In the event that the reader has not seen the excellent New York magazine article Burning Down The House written by Steve Fishman about the last months of Lehman Brothers, go read it now. The sub-title is "Is Lehman CEO Dick Fuld the true villain in the collapse of Wall Street, or is he being sacrificed for the sins of his peers?"

Toomre Capital Markets LLC ("TCM") believes that this is one of the better articles that explains some of what went on behind the scenes that led to the collapse of the fourth largest investment bank in September 2008. Lars Toomre at one point worked with or reported to some of the principal characters of this story. Several reporters have contacted Lars for information and background information on these characters. However, other than sharing some recollections about Bart McDade with the Wall Street Journal, Lars has declined. Rather TCM has written a number of articles about Lehman Brothers (including the very popular post Possible Bankruptcy for Joe Gregory of Lehman Brothers). An index of the various Lehman Brothers articles can be found here.

This article starts out with a description of a luncheon meeting that Dick Fuld had in June 2008 with a number of investment bankers that was arranged by the head of investment banking head Hugh Skip McGee. Two days earlier the investment bank had announced its first quarterly loss in fourteen years. The loss of $2.8 billion caused the stock to plummet again, 21 percent in a couple of days. The message to Dick Fuld was simple: "The board of directors is going to be under pressure. … It has to deliver a head to the street." Supposedly Dick Fuld shot back (as his veins on his neck popped), "I've given you fourteen years of earnings. I have one bad quarter. This is how you respond?" Yet the next day he canned both the then CFO Erin Callan and his long-time crony and then COO and President Joe Gregory.

Three months after that luncheon, Lehman Brothers on September 15 "filed for bankruptcy, the largest in history and a devastating blow to an already fragile financial system. Fuld became a symbol of failure, the face of arrogant, blindered, massively overleveraged Wall Street. Fuld is blamed for betting the farm on the way up, then stubbornly refusing to recognize the company’s dire straits on the way down. A few weeks after the bankruptcy, Congress summoned him to Washington for a deeply humiliating inquisition." Subsequently, "three sets of prosecutors launched investigations of Fuld and Lehman, probing whether shareholders had been duped."

The article goes on to make the point that in some sense Dick Fuld also is a victim. Apparently Fuld has been having trouble sleeping as he repeatedly goes over and tries to decipher the "mystery", his description of the firm's sudden collapse. "Why didn’t the government save Lehman the way it saved so many others, Bear Stearns and AIG and, just last week, Citigroup? Fuld and his allies can’t help but blame Paulson, whom he’d trusted and, until the end, viewed as an ally and even a friend. Yet Paulson, for reasons Fuld doesn’t yet understand, participated in making him the scapegoat." However, apparently "Mostly, he sits and replays Lehman’s calamitous end. 'What could I have done differently?' he thinks. 'In certain conversations, what should I have said, what could I have done?' How, he wonders, did it all go so disastrously wrong?"

Toomre Capital Markets LLC might suggest that Dick Fuld made the critical mistake of trusting too much his protégé and the firm's Mr. Inside Joe Gregory. TCM has previously written about Joe Gregory's decision to remove Michael Gelband in the spring of 2007 as the global head of the fixed-income division in the post Initial Reflections on Demise of Lehman Brothers. Apparently, Gregory did not want to cut back on the fixed-income's risk profile and may in fact have wanted to expand the risk to use the resulting profits to further fund the firm's aggressive overseas expansion.

The article confirms

By the end of 2006, some at Lehman had begun to think that real estate was nearing the end of its run. Mike Gelband, who was responsible for commercial and residential real estate, had by then turned decidedly bearish.

“The world is changing,” Gelband told Fuld during his 2006 bonus review, according to a person familiar with Gelband’s thinking. “We have to rethink our business model.”

But given the importance of real estate to Lehman’s bottom line, that wasn’t what Fuld wanted to hear. Fuld had seen his share of cyclical downturns. “We’ve been through this before and always come out stronger,” was his attitude. “You’re too conservative,” Fuld told Gelband.

“We’ve been lifted by the rising tide,” Gelband insisted.

Fuld, though, wondered if the problem was with Gelband, not the market. “You don’t want to take risk,” he said—a deep insult in the trader’s vernacular.

At the beginning of March 2007, Gregory took Gelband to lunch in the company dining room. The two had never been close, an ominous sign at Lehman. “When you had no chemistry with Joe, your time was going to be limited,” says one person close to him. Complicating Gelband’s life, Gregory agreed with Fuld on the market’s direction. “If Dick was rosy, Joe was rosier,” said one insider.

At lunch, Gregory pointedly told Gelband, according to a person briefed on the conversation, “you’re not moving. Either you make a change or I’m going to.”

Gelband soon left, an event that for many insiders marked an early sign of the Lehman crisis. “It upset a lot of people when Mike was fired,” said one senior Lehman official. Gregory brought in one replacement, then another for Gelband, the last of whom, Andrew Morton, left in September.

None of Gelband’s successors had deep experience in real estate. And later, Alex Kirk, who’d worked under Gelband and shared his bearish views, confronted Gregory about the hires. “What are you doing [putting these people in critical jobs]? These people are not experts,” Kirk told Gregory, according to people who heard accounts of the conversation.

Gregory disagreed. “No, people need broad experience,” he said. “It’s the power of the machine. It’s not the individual.”

After Morton was hired, Gregory told Kirk, “You can stay if you want, but there’s no place for you.” He got the message and left in February 2008, the culmination of what was sometimes referred to as “a Joe-icide.”

Earlier in the article, Joe Gregory is quoted as saying "I was one of those people who didn’t want to disappoint Dick." And not disappointing Dick also had the sub-text of not pissing off the seemingly always affable Joe Gregory. From personal experience Lars Toomre can testify that Joe Gregory did not respond at all well to contrary or "not with the program" views. Part of the problem with the Lehman Brothers situation was that so many of the mid-level managers had little to no experience working professionally outside of the firm's insular environment. Hence, many drank the "Kool-aid" and operated over a period of time in a way that would not rock the boat (and hence piss off Joe Gregory or one his senior managers). In short, Lehman Brothers was very vulnerable if the "group think" (heavily influenced by those at the top) was different from market realities.

In some ways, Dick Fuld and his proxy Joe Gregory were so domineering and capricious in their use of power that they created an environment where honest communication from those below was stifled. When the environment began to change in late 2006, no doubt there were those below Joe Gregory who knew that "smart" or "influential" clients were beginning to either pull back or express doubts. As more and more clients began to change their views, smart traders no doubt would also know that the environment was changing. How that got communicated up the chain of command is the issue.

By all accounts, Dick Fuld was not good at walking the trading floor to gain a personal and first-hand sense from his troops of the current environment. Instead, most stories (including this one) describe Fuld as being highly insulated in his executive office space or working primarily with external parties as Mr. Outside. From the many descriptions, he primarily relied upon his Mr. Inside, Joe Gregory, and his management committee for a detailed sense of what was going on in the markets.

Another portion of the Lehman Brothers problem was that much of its profits came from historically less liquid portions of the capital markets. Since the 1980's, the mortgage sector has almost always been a significant portion of the firm's revenue and profits. Initially, Richie Isaacs made a boatload of money with Harold Zietland and John Finegold trading pass-throughs. [The decision to short $400mm in GNMA 11.5% into the first arbitrage CMO deal may not have been that desk's finest moment. The comment that "It never will sell" no doubt spurred on Ron "Jessie" Juster and Deanne Landress to prove that that first deal would be a success.]

At the same time, Stuart Dauman and Karen Zimmerman were getting various computer tapes run of whole loans available for sale from a range of savings and loans. In those days, longer term interest rates were in the range of 12% and many financial institutions were reluctant to sell such whole loan portfolios (with mortgages in the range of 3-10%) at prices such as 60% on the dollar. Occasionally, though, a financial institution would make the decision to sell and resulting profits could be significant. [Of course, buying a discount mortgage portfolio at a yield with a slower presumed prepayment rate and then selling it at the same yield (or better) at a slightly faster prepayment speed results in significant price differences (and profits).]

Subsequently, the CMO business (which Lars and Aldon were intimately involved with) began to make significant profits. Later, Wes Edens and his team began to make noticeable profits in the "project" area and what became known as private pass-through securities. Many of those early private MBS had adjustable rate coupon features. The terms of the underlying mortgages varied considerably and often made it difficult to create a uniform pass-through interest rate.

Those early private pass-through structures generally included both a subordinated class and an excess-interest class as well as the primary pass-through class. As Lars recalls, in those early days, the underlying whole loans could be purchased at a price roughly equivalent to where the primary class might be sold to ultimate investors. As a result, both the subordinated class and the excess-interest class could be retained at near minimal cost. Imagine having an investment cost of say $3 million that threw off cash proceeds of say $400,000 per month declining by say $10,000 each month. No matter how one might mark such a position, no doubt the net result would have been quite positive. The key was knowing where to sell the primary private pass-through class. Wes was very good in that respect.

Later on, Mark Walsh emerged. His formal title was the head of Lehman's Global Real Estate Group. According to the article, "'Mark Walsh [head of commercial real estate] financed a lot of the firm for a number of years,' says one person who was above him." Even their best years, Lars Toomre and Wes Edens were very significant to the over-all profits of the firm; however, they never "financed" the firm. One can only imagine what percentage of the revenues and profits Mark Walsh's area contributed to Lehman Brothers' quarterly results. Of course, though, one will never definitively know based upon the limited disclosure made in Lehman Brothers SEC filings. As an article in the New York Observer discloses

Mr. Walsh made big, headline-grabbing deals. His team underwrote Tishman Speyer’s $22.2 billion acquisition of the Archstone-Smith apartment portfolio--360 luxury apartment buildings in cities from Houston and Phoenix to Fairfax and New York. Mr. Walsh partnered with SunCal in the $110.2 million purchase of a 2.25-acre plot of land in Southern California. At the time, Forbes reported that SunCal had outbid Donald Trump for the parcel.

Mr. Walsh had, according to Eastern Consolidated’s Eric Michael Anton, risen to “the top of this country’s professional real estate pyramid.” He had also earned a reputation as one of the biggest risk-takers on Wall Street.

“When you contrast them to a Goldman or Morgan Stanley, it’s a very different way of doing business,” said one capital markets broker. “You talk to Morgan Stanley, they have $3 billion worth of [commercial mortgage-backed securities] exposure in the States. Lehman had $30 billion.”

AND MARK WALSH, AS a source close to Lehman put it, “held the keys to the kingdom.” By virtue of his skillful manuevering or by virtue of plain old happenstance--depends on whom you ask--Mr. Walsh, as one real estate financier who regularly worked with Lehman said, “had extraordinary authority to commit capital as he saw fit.”

“One of his signature products was high-risk, high-return bridge debt and equity financing for large acquisitions, such as Archstone,” continued the financier. “By quickly committing to fund required-debt and equity, Lehman was able to ‘bear hug’ deals with large profits as positions were securitized and longer-term equity capital was raised. The downside was large balance sheet positions when market conditions eroded and values dropped.”

“In Wall Street, Mark held an unusual position in that all the different aspects of real estate reported directly to him,” said one admirer, who has done billions of dollars worth of deals with Mr. Walsh. “In most other Wall Street firms, those responsibilities were divided among two or three other people. While it was working, Lehman was one of the best players out there. They were great as partners and great as lenders; they were very astute real estate people. And I think they really facilitated a lot of transactions in the market.”
Mr. Walsh declined to go on the record for this article. Even in good times, when his deals made headlines, his name never did, summoning scarcely anything but press releases on Lexis Nexis, or, for that matter, Google.

In these days of Internet overexposure, only one image of Mark Walsh exists online. It’s a head shot, his face reddish against a gray background, under a conservative cut of brownish hair, circular glasses framing blue eyes. He’s wearing a plain suit and tie. The photo is on the Web site of UCLA’s Ziman Center for Real Estate. Mr. Walsh, one of its founding members, helped raise its initial endowment.

The 48-year-old appears to think highly of real estate education. In 2005, he and his wife endowed the Fordham University Albert A. Walsh Chair for Real Estate, Land Use and Property Law, in honor of Mr. Walsh’s father, a prominent affordable housing advocate.

“Real estate law and related issues touch everyone’s life every day, particularly in New York City,” Mark Walsh said in a Fordham press release.

His words were prescient. The manipulation of the residential and commercial real estate markets--by investors, credit agencies, mortgage brokers and the lowly homeowner--have
led to the destruction of Wall Street as we know it. Lehman ended up having to write down a number of its assets, including the Archstone-Smith and Suncal deals. The 158-year-old bank ended up declaring bankruptcy two weeks ago. Barclays has since gobbled up most of its American assets. And now that Lehman’s fate appears settled, the blame-mongering can begin.

Some former Lehman employees and observers have come out of the woodwork and laid the blame for Lehman’s demise at Mr. Walsh’s feet, including, most recently, deposed CFO Erin Callan, who this week told Fortune magazine that “the commercial real estate portfolio really was the albatross of the firm.” Critics in the real estate industry have criticized Mr. Walsh and his boss, Richard Fuld, for what they describe as a concentration of too much power, too much autonomy, and too much risk-taking in too few hands.

“He’s very calculating and political and was able to ingratiate himself with Dick Fuld and had incredible autonomy and was able to do things in the firm that no one else was able to do,” said the source close to Lehman. “There were reportedly capital committees and processes under way that everyone else had to go through, and Walsh didn’t have to go through them.”

In the "old" days of the late 1980's, Lehman Brothers Commercial Paper Inc. ("LCPI") was quite a profitable commercial enterprise. That organization was led by Dick Fuld and what was known as the Huntington Mafia: Christopher Pettit, Tommy Tucker, Joe Gregory, and Steve Lessing. Supposedly these individuals used to commute into lower Manhattan via a collectively owned 750 BMW automobile. Given that their parking space beneath the American Express Tower was just a few feet away from that designated for Lars Toomre, sometimes there were observations of these LCPI executives before they had put on their "game faces". The difference between such unguarded "playing around" moments and their executive representations was quite stark. In retrospect, one might wonder what value there might be for "taking one" for the team… especially the Lehman Brothers team led by Dick Fuld and Joe Gregory..