1. 1
Contents
Introduction ............................................................................................................................................2
Section 1 The Financial Crisis of 2007-2010............................................................................................2
FINANCE..............................................................................................................................................2
Compensation Issues ......................................................................................................................2
Collateralized Debt Obligations (CDO’s) and Credit Default Swaps (CDS’s) ...................................3
Credit Rating Agency Behaviour .....................................................................................................3
Implications of CDO’s and CDS’s.....................................................................................................4
ROLE OF THE U.S. GOVERNMENT .......................................................................................................4
Regulators Fell Asleep at the Wheel with Lehman.........................................................................4
Credit Expansion Policies ................................................................................................................5
Repeal of the Glass- Steagall Act and Greater Debt-Capital Ratio..................................................6
THE HUBRIS OF WALL STREET EXECUTIVES THROUGH ‘TOO BIG TO FAIL’.....................................6
Section 1 Conclusion...........................................................................................................................7
Section 2 Why Lehman Brothers Collapsed in October 2008.................................................................8
FINANCE..............................................................................................................................................8
Collapse of Bear Stearns .................................................................................................................8
Bank of America Bought Merrill Lynch Instead of Lehman Brothers. ............................................9
Market Ignorance Towards Liquidity ..............................................................................................9
Lehman’s Complex Financial Products............................................................................................9
Window Dressing Capabilities.......................................................................................................10
ROLE OF THE U.S. GOVERNMENT .....................................................................................................10
Insufficient Power to Bailout Non-Banks......................................................................................11
Emergency Powers Under Section 13(3) and the New Dodd-Frank Legislation...........................11
Emergency Powers for Bear Stearns and A.I.G.............................................................................12
Barclays Proposed Takeover of Lehman.......................................................................................12
DICK FULD FORMER CEO OF LEHMAN BROTHERS............................................................................13
Fuld’s Unethical Management Practices.......................................................................................13
Fuld Believed Lehman Was Too Big to Fail ...................................................................................14
Conclusion.........................................................................................................................................14
Bibliography .........................................................................................................................................16

2. 2
Introduction
The financial crisis was initially portrayed to be exclusively an American problem when
many of their financial institutions failed. However as we discovered after the Wall Street
Crash of 1929 when America sneezes the world catches a cold. This paper will be split up
into two sections. Part one will demonstrate how the causes of the financial crisis were not
strictly due to the world of finance alone as we will also analyse the US Governments’ role
through its policies as well as the actions taken by Wall Street’s elitist individuals who
thought they were too big to fail. In relation to part one, part two will explain exactly how
and why Lehman Brothers collapsed in October 2008.
Section 1 The Financial Crisis of 2007-2010
FINANCE
Here we will discuss the implications of flawed compensation structures which incentivised
high risk taking through the creation of more complex financialized products such as CDO’s
and CDS’s. We will then analyse the associated implications of credit rating agencies.
Compensation Issues
Former chief economist of the International Monetary Fund Raghuram Rajan’s raises an
important issue that “compensation practices in the financial sector are deeply flawed and
probably contributed to the ongoing crisis” which is no real surprise given the industry norm
of setting aside 40%-50% of company revenues for executive pay. (Rajan, 2008) He states
that employee compensation was not truly linked to the enormous losses which the banks
incurred for example Morgan Stanley increased its bonus pool by 18% despite suffering a
$9.4 billion charge-off. (Rajan, 2008) This leads us onto the suggestion that “firm’s
performance-based compensation did not produce a tight alignment of executives’ interests
with long-term shareholder value.” (Bebchuk, et al., 2009) One explanation for this includes
executives cashing out “large amounts of shares and options” which gave them “incentives to
place significant weight on the effect of their decisions on short-term stock prices.”
(Bebchuk, et al., 2009) At the same time we must consider Rajan’s suggestion regarding the
annual distribution of bankers’ bonuses. This compensation structure provides managers with
risk taking incentives to gain short term profits over long run losses because their short term
bonuses are not “clawed back” in the case of future losses. (Rajan, 2008) In other words this
limited liability “allows investors and executives the full upside benefits of their risk-taking,

3. 3
while limiting their downside exposure.” (Dowd, 2009) Therefore we can now see a clear
principal-agent problem which was only emphasized by Wolf’s suggestion as short run,
decisions taken by managers at the time “were extremely difficult to judge from outsiders.”
(Wolf, 2008) These factors fuelled the risk taking culture in the financial world.
Collateralized Debt Obligations (CDO’s) and Credit Default Swaps (CDS’s)
This greater risk taking culture meant financial institutions wanted greater business growth by
diversifying their product portfolio to target new markets to help drive shareholder value.
This helped to create CDO’s and CDS’s specifically designed for the higher risk subprime
mortgage market. A Collateralized Debt Obligation (CDO) is a complex financial product
which pools together cash generating assets such as loans, bonds and mortgages. In the event
of default these assets would be lost as they serve as collateral. This pool is then repackaged
into different tranches depending upon their perceived level of risk consisting of low (e.g.
AAA), medium (e.g. BBB) and high (unrated). The low risk (higher credit rating) will receive
the first payments from the CDO at a lower interest rate whilst having first say in the event of
a default. However as you move towards the higher risk tranch you would receive the
payments last (if there is any left) which is why you would receive the highest coupon rate
compensating for your highest risk. This product innovation was perceived to open up more
market opportunities to help match more individuals preferences regarding risk and reward
and was ultimately designed to spread thus reduce risk. However the assumptions behind the
formulator of a CDO were wrong as they incorrectly estimated the default correlations. Here
pooling mortgages to reduce risk only works if they are uncorrelated therefore do not default
at the same time which is mainly why the financial crisis occurred. (Economist, 2013) A CDS
is a credit default swap whereby the CDO would be insured by a third party such as A.I.G.
Therefore as these CDO’s were quickly shifted in the hands of insurance companies, financial
institutions did not have too much interest if these CDO’s defaulted or not as they would still
obtain the transaction fees. But how were companies able to quickly sell off these CDO’s?
Credit Rating Agency Behaviour
Standard & Poor’s amongst other credit rating agencies rated an estimated 70% of these
tranched CDO’s as AAA which was obscene considering their complexity of the
securitization chain and product nature. However these agencies bared no legal obligation or
responsibility if even their AAA (same rating as federal bonds) rated assets defaulted, which
questions their credibility. (Economist, 2013) Simultaneously this credibility was completely
flawed considering that the banks paid these agencies to rate their own products therefore

4. 4
there was no real surprise that these generous assessments were allocated. Essentially the
credit rating agencies payments were based upon quantity of ratings and not quality.
Therefore the incentive on the agency’s behalf would be to rate as many products as quickly
as possible which was in alignment with many financial institution’s interests because this
would allow them to sell even more CDO’s therefore generate even greater returns from
transaction fees.
Implications of CDO’s and CDS’s
The implications of these short run incentives can be explained by the Warwick commission
report. Firstly the housing bubble occurred during the economic cycle’s up-phase as the
“price based measures of asset values rose and price based measures of risk fell” whilst
“competition to grow bank profit increased” which we have seen with the credit rating
agencies. (The University of Warwick, 2009) Furthermore as the safer perceived banks
appeared more robust during this period “shareholders concluded the bank was under-
leveraged.” (The University of Warwick, 2009) Their response was expanding their balance
sheets, greater short term borrowing and leverage otherwise they would be “punished by the
stock markets” because “increasing leverage and expanding balance sheets puts a bid on asset
prices pushing them up further, amplifying the boom.” (The University of Warwick, 2009)
ROLE OF THE U.S. GOVERNMENT
Former Secretary of the Treasury Hank Paulson has time and time again stated that all
financial crisis stem from flawed policies. (The Huffington Post, 2013)The aim of this section
is to see which policies were flawed and why.
Regulators Fell Asleep at the Wheel with Lehman
Firstly regulators “fell asleep at the wheel” as Lehman went bankrupt because this shattered
confidence across all the financial institutions. (The Economist, 2013) It created a sense of
panic as no one believed in each other’s ability to repay its obligations therefore the industry
stopped loaning to each other, especially in the vitally important short term cash repo market.
This shortage of cash at the top had a detrimental knock on effect to thousands of non-
financial firms who heavily relied upon financial institutions to finance their daily operations
including supplier payments and employee wages. This cash flow was critical to the wider
economy because one major implication was for businesses to delay payments, lay off staff
and in many cases bankruptcy. This subsequently meant less confidence across all market

5. 5
sectors which led to further unemployment as this vicious downward spiral continued. In
essence businesses were starved of their oxygen (cash) because of Lehman’s collapse.
Credit Expansion Policies
The affordable housing quotas
The Bush Administration knew that house prices had risen steadily since World War 2 and
were perceived to be a safe investment for Americans. Therefore in a political attempt to
increase popularity their policies concentrated on enabling more Americans to live the
American Dream, especially those who did not have the most credible credit histories. For
example, according to a Cato Institute report, “the affordable housing quotas” on Fannie and
Freddie in 2002 and 2004 encouraged more involvement in the subprime market. (Dowd,
2009) This consequently led to their competitors such as Lehman doing likewise.
Why such a sharp fall in interest rates?
The sharp fall in interest rates was seen economically crucial to increase borrowing to
stimulate expenditure thus driving growth whilst borrowing was seen as socially beneficial as
it helped more to realise the American Dream. But why was this decision taken?
Controlling inflation is the primary aim of monetary policy. However this depends on the
policymaker’s views in America. (Dowd, 2009) Dowd suggests that the ‘Greenspan
Doctrine’ was vital as “the Fed could do nothing to stop asset bubbles from occurring, but
would stand by to cushion the fall if they did occur” meaning they would offer “partial
bailouts of bad investments.” (Dowd, 2009) This only emphasized the too big to fail
argument as Government financial assistance was likely if ever required in the future.
In 2002 the “false deflation scare” presented to the Fed policymakers by Bernanke was
another reason for monetary loosening which saw interest rates fall to around 1% in July
2003 as the U.S. economy was encircled by uncertainty following the .com bubble burst and
9/11. (Dowd, 2009) Consequently this encouraged both institutional and public borrowing as
riskier investments offered a comparatively larger reward relative to low risk U.S. bonds.
Therefore despite the goal of increasing home ownership their policies had the unintended
consequence of building the foundations of the financial crisis as higher expenditure raised
house prices which fuelled the housing bubble. Inevitably this greater spending raised the
inflation rate which pressurised the Fed to act as bondholders’ returns would diminish in real
terms. Subsequently the Fed responded by gradually raising its interest rates to a peak of

6. 6
5.26% in July 2007. (Dowd, 2009) This caused the subprime mortgage market to crash as
mortgage owners could no longer afford to pay their rents and consequently defaulted. The
Fed could have responded by again lowering interest rates until these financial institutions
became less exposed to subprime mortgages and by introducing tighter regulatory control but
instead they chose not to act. This left those insurers who engaged in CDS’ such as A.I.G. to
incur the bulk cost of defaulting mortgages. Only now did the world begin to truly realize the
liquidity crisis.
Repeal of the Glass- Steagall Act and Greater Debt-Capital Ratio
With America’s ambition to become the world’s financial hub above London the first alarm
bells rang from the Repeal of the Glass-Steagall Act known as the Gramm-Lach Blily Act
under President Clinton in 1999 which was labelled ‘public enemy number one’ by Nobel
Prize economist winner Joseph Stiglitz. (Brook & Watkins, 2012) This portrayed a lack of
standards because holding companies could now operate both commercial and investment
banks meaning they could accept deposits and gamble this money by underwriting or dealing
in securities. However the game changing policy came under the Bush Administration. The
credit expansion obsession surrounding the American Dream gathered pace in 2004 where
SEC allowed the debt-to-capital ratio to be increased from 12:1 to 30:1, a policy coincidently
supported by then Goldman Sachs CEO, Hank Paulson. This sent financial institutions, but
especially Lehman, into a leveraging frenzy as they were believed to have leveraged around
this upper threshold which left Lehman vulnerable to insolvency as anything just over a 3%
decrease in their asset value would have left them insolvent. (Morning Star, 2007) (This
proved to be the case when interest rates went up as many institutions’ subprime mortgage
defaults increased.) Theoretically this would raise great concern regarding liquidity as cash
flows are often perceived to be the oxygen of a company. Evidently this was not the case for
the credit rating agencies, investors or Wall Street executives but more importantly the US
Government. Their judgement had been clouded over by their policies tailored towards the
pursuit of living the ‘American Dream’ which was in fact more interventionist than
America’s so called free market tendency.
THE HUBRIS OF WALL STREET EXECUTIVES THROUGH ‘TOO BIG TO FAIL’
In business academia there is a huge case that many Wall Street executives believed they
were ‘too big to fail’ which is undoubtedly connected to the flawed compensation structures
and flawed Government policies which we have previously discussed. However to further
emphasize this claim, the shift in the financial industry’s concentration between 1990 and

7. 7
2008 was staggering. “The share of financial assets held by the 10 largest US financial
institutions rose from 10% to 50% as the number of banks fell from over 15,000 to 8,000.”
(Ferguson, 2009) These companies were bound to fail as the industry “was too important to
be left to bankers” whom had “talent for privatising gains and socialising losses.” (Wolf,
2008) Meanwhile the industry had received, as the market expected, numerous bailouts
including Government supported, but not owned, Fannie Mae and Freddie Mac who received
subsidies for 30 year mortgages. (Tyrangiel, 2013) Additionally the approval of JP Morgan’s
takeover of Bear Stearns with a bailout only emphasised this ‘too big to fail’ attitude amongst
Wall Street’s financial institutions. (In section two we will discuss Dick Fuld, CEO of
Lehman.) Further evidence suggests Wall Street CEO’s saw the liquidity warning signs of
France’s largest bank BNP Paribas in 2007 which had three sub-prime related bonds funds
frozen. (Tyrangiel, 2013) However as they were too big to fail subprime operations
continued.
Section 1 Conclusion
Throughout this paper we have learnt that the causes of the financial crisis of 2007-2010 do
not solely focus on the world of finance alone as the Government and executive behaviour
also had a significant influence. Nevertheless finance played a major role in creating the
crisis. Firstly, the flawed compensation structure allowed managers to generate high short
term profits by taking high short term systematic risk because they would not incur any future
financial repercussions as their business would. This led to the creation of complex financial
products such as CDO’s and CDS’s which were inaccurately rated by the credit rating
agency’s as it was in both sides’ financial interests to concentrate on quantity and not quality.
These products were designed to minimize risk to fuel the American Dream. However
realistically, its miscalculated formula and almost untraceable risk in the complex
securitization chain turned this dream into a nightmare. Secondly, we have seen the argument
of regulators falling asleep at the wheel regarding Lehman but we have mostly supported
Hank Paulson’s perception that the financial crisis of 2007-2010 like all financial crises stems
from flawed Government policies. Flawed policies such as the affordable housing quota,
falling interest rates, the Repeal of the Glass-Steagall Act and the increased debt-to-capital
ratio policy all helped to widen their macroeconomic imbalances regarding excessive
spending. They were aimed to assist the American Dream in order to help stimulate the
American economy, they acted like a short term fix for a sick patient as giving the patient
more pain relieving drugs does not fix the fundamental health issue which is why the

8. 8
Government played a key role in creating the financial crisis of 2007-2010. Finally we have
seen how the financial world and various government policies helped to grow the ‘too big to
fail’ belief planted in the minds of Wall Street executives who carelessly ran their companies
into the ground. Ultimately finance, the role of Government and executive behaviour all
helped to cause the financial crisis of 2007-2010. This leads us into section two where we
will explore precisely how Lehman collapsed.
Section 2 Why Lehman Brothers Collapsed in October 2008
On the 15th
September 2008 Lehman Brothers, the 4th
largest investment bank In America,
filed for chapter 11 bankruptcy protection. But how did this happen? The paramount areas for
analysis explored in this section again include the world of finance, the role of government
and the hubris of former CEO Dick Fuld who believed that Lehman was ‘too big to fail’.
FINANCE
In the financial world there were many reasons behind the collapse of Lehman Brothers.
Firstly we will explore the exogenous confidence shock to Lehman by the collapse of Bear
Stearns as well as the implication of Merrill Lynch’s actions. However the main reasons lie
behind the flawed compensation structure, which we explored in part one, that encouraged a
risk taking culture within the industry. Despite this risk we must wonder why there was there
no suggestion of the Lehman Brother’s fragility even in their final full year filing. This will
bring us to the crucial financial aspects of the markets’ ignorance towards liquidity,
Lehman’s complex financial products, and finally Lehman’s fraudulent window dressing
capabilities which all portrayed their superficial performance.
Collapse of Bear Stearns
On 17th
March 2008 the collapse of the second-largest underwriter of mortgage backed
securities Bear Stearns demonstrated that the CDO and CDS engagement in the subprime
market was a ticking time bomb. Simultaneously as JP Morgan took over the company for a
favourable $2 per share, this shattered confidence in the Lehman Brothers as the market
feared they would be next in line to fail. Consequently this sparked JP Morgan to demand
greater weekly collateral from Lehman in order to secure short-term loans, amounts which
essentially “suffocated” Lehman according to Bloomberg. (McDonald, 2009) Subsequently,
rumours spread about Lehman’s inability to externally raise capital which led to Lehman’s
share price plummeting by over 95% despite them having some cash reserves. (BBC, 2008)

9. 9
Bank of America Bought Merrill Lynch Instead of Lehman Brothers.
Merrill Lynch knew that in order for Bank of America to take over Lehman, another buyer
was required to take over Lehmans’ toxic assets and they could only afford one takeover.
Therefore knowing that Merrill Lynch themselves would also be on the brink of failure unless
they were recapitalized they successfully persuaded Bank of America to take them instead of
Lehman in a deal the New York Times believed to be worth around $50 billion. (Sorkin,
2008) If Merrill Lynch had not offered this proposal then Lehman may have been saved.
Market Ignorance Towards Liquidity
Despite Lehman’s huge leverage, liquidity was never considered a problem because of the
high market confidence and trust that financial institutions would lend and repay its cash
loans to one another. Therefore analysts turned a blind eye to the continual negative cash
flows Lehman ran up for investing activities during the three years up to its demise, including
£1,698 billion in 2007. (Morning Star, 2007) Clearly investors were distracted by Lehman’s
continuous record profits between 2005 ($3.26 billion) and 2007 ($4.2 billion) which also saw
rocketing share prices. (Morning Star, 2007)
Lehman’s Complex Financial Products
Prior to the crash, the American economy was dominated by low inflation and stable growth
which had saturated the prime mortgage market. This consequently encouraged risk taking in
the financial world through financial product innovations which included the previously
mentioned CDO’s CDS’s. These complex products involved many different products and
actors throughout the securitization chain. However they were designed to minimize but not
completely eradicate risk as Milton Friedman once famously said ‘there ain’t no such thing as
a free risk.’ Consequently, this gave Lehman Brothers the green light to expand their
portfolio into the capital markets. This mainly included the higher risk sub-prime mortgage
market which was aided inorganically by Lehman’s taking over five mortgage lenders
between 2003 and 2004 including BNC Mortgage. Instead the unintended consequence was
that these products had helped Lehman Brothers to lose track of and thus increase its risk.
Consequently, Lehman claimed it would write down its residential mortgages and
commercial property investments by $700 million in 2007 but instead reached $7.8 billion in
2008, its greatest historical net loss. (BBC, 2008) Simultaneously Lehman admitted it was
struggling to value its $54 billion exposure to other mortgage-backed securities. (BBC, 2008)
Such a complex structure was undermined by Lehman’s one lost bet regarding all house and
asset prices not falling at the same time which they did.

10. 10
Window Dressing Capabilities
As Fuld told his executives to reduce their debt, investors still continued to invest as nobody
could see Lehman’s huge exposure to subprime mortgages as the lies were hidden by top
management mainly through the repo (repurchase agreements) transaction manipulation
which later became known as repo 105 in Lehman’s case. In essence, this involved
transferring one company’s assets to another in exchange for short-term cash and is popular
in the financial world as firms may have short term illiquid assets therefore resorted to the
repo market to obtain short term cash. Furthermore the Financial Times reported evidence
from Anton Valukas, the Lehman bankruptcy court examiner, who found “credible evidence”
of an “accounting gimmick” which window dressed their results at a time where Lehman had
assured its board that it had “the strongest liquidity position of the brokers.” (Baer & Thomas,
2010) Valukas was referring to Lehman’s fraudulent and aggressive manipulation of its repo
market operations where it would borrow cash from the repo market in exchange for their
toxic assets (in which case even some of their AAA CDO’s were toxic as previously
discussed) just before it was due to release its financial reports. The implication for
shareholders, potential investors and regulators was that they would not see Lehman’s
illiquid, toxic assets but instead see propped up liquidity i.e. the cash borrowed from another
company obtained through the repo market. They were able to perform this method by
classifying these repo loans not as loans but as sales meaning they never actually disclosed
that they would have to pay back this repo loan to the other companies. This was supported
by Merrill Lynch who reported to regulators after Lehman’s first quarter results in 2008 that
Lehman had “regulatory capital in its calculation of excess liquidity” through “cash and
collateral locked up in other banks.” (Sender, 2010) Moreover once the financial reports were
published the cash plus interest would be repaid by Lehman in exchange for their illiquid,
toxic assets. Overall this fraudulent method painted a brighter picture of Lehman’s financial
health by improving their debt levels by an estimated $39 billion in quarter 4 2007, $49
billion in quarter 1 2008 and $50 billion in quarter 2 2008. (De La Merced & Sorkin, 2010)
ROLE OF THE U.S. GOVERNMENT
In section one we explored the Bush Administrations’ credit expansionary policies tailored
towards the American Dream which turned out to be a nightmare by helping to fuel the
financial crisis. Some suggest that Clinton should not had repealed the Glass-Steagall Act, or
Bush not changed the debt-to-capital ratio whilst many point the finger towards not

11. 11
regulating those flawed remuneration schemes which we have analysed in part one. These
were credible at the industry level.
Hank Paulson believed with more power he may not have needed to go to Congress where
legislation was extremely difficult to pass unless there was an immediate crisis. On the other
hand the Financial Times reported an e-mail from Jim Wilkinson, Paulson’s chief of staff
who quoted “I just can’t stomach us bailing out Lehman. Will be horrible in the press.”
(Braithwaite, 2010) Maybe there was a moral hazard as no firm should be too big to fail.
Here specifically in Lehman’s case, we will concentrate on the lack of crucial policies at the
Government’s disposal such as TARP and the new Dodd-Frank legislation which in hindsight
could have saved Lehman from the brink according to Paulson.
Insufficient Power to Bailout Non-Banks
Firstly, unsurprisingly to Paulson’s support was Phillip Swagel, who was assistant secretary
for economic policy at the Treasury Department from 2006 to 2009, who believed that
“Lehman failed before the T.A.R.P. (Troubled Asset Relief Program) was passed or even
proposed to the Congress.” This essentially meant the “Treasury Department had no legal
authority to put government money into the firm or provide a guarantee for its obligations.”
He further claimed that this only changed “with the passage of the Emergency Economic
Stabilization Bill on October 3rd
2008 which provided $700 billion in T.A.R.P. financing to
be used to purchase troubled assets.” (Swagel, 2013)
Emergency Powers Under Section 13(3) and the New Dodd-Frank Legislation
Another option to impose was the emergency powers under Section 13(3) where an
emergency loan could be made to a firm during “unusual and exigent circumstances”.
(Swagel, 2013) However this was somewhat restricted to “classes of firms rather than
individual ones” by the old Dodd-Frank legislation where approval from the Treasury
Secretary, Hank Paulson and the Fed’s governing board were required. This was never truly a
viable route as it was illegal for the Fed to make a loan on which it expected to take a loss.”
(Swagel, 2013) Furthermore, the Fed clearly did expect a loss according to a testimony before
the Financial Crisis Inquiry Commission in Washington by the New York Fed General
Counsel in Thomas Baxter. He suggested that Lehman “had no ability to pledge the amount
of collateral required to satisfactorily secure a Fed guarantee, one large enough to credibly
withstand a run by Lehman’s creditors and counterparties.” (Baxter, 2010)

12. 12
Emergency Powers for Bear Stearns and A.I.G.
This inability to offer collateral was the fundamental difference to other bailouts in which the
US Government had previously dealt with including Bear Stearns where they allowed JP
Morgan Chase favourable terms to buy them out. In this case the Fed risked $29 billion
against Bear Stearns’ estimated $30 billion assets which eventually proved to be a successful
deal as the Fed was repaid in full with interest. (Swagel, 2013) However a more interesting
case entails the events post Lehman Brothers collapse where “the Fed’s loans were
collateralized by the entire assets of insurance giant A.I.G.” because of the enormous
potential loss it could incur. During this volatile period it was very difficult to place a value
on A.I.G. meaning its assets may not have offset any Fed loan. (Swagel, 2013) Now we have
a visible grey area in interpreting Section 13 (3) because in A.I.G.’s situation there was no
certainty that the Fed’s $40 billion loan would not result in a loss because they clearly could
not place a value on A.I.G.’s assets. Therefore this suggests that the Government noticeably
viewed A.I.G. as too big to fail and not Lehman as Lehman’s problems involved solvency
and not just liquidity. (Swagel, 2013)This was critical to justify the Government allowing
Lehman to fail under their noses.
Barclays Proposed Takeover of Lehman
The last throw of the dice during Lehman’s final hours was a desperate one and proved that
the US Government had tried everything to prevent Lehman’s collapse. They had crossed
their fingers that UK Bank Barclays would miraculously acquire the essentially bankrupt
Lehman Brothers. In the meantime the FSA had essentially blocked the deal unless the US
Government would guarantee Lehmans’ trading obligations, in other words its incurring
losses, during the 30 day shareholder approval period in order to mitigate uncertainty. At the
time the US Government could not approve as it involved pumping in taxpayer money which
is both exponentially damaging during the election campaign for candidates and illegal as
previously discussed. This is where Paulson famously quoted “the British screwed us” but
later claimed he said this out of pure frustration with the somewhat limited powers they had
at their disposal. However Swagel believed the US Government would have utilized the
newly revised Dodd-Frank legislation had it been available at this stage because Lehmans’
financial losses would have been covered “by other financial firms and not taxpayers.”
(Swagel, 2013) Here Swagel presented a strong case as Hank Paulson had gathered a crisis
meeting in which he successfully persuaded the CEO’s of Wall Street’s top financial
institutions to collectively pay for Lehmans’ toxic assets through each institution pooling

13. 13
some capital. Wall Street agreed because this was more favourable than the detrimental
alternative of a Lehman collapse as the implications involved systemic risk through a crash of
market confidence and trust in each institution’s ability to pay its trading obligations. They
knew this could destabilize the entire financial sector through a domino effect of failing
institutions whilst the pure existence of this meeting suggests the Treasury’s concern as it did
not want Lehman to fail. Surely if this new Dodd-Frank legislation had been available it
would have been used because standing up to Wall Street by making them pay for their
collective failures meant no use of taxpayer money which portrayed enormous potential for
political gain during the election campaign.
DICK FULD FORMER CEO OF LEHMAN BROTHERS
Throughout his 46 years, Dick Fuld, the former Lehman Brothers CEO was the man who
almost single handedly transformed the company into becoming one of the key players
amongst the financial world. Fuld was a charismatic man, famously known for his ‘ripping
their heart out’ speech regarding short investors which typified his hugely admired and feared
persona. Furthermore, although it may not seem unusual for Hank Paulson, former Goldman
Sachs CEO, to partially blame Dick Fuld for the collapse of Lehman we can clearly see why.
Fuld’s Unethical Management Practices
As Wall Street’s highest paid CEO Dick Fuld had a duty to sign Lehman’s financial reports
therefore he had both a legal and moral duty not to undermine his stakeholders, especially his
shareholders. Fuld knowingly helped to destroy Lehman because a man with 46 years of
experience with years as a responsible CEO cannot have made him incompetent at his job. To
touch upon the repo accounting scandal, Valukas’ report quotes the Lehman Senior Vice
President Matthew Lee who “wrote a letter to management to alleging accounting
improprieties” which proves Dick Fuld was more than aware of his company’s fraud. (De La
Merced & Sorkin, 2010) Furthermore he must have known about immoral dealings regarding
the loans his company made specifically to people who would never be able to pay the loans
back. This is supported by the former Lehman vice president’s book ‘A Colossal Failure of
Common Sense: The Inside Story of the Collapse of Lehman Brothers’ in which he suggested
your job would had been at risk if you starting questioning your required practices. They then
went one step further into saying “It was the Ivory Tower. Lehman was never rotten at the
core, that’s where all the beauty was, she was rotten at the head… there were 24,992 making
money and eight guys losing it.” (McDonald & Robinson, 2009) It was these executives who
even welcomed benefitting from defaulting securities by unethically backing against them

14. 14
through their CDS operations which only emphasises Dick Fuld’s conflict of interest between
his clients and his own bonuses.
Fuld Believed Lehman Was Too Big to Fail
Paulson had advised Fuld on numerous occasions to solve their liquidity problems by
recapitalization but did nothing even during the 6 months he had to act after the collapse of
Bear Stearns. (Gapper, 2010) However Fuld’s greed became overwhelmingly apparent as he
ignored Paulson by rejecting multiple offers from private institutions including Blackstone,
Colony and the Korean Development Bank. The Korea bailout rejection alone in September
2008 sent Lehman’s stock plummeting by 77% through an exodus of investors. (McDonald &
Robinson, 2009) Consequently Moody’s informed Lehman that they needed to sell a majority
stake in order to avoid a downgrade which Fuld would not do leaving their stock in freefall.
This led to their $46 billion market value loss as they declared bankruptcy on September 15
2008. But why did Fuld reject these offers? He did so for two reasons, the first being a “false
sense of confidence” that the Government would bail them out like they did with Bear
Stearns. (McDonald, 2009) Secondly and most importantly, Fuld believed these offers were
too low which is no surprise for a man wanting to overtake his rivals to become the number
one bank in America after all he even had his own lift. Furthermore it was abundantly clear
that Fuld did not like being governed by his old rival Paulson as he wanted to keep hold of
Lehman at all costs. This is supported by a Bloomberg report which claims Fuld began
“thrashing around” investing in both domestic and overseas, major and small hedge funds and
even creating hedge funds around the time of the Korean bank’s negotiations. (McDonald,
2009) Fuld believed their price free fall from $66 to $23 was a blip but maybe if his vision
was not impaired with hubris then Lehman would have been taken over which may have
prevented Lehman’s collapse and “probably would have saved the world”. (McDonald, 2009)
Conclusion
Firstly, in the financial world we have analysed how the collapse of Bear Stearns shattered
confidence in Lehman who the market believed were next to fail as well as Merrill Lynch’s
actions which prevented Lehman from being taken over by Bank of America. We have seen
how the risk taking culture, stemmed from the flawed compensation structures, incentivised
the creation of complex financial products such as CDO’s and CDS’s which Lehman used to
become heavily involved in the toxic subprime mortgage market. Most importantly the
financial capability to window dress Lehman’s accounts through the repo 105 transactions

15. 15
portrayed superficial performance to shareholders, investors and to the world which allowed
them to continue trading whilst realistically suffocating from liquidity issues. Secondly the
Government played an enormous role in the collapse of the Lehman Brothers. Some blame
the Bush Administrations’ policies geared towards living the ‘American Dream’ through the
expansion of credit with low interest rates and greater leverage ratio legislation which
encouraged excessive risk. Some blame the Government’s free market ideology and ambition
to become the global financial hub above London which explains their regulatory negligence
towards the entire financial sector including the remuneration packages which further fuelled
the already excessive risk. Finally some blame the politically damaging impact of taxpayer
funded bailouts especially during the election campaign. However Lehman undoubtedly
failed because of the lack of available political powers specifically the new Dodd-Frank
legislation and T.A.R.P. which would have been used because most parties including
Lehman, the US Government, and most importantly society would have benefited. The final
driving factor behind Lehman’s collapse was the hubris of Lehman’s former CEO Dick Fuld,
the man who became so obsessed and arrogant in self-belief that he did not listen to anyone.
He was too obsessed in his bonus related pay and despite Hank Paulson’s constant advice to
recapitalize, he failed to do so. Clearly Fuld’s ego had a huge part to play but we can also
support Paulson’s claim that all financial crisis stem from flawed policies or lack of policy
which we also saw in section. This directly relates to Lehman’s collapse as Fuld believed that
Lehman was too big to fail and would always obtain financial backing by the Government.
Overall Lehman failed because of finance, the role of Government and finally the hubris of
their former CEO Dick Fuld.

16. 16
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