On Thursday January 22nd 2009, John Thain, the former CEO of Merrill Lynch, resigned from his new post at the merged Bank of America Corporation. Bank of America Chief Executive Ken Lewis flew to New York to talk with Mr. Thain on Thursday, and they mutually agreed "that the situation was not working out" and that he would resign, said Bob Stickler, a spokesman for Bank of America.

Some privately say though that Mr. Thain was fired after the banking giant lost confidence in his leadership, particularly during the transition period since the acquisition was announced in the hours following the collapse of Lehman Brothers on September 14th 2008. Apparently Mr. Thain failed to tell the acquiring bank about mounting losses at Merrill in the fourth quarter. Those losses apparently totaled more than $15 billion and which were much larger than Bank of America had factored into its acquisition analytics.

The shareholder votes were held on December 7th approving the merger. At the time, the large Merrill losses were not disclosed. Sometime later in December, the Merrill Lynch merger team and not Mr. Thain himself informed Bank of America of the losses, quite a bit apparently attributable to soured trading positions. These losses prompted Bank of America to seriously consider walking away from the deal and eventually led to another contribution from the TARP fund earlier this month.

Press reports indicate that Mr. Thain at the time was off skiing in Vail, Colorado. When he returned, apparently on a head count adjusted basis, the Merrill bonus pool was distributed to firm employees three days before the merger was concluded. That bonus pool is said to have been down less than ten percent from the 2007 levels. That is right! Less than a ten percent year prior when most other firms distributed pools that were less than half of the prior year!! Mr. Thain also was apparently scheduled to shortly depart for Davos, Switzerland where the World Economic Forum will be held later this month. This was despite strong hints from others at Bank of America that such a trip would not be appropriate at this time.

Back in January 2008, Toomre Capital Markets LLC ("TCM") penned the post Option ARMs Spur New Worries. That post highlighted a number of other ticking credit bombs that were going to be effecting the Capital Markets in the coming months. Its chief focus was on the most toxic mortgage credit "bomb" of all: the Pay Option ARMs.

On Saturday December 6th 2008, The Los Angles Times and its writer E. Scott Reckard yet again return to this toxic subject in the article entitled Record 10% of U.S. Homeowners In Arrears Or Foreclosure. The subtitle of the article is "California, with 19% of new foreclosures in the third quarter, is a big contributor to the worsening picture." The prime culprit of this rise in the combined delinquency foreclosure rate are those Pay Option ARMs, given primarily to what were known as Prime borrowers and to a lesser extent to Sub-prime borrowers.

One might remember from the earlier TCM post: "Typically, these Pay Option ARMs present the mortgage borrowers with a choice every month during the first five years of the loan: pay the interest due and some of the principal; pay interest only, leaving the loan balance untouched; or pay less than the interest due, making the loan balance rise. Then, at the end of the five year option period, the loan is reset to fully pay-off with a fully indexed adjustable interest rate. Since many of the mortgage borrowers elect to pay less than the amount that will fully amortize the mortgage and the effect of fully indexing the interest rate from the typical more "teaser" initial rate, when Pay Option ARMs are reset, they almost always require a higher principal and interest ("P&I") payment than initially was required. Sometimes these reset P&I payments are as much as two or even three times what the borrower was originally paying on the mortgage each month. If the borrower elects only to pay interest only during the initial months and the balance rises above a set percentage of the original loan amount, the reset process can occur earlier as soon as three years."

Remember too Pay Option ARM loans often were granted on the basis of stated income, not proof of a borrower's income, giving rise to their nickname, "liar's loans." It has been said that "This is not a sub-prime crisis. This is a stated income crisis." In short, where Pay Options ARMs were most issued (Florida and California), evidence is accumulating that a significant portion of the spectacular rise in residential housing prices earlier this decade was driven by people who stated that they more financial income and assets than was truly the case.

From the above article, according to Jay Brinkmann, chief economist for the Mortgage Bankers Association, "California represents 13% of the loans in the country, but is recording 19% of all new foreclosures." One why might wonder why California is having so many more problems than other parts of the country. It is visible in the so-called "roll rate, which is defined as when one compares the number of newly delinquent loans in one quarter with the number of loans entering the foreclosure process in the subsequent quarter.

As Brinkman explained, That foreclosure "roll rate" was about 10% to 12% nationally in the 1990s and ran from 12% to 15% for most of this decade. The percentage is now 30% nationally but has reached 79% in California and 65% in Florida. "This is nothing like anything we've ever seen before," Brinkmann said. "We were shocked when we saw the California roll rates."

In the January 2009 issue of Vanity Fair, reporter Michael Shnayerson has penned another excellent article, this time entitled Profiles in Panic. This article goes into some detail about how the downturn that intensified in September is affecting the Wall Street types who were living high on the hog in a gilded era. That era is very definitely changing as many are just happy to still have a job and not be one of the more 100,000 world-wide in financial services that have been laid off. It is a well written article definitely worth reading in its entirety.

In the middle of the article, the narrative turned to the sudden bankruptcy of Lehman Brothers. Perhaps no man better represented the excesses and hubris of this gilded era than the former number two at Lehman Brothers, President and COO Joe Gregory. From the article,

If the gilded age has come to an end this fall, surely Lehman’s demise—with its bankruptcy filing on that Monday morning of September l5, 2008—was the tipping point. It panicked the money markets, froze global credit, and sent stock prices spiraling down.

Lehman’s 31st floor—where Fuld and his top executives worked—was by all accounts a quiet place, especially by midafternoon, one managing director recalls dryly. Among Fuld’s loyalists, no one was more loyal than his number two, chief operating officer Joe Gregory, whose story, even more than Fuld’s, seems emblematic of the age now past. If Tom Wolfe were writing a sequel to The Bonfire of the Vanities, Gregory would be his man.

Gregory, 56, was a legend at Lehman—less for his business exploits than for his lifestyle. He had several homes: a principal residence in Lloyd Harbor, on Long Island’s North Shore; an oceanfront McMansion in Bridgehampton; a ski home in Manchester, Vermont; an apartment at 610 Park Avenue; and reportedly a house in Pennsylvania. “He had a kid who went to a small school in Pennsylvania,” a former senior colleague recalls. “Joe didn’t like the hotel, so he bought [a] house in town. It was probably only $500,000, but he paid for it so that, on the maybe two trips a year he took there, he’d have a nice place to stay. And then he had it redecorated!” The colleague says he heard it on good authority that Gregory’s after-tax expenses approached $15 million per year. That, he heard, was exclusive of mortgages. (Gregory’s lawyer declined to comment on e-mails from Vanity Fair.)

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.

On Friday November 28th from London, The Financial Times is reporting UBS Poised To Name US Tax Dodgers in an article written by Haig Simonian. At the shareholder meeting held the day before to approve the latest round of capital raising for UBS, "The 2,395 investors gathered in a dingy suburban hall and heard for the first time that the world's biggest wealth manager looked poised to bow to US pressure and release the names of an unspecified number of US customers who may have committed tax fraud in squirrelling away their assets."

One has to wonder whether the "limited number" of such cases that were announced to have been identified (among the roughly 19,000 US citizens who held offshore accounts with the bank's Geneva, Zurich and Lugano offices) were the result of shall one say "illegal" activities, such as proceeds from drug transactions, bribery or other criminal enterprise behavior. Certainly the public revelation that mod and drug traffickers were hiding their money with UBS will create a great political uproar in the United States.

Perhaps the Swiss government hopes by releasing only the names of such known individuals who clearly committed crimes under both United States and Swiss law, there will be less pressure to expose the names of the other American account holders. From the story, "Peter Kurer, UBS chairman, gave no details, and officials stressed that the decision to transmit names to foreign authorities remained a government matter." But in noting the discovery of tax fraud "under both US and Swiss law", Mr. Kurer added: "Contrary to the idea conjured up in public discussions, bank secrecy is not absolutely valid. It is not there to protect cases of tax fraud." However, these comments suggest that there soon may be a settlement with the US authorities in their long-running investigations into alleged tax evasion in Switzerland.

The above also is the title of a November 21st 2008 editorial by The Editors of Scientific American. The editorial's sub-title is "Overreliance on financial software crafted by physics and math PhDs helped to precipitate the Wall Street collapse". This editorial is well worth reading both today and in the months and years to come, as all parties consider the form and regulation of global financial markets after we get through the current credit crisis.

The editorial begins:

If Hollywood makes a movie about the worst financial crisis since the Great Depression, a basement room in a government building in Washington will serve as the setting for a key scene. There investment bankers from the largest institutions pleaded successfully with Securities and Exchange Commission (SEC) officials during a short meeting in 2004 to lift a rule specifying debt limits and capital reserves needed for a rainy day. This decision, a real event described in the New York Times, freed billions to invest in complex mortgage-backed securities and derivatives that helped to bring about the financial meltdown in September.

In the script, the next scene will be the one in which number-savvy specialists that Wall Street has come to know as quants consult with their superiors about implementing the regulatory change. These lapsed physicists and mathematical virtuosos were the ones who both invented these oblique securities and created software models that supposedly measured the risk a firm would incur by holding them in its portfolio. Without the formal requirement to maintain debt ceilings and capital reserves, the commission had freed these firms to police themselves using risk tools crafted by cadres of quants.

The staff at Toomre Capital Markets LLC has long admired this publication, partly since both Lars and Aldon started in technical fields before moving to Wall Street in the 1980s. Immediately before starting at Lehman Brothers, Lars Toomre was at M.I.T. and Aldon Hynes was at what then was one of the Mecca's of industry research, Bell Labs.

Where did we work in Lehman Brothers? We each started work in the mortgage department focusing on the very software that let Lehman Brothers and other investment banks slice and dice pools of assets into various classes (or tranches) of debt securities then known as Collateralized Mortgage Obligations ("CMOs") and now as Collateralized Debt Obligations ("CDOs"). We were two of the first quants hired by Lehman Brothers' fixed-income division working on some of the early software that this editorial targets!

Lars Toomre of Toomre Capital Markets has been actively involved in the credit markets ever since he was moved from the investment banking division to the Lehman Brothers fixed-income trading floor late in 1983. As a result, he has witnessed many the upheavals in the bond markets including the 1986 rally due to $9 per barrel oil, the 1987 stock market crash, the S&L meltdown of 1990, the Asian currency crisis of 1997 and the Long-Term Capital Management ("LCTM") crisis of 1998. During that period, Lars never witnessed a day like Thursday, November 20th 2008.

The bench-mark 30-year Treasury bond is now trading at a yield of 3.43 percent down from 3.95 percent yesterday. This single-day move of 52 basis points and increase of nine points in price rivals the incredible moves in the flight to Treasuries (at the exclusion of all else) during the 1987 crash and the LTCM crisis. Just a week ago on Thursday, November 13th 2008, this same benchmark security was auctioned by the United States Treasury Department and the stop out rate on that auction was 4.30 percent. This particular Treasury bond ended the trading day on Tuesday with a yield of 4.13 percent.

However, as stunning as the rally in the bench-mark 30-year bond has been, the performance of the 30 year swap has been even more impressive. Unbelievably, the 30 year swap rate is now 2.84 percent. Apparently it has dropped approximately 80 basis points on the day and now trades at about 60 basis points rich to the benchmark 30-year Treasury security. Yes, the 30-year swap is now trading almost 60 basis point through Treasuries!!

Remember a swap spread is the yield differential between Treasury bonds and the fixed leg of a fixed-floating interest rate swap. Also, remember that any interest rate swap has to have a bank or other financial institution standing in the middle. With the world excessively concerned over counter-party risk, how is this spread at all-time negative spreads to United States guaranteed Treasury Bonds!?! Why are investors so willing to buy the 30-year swap with all of the attendant long-term credit issues at a lower yield than the underlying 30-year reference Treasury? This implies investors are somehow reckoning that they are more likely to be paid back by a private counterparty than by the government.

To gain a better sense of this stunning 30-year swap move, this swap closed last week at approximately -15 basis points. On Monday of this week, this swap was at approximately -19 basis points. On Tuesday, it closed at approximately -27 basis points and yesterday it closed at -33 basis points. Today it closed at -60 basis points!! Ten basis points in the 30-year Treasury are worth approximately 58 32nds of a point in price (or 1.8125% in price). Since Tuesday's close, the 30-year swap has moved from 3.80% to 2.84% or alternatively has appreciated approximately 17.4% in price!!! Simply amazing!!!

As many readers of the Toomre Capital Markets LLC ("TCM") no doubt are aware, there is an on-going populist revolt on-going against the "fat cats" of Wall Street. The national politicians are responding to the deep-rooted anger of their constituents about how the $700 billion TARP program was urgently needed to "bail out" the major American global and investment banks. Hence, there is considerable rhetoric about "Main Street" vis-à-vis "Wall Street".

Much of the populist anger has centered on the large amount of pay and bonus compensation that the Wall Street investment bankers and traders receive, which is multiple times what professionals in other non-finance industries receive. The general thrust seems to be "What work exactly do these investment bankers do that is so special that these professionals are 'entitled' or 'deserve' to receive bonuses that are hundreds of thousands or even multiple millions of dollars?"

New York Attorney General Andrew Cuomo appears ready to proceed to beyond mere populist rhetoric. Using his authority under New York State's fraudulent conveyance legal code, he recently has written to each of the banks that have recently received capital infusions under the TARP program. He has demanded to receive information about executive compensation and how their 2008 bonus pools were calculated as well as information on the 2006 and 2007 bonus pools. He has ominously warned "We will have grave concerns if your expected bonus pool has increased in any way as a result of your receipt or expected receipt of taxpayer funds from TARP."

Partly as a result of this political pressure, the top seven executives at Goldman Sachs recently announced that each of them will be receiving no bonus at all for 2008. UBS quickly followed suit for its top executives as have Deutsche Bank AG and Barclays Plc subsequently. Other banking institutions receiving TARP funds are being pressured to likewise eliminate 2008 senior executive bonuses in the coming weeks.

With senior executive bonuses being eliminated or likely to be, the next challenge is what to do with the bonus pools for the lower levels of each of these banking institutions. Clearly, the bonus pools will shrink in size. However, the key question is by how much? Should they shrink to zero like many populists want? Or should the bonus pools be compressed only to the point where they can hope to retain their most important assets – their people? And if the latter is the objective, how much of a decline will be sufficient to prevent those "star" investment bankers and/or traders from moving to one of their competitors, a hedge fund or an asset manager?

Clearly, if Bank A pays zero percent of previous year's bonuses and its competitors pay about half of the previous year's amounts, the most talented personnel at Bank A will tend to move to competitors with better compensation, thereby hurting the future earnings prospects of Bank A. Likewise, if Bank A pays about half of the previous year's amounts and its competitors are at zero percent, Bank A will receive incredible political rhetoric and potentially legal inquiries by New York Attorney Andrew Cuomo. Hence, the board of directors and senior managements at each of these institutions are in a difficult position.

On Wednesday November 19th 2008, The Wall Street Journal printed the article Top Traders Still Expect the Cash written by Ann Davis. The sub-title of the story is "Wall Street CEOs Are Giving Up Pay, but Hotshots Are Another Story." The gist of this article is that there are a small group of Wall Street traders, primarily trading commodities, currencies and/or interest-rate products, who have had extremely profitable years and these traders expect to be compensated for excellent, if not career, years in terms of profitability.

Toomre Capital Markets LLC ("TCM") wrote yesterday about the likely coming indictments in the scandal concerning American citizen tax-avoidance schemes facilitated by the Swiss banking giant UBS. A day later the first of what are likely to be the first of several indictments was revealed.

On Wednesday, November 12th 2008, according to court papers unsealed that day, Raoul Weil, 48, chairman of global wealth management at UBS in Zurich, was indicted Nov. 6 in Fort Lauderdale, Florida. Mr. Weil is the top global wealth management executive at UBS. The case is U.S. v. Weil, 08-60322, U.S. District Court for the Southern District of Florida (Fort Lauderdale). A copy of the indictment is here.

According to the indictment, between 2002 and 2007 Raoul Weil supervised the Swiss bank's overseas activities that serviced some 20,000 US customers. The indictment alleges that by using encrypted laptops and other counter-surveillance techniques, Mr. Weil and his co-conspirators helped US customers conceal around 20 billion dollars in assets from the IRS. Mr. Weil apparently instructed fellow Swiss bankers to increase their cross-border activities knowing that such activity meant bankers would be violating US law.

Toomre Capital Markets LLC believes that it is significant that this very senior executive was indicted with only one charge: conspiracy. The maximum punishment apparently is a fine of $250,000 and/or imprisonment for up to five years. TCM believes that this indictment will serve to squeeze Mr. Weil to reveal what he might know about the activities of yet further more senior executives at UBS.

Back in late May and early June 2008, Toomre Capital Markets LLC ("TCM") wrote about Bradley Birkenfeld and the UBS private banking business serving wealthy American clients. Mr. Birkenfeld, an American citizen based in Geneva, was an mid-level UBS private banker who subsequently pled guilty to helping American clients avoid tax liabilities through various tax-avoidance schemes.

Billionaire real-estate developer Igor M. Olenicoff was a client of Mr. Birkenfeld. In late 2007, he pled guilty to charges about avoiding to pay income taxes on some $200 million in assets hidden at one point with UBS in Switzerland. As a result of this guilty plea, federal prosecutors focused on Mr. Birkenfeld's role and secured an indictment of both him and his co-conspirator, a Mario Staggl, a Liechtenstein citizen and employee of a trust bank located in that secretive country. As part of the federal investigation, Martin Liechti, a top private banker at UBS overseeing the Americas region, was detained for a period by federal authorities in Florida as a material witness.

After Mr. Birkenfeld pled guilty in June, attention shifted to just what role UBS as an organization had in facilitating tax avoidance by American citizens. Over the summer, Congress held formal hearings about the matter. In the opening remarks by Senator Carl Levin on July 18th, he declared "UBS has an estimated 19,000 so-called “undeclared accounts” for U.S. citizens with an estimated $18 billion in assets that have been kept secret from the IRS." Partly as a result of such political and prosecutorial focus, UBS announced that "it would stop offering offshore banking services to clients in the United States". The investigations into UBS's private banking practices have continued through the summer and fall.

On Tuesday November 11th 2008, The New York Times is reporting more on the status of the various investigations. In an article entitled Indictments Said to Be Possible in UBS Inquiry written by Lynnley Browning, news emerges that "A federal investigation into UBS concerning its sale of offshore private banking services to wealthy Americans is concentrating on senior and midlevel executives and bankers, and could result in one or more indictments." Further, "Investigators are sifting through more than 70 names and related account details of American clients provided by UBS over the last few months to the Justice Department, which has passed the details to the Internal Revenue Service for further scrutiny. The Justice Department and the I.R.S. plan to build both civil and criminal tax-evasion cases against some of the clients."

The really interesting issue is how prosecutors will handle the criminal investigation of the bank itself. "The most severe outcomes could include an indictment, a deferred-prosecution agreement or a plea by UBS of wrongdoing. The Securities and Exchange Commission is also investigating the bank, which owns Paine Webber, over possible violations of securities laws." Apparently, UBS disclosed in third-quarter financial statement on Nov. 4 that "the investigations are ‘focused on the management supervision and control of the U.S. cross-border business and the practices at issue.’ "

The New York Post is published by Rupert Murdoch and is well-known in the New York City area for its Page Six section which reports on various gossip items that might be appealing to the greater community. In the November 10th 2008 edition of Page Six, the following tidbit appeared under the section Just Asking:

WHICH wife of a top Lehman executive went on a $132,000 shopping spree at the Americana Manhasset Mall the day after her hubby filed for bankruptcy?

Toomre Capital Markets LLC ("TCM") has written previously about the Possible Bankruptcy for Joe Gregory of Lehman Brothers. Mr. Gregory was the former President and Chief Operating Officer of Lehman Brothers who Dick Fuld relieved of his position back in June 2008 simultaneous with the replacement of then Chief Financial Officer, Erin Callan.

On the day after the election of Barack Obama as the next President of the United States, The Washington Post examined why he won in an article entitled Measured Response To Financial Crisis Sealed the Election. The conclusion of the article is that Barack Obama won because of the sudden collapse of Lehman Brothers on September 15th. That bankruptcy filing triggered "the biggest corporate collapse in U.S. history and an international financial meltdown", ultimately transforming the presidential race.

Is it any surprise then on the day after Obama's election, Bloomberg News reports that Lehman Brothers' much vilified Chairman and CEO Dick Fuld will be "terminated" by the bankrupt company by year-end without any bonus or severance pay?

Dick Fuld has been rightly criticized for driving the fourth largest investment bank into the ground and for the seemingly "large" amount of compensation he received over the years. For instance, Dick Fuld was openly criticized at an Oct. 6 hearing by Henry Waxman, chairman of the House Committee on Oversight and Government Reform, for taking excessive pay, which was estimated at $484.8 million since 2000. He is also being investigated long with 12 other individuals by three federal criminal probes focusing on Lehman Brothers.

Surely, Dick Fuld has become a regular punching bag on Wall Street. Both there and on Main Street, Fuld's various failures and excesses have been ridiculed by politicians, the media, and fellow bankers and executives to illustrate what is wrong with the way Wall Street operates. Equally well, Main Street citizens are quite angry about the Wall Street types who made many times the annual compensation of professionals in other lines of work like academics or engineering.

However, does not this vilification of Dick Fuld seem like a bit much? Many on Main Street have little appreciation of how the mortgage securitization process lowered homeowner mortgage rates for many years. That process saved hundreds and sometimes thousands of dollars each month on both residential and commercial real estate. Spread across the many mortgages in the United States this "benefit" to Main Street offsets some of the amazing "profits" that Wall Street rang up in an environment of particularly low volatility and risk premiums.

During the past few days, there have been a large number of readers of the Toomre Capital Markets LLC ("TCM") website looking for more information on the bankruptcy filing of Lehman Brothers. Some of those inquiries have been looking for details on both "Joe Gregory" and "bankruptcy".

This was a bit surprising because there were few other searches for the names of other Lehman Brothers executives in combination with the term bankruptcy. Perhaps the readers were looking for more information about Joe Gregory's extravagance of using a helicopter to commute back and forth to work in mid-town Manhattan from his (plural) homes on Long Island. TCM has previously written about Joe Gregory and his extreme example of hubris and excess in the posts Employee Losses in Lehman Brothers Stock Holdings and Initial Reflections on Demise of Lehman Brothers.

On Sunday, September 21st 2008, New York Magazine published an article about the pain of sudden down-sizing that many are feeling with the demise of Lehman Brothers in an article entitled The Rage of the Previously Rich. Buried in the middle of that article was the text:

On Friday, September 12, the Wall Street Journal reported that Lehman’s former president, Joe Gregory, who was demoted along with former CFO Erin Callan in a management shake-up in June, was listing his Bridgehampton house on Surfside Drive for $32.5 million. The collapse of Lehman’s stock is a blow to Gregory’s lifestyle. He reportedly used to travel by helicopter to midtown from his $3.5 million mansion in Huntington, which was recently renovated, according to a Sotheby’s broker. According to one source, Gregory’s financial adviser was in negotiations with Lehman’s attorneys at Simpson Thacher & Bartlett, working to avert his filing for bankruptcy, after he borrowed money against his Lehman stock to pay for the renovation. “He owes a lot of money for it. They called the margin loan” late last week, the source said.

The weekend of September 14th 2008 certainly will be known as a most remarkable weekend for American high finance. Both Lehman Brothers and Merrill Lynch have disappeared; the first to bankruptcy, the second to a Fed-directed merger with Bank of America. Several people have contacted Lars Toomre to ask various questions about might lie ahead in the near and longer-term future, and what "I" might know.

As a former employee of Lehman Brothers, I am sad to see that franchise disappear seemingly into thin air. Yet as readers of this blog no doubt are aware, I have been very contemptuous particularly of the former Capital Market managements of Citigroup, Merrill Lynch and UBS and their risk management teams. Clearly, the leaders of those firms really did not understand what types and amounts of risk they were taking on with all of their accumulation of sub-prime mortgages, CDOs, SIVs and other structured finance products. Why they had to own so many billions of these products made no sense except if they were making the bet that they could make a spread between the asset yields and where those products could be funded.

Back in the late fall of 2006 and early winter of 2007, I became extremely worried about the irrationality of the fixed-income markets. On February 5th 2007, I wrote the post It's All Fun and Games Until Someone Gets Hurt where I highlighted

Toomre Capital Markets LLC has been quite concerned about the irrationality of the United States fixed-income markets. Recently, the current coupon mortgage-backed security has traded with a negative option adjusted spread ("OAS"). Buyers of the current coupon MBS apparently were paying little heed to the fact that the underlying mortgages could be pre-paid. Rather the demand for nominal yield far outweighed the risk of prepayment. It will be very interesting to observe what happens with this market sector in the coming months as the Federal Reserve seemingly remains on hold. Is it a time to reach for yield? Or is it a time for safety ahead of one of the bond market's periodic up-heavals?

That post was followed up by one the next week entitled Hedge Funds, Investment Banks and the Value of Liquidity? In that post, I wrote "The financial markets now are full of much liquidity. Are investors, speculators and their bankers appreciating and pricing in liquidity risk? Toomre Capital Markets LLC would suggest that liquidity risk presently is greatly under-valued in the search for 'alpha', absolute return and portfolio yield. The stretch to get ten percent return (after fees) appears to be making rational people start to do irrational things."

Apparently, the folks running Lehman Brothers were not fully paying attention to what they were doing with their mortgage business. Somewhere in my reading of the past few days, I saw reference to why Michael Gelband resigned as the head of Lehman Brothers fixed-income division in June 2007. Apparently, the Lehman Brothers COO Joe Gregory did not want to reduce the risk profile of the fixed-income business (and may even have wanted to expand the risk even further to help fund the firm's global expansion plans).

On the morning of Monday June 9^th 2008, Lehman Brothers pre-announced their second quarter earnings report and gave limited details on their capital raise efforts. [A link to the press release can be found here.] The numbers are larger than what Toomre Capital Markets LLC ("TCM") wrote about last night in the post Lehman Brothers Said to Lose $2 Billion Plus in Second Quarter. Lehman Brothers now expects to lose $2.8 billion for the period ended May 31^st 2008 as well as raising close to $6 billion through a combined common stock and preferred offering.

Partly as a result of this announcement, Moody's Investors Service has put the ratings of Lehman Brothers under review for a likely downgrade. Lehman Brothers will be conducting a 10 AM conference call to discuss further this press release. From the press release, it appears that the fixed-income division had a net loss of approximately $5 billion, which is much larger than the losses that Lehman Brothers has announced in prior quarters.

Lehman Brothers in the past months has pledged to increase its transparency regarding its financial transparency. It certainly will be quite interesting to learn more about where these losses came from. Toomre Capital Markets LLC will post more about this company later in the day as further information becomes available.