Book Review: “A Colossal Failure of Common Sense”, Lawrence G. McDonald

By Lawrence G. McDonald

Reviewed by David L. Perkins, Jr.

More than an insider’s account of events that led to the collapse of Lehman Brothers, it’s also a truly amazing story of a young man’s ”by hook or by crook” determination to break into the ultra-exclusive club that is Wall Street. Although the story could have been told in fewer pages, it’s chock-full of tales of hustle, determination, greed, ego, intelligence, big bets and the chase for big bonuses. It also reveals the complexity of the world’s economic system and financial markets; how relationships and power struggles at this level can swing billions, if not trillions; and how even the smartest people can, and often do, get it wrong.

Lawrence McDonald, a confused kid from a broken home, steadied his ship and set a goal to work on Wall Street after graduating from college in 1989 in the middle of the pack at a middling university. Despite exerting an almost impossible-to-believe effort to secure any job at all on or near “The Street,” he failed. Plan B was to follow the advice of the only investment banker willing to talk to him: Take any sales job you can find and demonstrate an ability to sell. So he took a job selling pork chops door to door. Yes, pork chops. As in the other white meat.

He went at it as if his very life depended on it and soon became the #1 pork chop salesman on the East Coast. Then with this one bullet point of experience on his resume — one that showed an ability to sell — he again knocked on the doors of investment banks. This time, he landed a commission-only securities sales job for a god-awful, hard-selling, cold-call-out-of-the-phone-book “boiler room” operating hundreds of miles from Manhattan. He again worked day and night with near-maniacal determination, built a little book and earned some money. He obtained his securities license and developed a love and passion for convertible bonds (“converts”). It was 1997 and no online services offered information on convertible bond issues, so he quit his job and started www.convertbond.com with a friend.

Once again, working day and night and using creativity, ingenuity and a willingness to break through any and every barrier, rule and unwritten law that was in his way, he and his buddy built and then sold www.convertbond.com for a tidy profit.

With his new bit of street credit, documented sales ability and Series 7 certification, he cashed in on a boyhood relationship he’d worked hard to maintain and nurture. The result was a low-level job on the bond trading desk with one of the top investment banks on The Street — Lehman Brothers. Little did he know that the seeds of the firm’s demise were already planted.

McDonald spent four years at Lehman Brothers, 2004 through 2008, rising to become a successful and respected bond trader. He became familiar with the inner workings of the firm and as he studied the financial markets — particularly the bond market — he saw reasons for concern. He listened to concerns expressed by others he respected in the firm, and even did some gumshoeing, making a firsthand assessment of the residential mortgage origination process and of the true credit quality of residential mortgage-backed securities. Lehman had hundreds of billions of dollars of exposure to them, and the top brass was operating under the assumption that their quality was good as gold. But McDonald and others had reason to believe otherwise and, if they were right, the firm’s very existence was in jeopardy.

Lehman was operating with incredible amounts of leverage — 40+ times debt-to-equity — and with a concentration of assets in commercial real estate and residential and commercial mortgage debt to boot. But despite repeated and multi-point warnings, Lehman Chairman and Chief Executive Officer Richard S. Fuld, Jr. and President and Chief Operating Officer Joseph Gregory spent most of their time secluded in their penthouse offices, unwilling or unable to converse with the troops or give any credence to repeated pleas for a course change. Fuld and Gregory were instead focused on becoming the largest investment bank in the world, on competing with the likes of Goldman Sachs and Blackstone Group, gaining title to the world’s most prestigious real estate assets, founding and investing in hedge funds, being the leader in mortgage securitizations, and manufacturing continuous revenue and profit increases.

There are many themes and lessons in A Colossal Failure. Not surprisingly, greed, selfishness, ego, excess and foolishness. Also covered are the complexity of the financial markets and the dilemma of what to do when a firm becomes too big to fail but also too large to bail out. And then there is what to do about the fact that large, public companies such as Lehman are run by boards of directors who are simply members of a mutual admiration and support society with the CEO and president.

When a bank becomes impossibly large and complex and sparingly regulated, tremendous power is concentrated in the hands of a few. Bad things can and do happen. Lehman Brothers — one of the largest investment banks in the world — more than 100 years old and with nearly a trillion dollars of equity — evaporated — added fuel to the fire already burning in worldwide financial markets, resulting in an inferno that nearly enveloped the entire modern financial system.

The first step in preventing it from happening again is, of course, understanding what happened.