at Lehman, but of course the numbers ultimately decide the investment case, and I was as guilty as any in fanning the flames that had turned Erin into a hot commodity. To be sure, I was more interested in dinner with Erin than a position in her stock; she shows very well, indeed. Erin had slapped lipstick all over Lehman’s ticker symbol, but I tried to maintain a semblance of objectivity as Erin lit up the big screen.

If she can narrow the stock’s discount to rival Goldman, the love affair will deepen as traders leg in to Lehman.

Of course the discount can narrow as the stocks fall, and not even Erin’s lipstick can dress up a pig. I don’t know what the hemline indicator is flashing either, but the brokers need to mark some time, as Citi’s estimate reductions on Lehman, Goldman and Morgan Stanley today evidences. The crisis has been averted, but reality bites, and sideways might be the best shareholders can hope for.

Einhorn was not buying into the glitz, he has a wife and does not need a date:

Lehman’s management is charismatic and has almost cult-like status. Lehman management gets tremendously favorable press for everything from handling the 1998 crisis to supposedly hedging in the crisis to not playing bridge while the franchise implodes.

And perhaps I gave her too much credit in knowing how to deal with Wall Street’s alpha males; she participated in many of the alternative asset management IPO’s of late, and clearly gained the confidence of their mercurial founders. But that is different than dealing with a determined foe probing the soft underbelly of a leveraged financial institution, and ultimately Einhorn rolled over her in an offensive reminiscent of Patton taking Europe, circa spring of ‘45.

Einhorn’s appearance at the Ira W. Sohn event highlighted the inconsistencies between the March 18th conference call and the 10-Q filing. To be fair, Erin was working with interim numbers that were subject to change, but chastened investors were past forgiveness due to many issues beyond Callan’s control, and Einhorn exploited the opening as he wisely pressed his bet in the media.

May 28th, approximately one week after Sohn conference

By this time, it was widely assumed that most of the brokerage firms, with the exception of Goldman Sachs, were in the process of de-levering and raising capital. Including equity raises that were sure to dilute existing shareholders, given the prohibitive cost of capital the stocks were now implying. Beggars cannot be choosy.

And not to take anything away from Einhorn, but the lynch mob mentality certainly played to his advantage. I expected the Bear Stearns-like rumors to be trotted out as traders went in for the kill, which seemed to be confirmed when Minyanville ran a piece that I certainly never would:

June 3rd
We don’t “do” rumors in the ‘Ville but we’d be remiss if we didn’t pass along our ears to ye faithful. The chatta--and it’s just that, unconfirmed chatta--is that counter-parties are “pulling a Bear” on Lehman Brothers (LEH). In other words, the “rumor becomes reality” scenario is making it’s way around the trading wires. I have no insight to the legitimacy of these stories but I’ll say the same thing I said about Bear Stearns (BSC) in March. If rumors alone can bring down a franchise, how strong can that franchise be? This speaks to the fragility of a globally interwoven banking system in a finance based economy built on more than $500 trillion of derivatives.

At this point Callan’s position was clearly untenable, and she was preparing to throw in the towel

Lehman finally pre-announced the losses that that had to be lurking in the deep recesses of its balance sheet, and they telegraphed a capital raise that lead to an easy trade short in the stock, given they had to price it in the hole. Callan fell on her sword, telling Lehman CEO Dick Fuld she had clearly had lost control of the situation. and it would be best for the company if she left or was reassigned, and he should move forward to clean up the mess.

The trump card Einhorn held in his hand all along was under appreciated; business on Wall Street is unlikely to return to 2006-07 levels any time soon. And without a meaningful commodity business, Lehman is not involved in the one engine of growth left on Wall Street.

Einhorn pulled together a fairly water tight thesis, although I had thought that he had once suggested that Lehman had to raise $70 billion in capital, which sould have been a gross exaggeration. Of course, the pile on led to some wildly exaggerated claims, and if blogs and journalists cannot distiguish the difference between Blackrock and Blackstone Group it is unlikely they can reliably discuss complex balance sheet items or the resulting ratios, some of which can be trotted out to imply that Lehman is in better shape that even Goldman.

The confusion over a share buyback two weeks ago was probably much ado about nothing, although buying back stock while rumors of a capital raise circulate certainly adds to the confusion, and the first story out last Tuesday, the day after Lehman raised $6 billion, was that they might tap Korean investors for additional capital, which had to be the kiss of death to the stabilization efforts for the stock in the wake of the deal.

Hopefully the next the next battleground on Wall Street will be a more sober affair, but given what we have seen with First Marblehead and other battlegrounds, this is unlikely to happen.

Wall Street’s Three Amigos (Einhorn, Ackman and Tilson) will no doubt be back with more grist for the mill, as they appear to enjoy the spotlight.

And there is a downside to all of this, as it appears Jean Bernhard Buttner is now the most powerful woman on Wall Street. The CEO and Chairwoman of Value Line, Inc is not nearly as easy on the eyes or as charismatic as Callan.  But she is worth half a billion dollars, and knows how to bury men in a firefight.

Years ago she launched a palace coup that dispatched her main rival, her twin brother, and narrowly lost a zoning battle with neighbors after planning to bury her father, Value Line founder Arnold Bernhard, in the backyard of her Westport, CT estate, horrifying her neighbors who prefer swimming pools to headstones.

Yes, Wall Street is a wacky place, something Erin can surely agree with. While she debates her future with Lehman, I would encourage her to talk to Mr. Lane at (Lehman subsidiary) Neuberger & Berman’s fledgling alternative asset management operation. It would be a chance to help build something from scratch, and she could help nurture the talent while pitching in with marketing, given potential clients would likely be eager to meet with her.

Hopefully she carries no grudge against hedgies. While they were at first a bee in her bonnet, a swarm of hedgie killer bees eventually created a clusterf*ck that even the most seasoned executive could not escape from.

In stepping down, Erin showed more class than either Stan O’Neal or Jimmy Cayne, who had to dragged away kicking and screaming.

I cannot condone fibbing by the women on Wall Street, unless it involves disclosing their age or weight. But in the end, Erin fell on her sword like a true samurai

Yes, Dick Fuld, there is a warrior at Lehman. And she took the hit for you.
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Brad Hintz used to be Lehman’s CFO, and knows how thankless the job can be, as he told CNBC earlier today.


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Ode to Erin:

Erin’s candle burned out long before her legend ever did.

Time to move on Wall Street!

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The content contained in this blog represents the opinions of 1440 Wall Street. This commentary in no way constitutes a solicitation of business or investment advice. It is intended solely for the entertainment of the reader, and the author. No Position

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