From the October 01, 2011 issue of Futures Magazine • Subscribe!

McDonald: Inside the fall of Lehman


FM: Talk a little about and how that prepared you as a trader?

LM: The vision there was that with convertible bonds and all bonds, there was a thirst for getting more and more information up on the web. Luckily we were out in front of that. I think we were the first web site in the world to get information up on the web for investors globally that they could digest.

FM: Your timing was good.

LM: We were very lucky. In the last 15 years you have seen a steady commoditization of financial products. Stocks that used to trade in 30¢-40¢ spreads are trading in pennies, bonds that used to trade [several] points wide are trading much thinner. Our theory was to get out in front of it. Technology is marching forward and you want to be out in front of it. There was a need for more transparency. Back then if you wanted to get bond prices you had to wait until they got published and it would take weeks.

FM: Do you think the crisis would have been less severe if Bear Stearns would have been allowed to fail in March 2008? Would it have scared others straight or was it already too late at that point?

LM: It would have made things more swift, it would have accelerated prices somewhat. The [Bear Stearns] balance sheet was about half the size but it still would have been very disruptive and caught the market off guard. Hank Paulson and his team felt the market needed a speed bump at that point and that was their decision.

FM: Did the Fed's sweetheart deal for Bear Stearns convince others, Richard Fuld in particular, that Treasury and the Fed would not allow a major investment bank to fail?

LM: It wasn't just Mr. Fuld, it was the entire marketplace. When you look at when Lehman failed, the credit default swaps were only 770 basis points wide (roughly a 7.7% chance of default), so the market wasn't really pricing in a failure. Today, for example, Greece is trading at 2500 basis points. The entire market was under the impression that there would be some type of deal. The [only] question was price.

FM: From the point that Bear Stearns collapsed, many analysts pointed to Lehman as the next most likely investment bank to fail. How was this received at Lehman?

LM: There was a lot of denial.

FM: Did the leadership at Lehman think that short-sellers were out to get them?

LM: That was part of it, there definitely were some people in the firm with the belief that there was a posse [out to get them], but 40X leverage knocks you out of business, not short-sellers.

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