Legal Commentary

Why Lehman Brothers Failed

By Big Tent Democrat

First and foremost, the repeal of the Glass-Steagall Act had nothing to do with it. Lehman Brothers' financial free fall resulted from its position in the mortgage backed securities market. As an investment bank, Lehman Brothers followed the lead of Salomon Brothers, that invented the non-Fannie/Ginnie Mae mortgage-backed securities business:

An ambitious mail-room clerk named Lew Ranieri worked at S[a]lomon Brothers and saw an opportunity in the mid 80s. S[a]lomon Brothers was hiring rocket scientists to create a new breed of mortgage-backed security, a collateralized mortgage obligation (CMO), designed to more accurately predict the prepayment speed of the mortgages backing the bonds they sold. Lucky Lew ran around the country preaching God, motherhood, baseball, and a CMO in every portfolio. Lew convinced the WORLD investment community that the American homeowner was a damn good bet.

More . . .

It turned out that by 2007, a lot of mortgage-backed securities were not a damn good bet. And Lehman Brothers was completely overexposed in mortgage-backed securities. And the main reason it turned out to be a bad bet was the inability of homeowners to service their mortgages in the "sub-prime mortgage" market. Why that happened is an argument we can have - I mostly blame the performance and policies of the Bush Administration with regard to the economy and financial market regulation. But one thing I believe did not cause it is the repeal of the Glass-Steagall Act. Lehman Brothers did not fail because it engaged in commercial banking. And no commercial bank will fail because it engaged in investment banking.

By Big Tent Democrat, speaking for me only

Full post as published by TalkLeft on September 15, 2008 (boomark / email).