by Christoph Schon, CFA, CIPM
With the 10th anniversary of the Lehman Brothers collapse fast approaching, it is a good time to take stock and reflect on the lessons we have learned from it. For us financial professionals, September 15th, 2008, will always be one of those days where we exactly remember where we were and what we did at the moment we heard the news. For me, this was particularly true, as I was working at the Lehman Brothers European headquarter in Canary Wharf at the time. Looking back, I like to say that it was one of the worst days in my life, but it was also one of the best, as it taught me a lot about the value of human connection and the importance of monitoring and managing one’s risks.
When we arrived in the office on that fateful morning, we were told that our UK subsidiary was under administration, separately from the mother and sister companies in the US. What we also learned was that there was not a single penny left in our coffers, as the holding company had conveniently swept all the cash from its overseas subsidiaries on the Friday night. So, we didn’t even know whether we would be paid for the current month, not to mention any notice period or redundancy payment. We were staring into a big, black abyss.
The value of human connection
But as I said, there were also a lot of good things that came my way that day—first and foremost the wave of solidarity and readiness to help that I experienced. Family and friends called to ask how we were coping, whether we needed help and what they could do to support us. Colleagues offered to lend each other money. Clients volunteered to provide references if we were looking for new jobs. Headhunters bent over backwards to get hold of our CVs—in those first few days, the coffee shops in Canary Wharf looked like a huge speed-dating event.
The importance of diversification
Another valuable takeaway was the importance of diversification. Lehman Brothers was very big on employee share ownership. A large part of our annual bonuses was paid in restricted stock that would take several years to vest. By the time of the default, I had been there 2.5 years, but had never seen a single one of the shares I had been granted. While this supposedly served the purpose of aligning employees’ interests more closely with those of the company, it was a total disaster from a diversification point of view. Our most valuable asset—our manpower—had already been 100% invested in the company. Any more exposure to the same asset simply increased risk.
Nowadays, I see the power of diversification every week when I look at Axioma’s global, multi-asset class portfolio. Most of the time, the fact that it is invested in stocks, bonds and commodities across a number of currencies and regions means that risk is about half of what it would be if all the underlying risk factors were perfectly, positively correlated.
Be prepared for the unexpected
Even though most of us at Lehman Brothers—like the majority of market participants—believed that “they would somehow find a solution to save us”, we had still put contingency plans in place. I was in the fixed-income index and portfolio analysis group at the time, and we had to ensure that we would get external prices and analytics for our fixed income indices, in case there was no more internal trading desk. In this way, we managed to keep our indices and portfolio analysis platform alive when the worst happened, which would ultimately be our escape ticket to our new home within Barclays Capital. This taught me to distrust the conventional wisdom of the market—which has recently been proven wrong over and over again—and has certainly encouraged my interest in stress-testing.
Focus on what you can control
The sudden collapse of your employer is probably one of the worst things that can happen to you professionally. Unlike in a ‘normal’ redundancy round—of which I have also seen many in my 18 years in the financial industry—there is no consultation process, no outplacement support, no notice period and no redundancy payment. A situation like this teaches you to focus on the things that you actually have control over.
In a system as complex as the financial markets, it is almost impossible to predict what other players are going to do and how they are going to react in certain situations. But what you can do is make sure that the exposures in your portfolio match your investment strategy and philosophy and that you are prepared for and protected against adverse events, which again leads us back to the topic of stress-testing.
Be in it for the long term
Even though securitized assets—or rather securitized assets secured by other securitized assets—were at the core of the financial crisis, I still believe that securitization is essentially a good thing. It is just that Wall Street has this unfortunate tendency of taking a good idea and blowing it up to such proportions that it ultimately turns into something that can no longer be controlled. At the end of the day, the majority of the underlying assets and loans were sound. You just needed to have the patience for the cashflows to materialize. Ultimately, Lehman Brothers International Europe—my former employer—did not only repay its senior unsecured creditors in full, but is now also using the surplus to pay interest. It eventually turned out to be worthwhile to be in it for the long term.
If it sounds to good to be true, it probably is
Closely related to the topic of securitization is that of credit ratings. I always had a slightly queasy feeling when I saw securities that supposedly had no credit risk pay coupons well above interbank interest rates. Thankfully, modern risk models now include the spread level—not just its variation over time—into volatility calculations. Also, market-implied ratings can give a good indication of whether what traders considers as the default risk still matches the probability assigned by the rating agencies.
A blessing in disguise
Has the industry changed for the better in the last 10 years? I’d like to hope, at least, that many others have learned similar lessons and put them to good use. What I can say for me personally, though, is that the Lehman default was, in retrospect, a blessing in disguise. I was able to find a new job relatively quickly and subsequently had the opportunity to move on to new, exciting career opportunities. And because the worst had already happened to me, I have been much less daunted by the prospect of ever losing my job (again). But most importantly, I know that I have a network of colleagues, friends and clients that I can rely on and who will not let me down should anything as bad ever happen again.
