The Interest of Time: A Great Balance Sheet Recession

By Alejandro Reyes

The Interest of Time is a book about your Money.

As we approach the 10-year anniversary of the events that led to the Global
Financial Crisis, the economies around the world have yet to regain pre-crisis
growth levels. After unprecedented levels of stimulus, the US has embarked
on a process of normalization of interest rates. Will the central banks of
the world raise rates before the private sector has repaired their balance sheets?
Or will another recession put us on a collision course with 0% interest rates and
the Zero Lower Bound?

There are two ways to build wealth. Make more money. Or spend less. Traditional
economic theory relies on households and corporations who are always
trying to “maximize profits” (make more money). However, once every 50-100
years, a special type of debt-driven recession damages balance sheets so drastically it changes people’s thinking. They go into balance sheet repair mode. They spend less, instead of trying to make more.

The Great Depression was a Balance Sheet Recession that lasted over 12
years and caused a global depression that fueled the start of World War II.
Japan’s Lost Decade is a Balance Sheet Recession and has been raging for
almost 2 decades now.

And finally, the Global Financial Crisis, or The Great Recession, is a Balance
Sheet Recession. And it is not over.

Everybody knows that there was a financial crisis that occurred in 2008. This
is the true story about how the 30 million families that found themselves in underwater balance sheets recovered from the greatest financial crisis since The
Great Depression. Many more are still struggling under the weight of backbreaking
debt and stagnant wages in the US, and around the world.
This book is about the Great Balance Sheet Recession, why it happened, how
the governments, households and corporations of the world can deal with it,
and steps you can take to strengthen your family’s balance sheet for the future.

• Language: English
• Publisher: Coldmark Press
• Release date: Dec 20, 2018
• ISBN: 9780578427164

Book preview

Index

Chapter 1

Days of Thunder

On Monday September 15th, 2008, shortly after 1 am, Lehman Brothers filed for Chapter 11 Bankruptcy protection in a New York court. It was the largest bankruptcy in US history at the time, and it remains so to this day.

The 164-year old investment bank was out of business. The Wall Street titan’s demise began the chain reaction of events that led to the largest economic crisis since the Great Depression.

The original firm was founded in 1844 by Henry Lehman. It was originally named H. Lehman. However, when his brothers Emanuel and Mayer joined the firm in 1850, it took on the Lehman Brothers moniker.

The firm would dominate the residential mortgage backed security market until all the dominoes came crashing down that crisp September Monday morning.

Their leader, Dick Fuld Jr., had risen to the level of Chairman and CEO after 40 years of climbing the ranks. From fixed income trader, all the way up to the C-Suite. The Chairman and CEO had led the firm since 1994.

Lehman Brothers was the fourth largest Wall Street bank at the time of their bankruptcy filing, with a total of $639 billion in assets, and $619 billion in debt. The firm’s foray into the private label mortgage backed security market would eventually lead to their collapse. Lehman Brothers employed over 25,000 people around the world and had offices in every major financial center in the world.

The bankruptcy judge would approve the filing, simply stating that: I have to approve this transaction because it is the only available transaction. Lehman Brothers became a victim, in effect the only true icon to fall in a tsunami that has befallen the credit markets.

The aftermath of what occurred in the following days and weeks would become the raw material for what I will call The Great Balance Sheet Recession.

The story begins well before Lehman Weekend, as it will forever be known. We can trace the beginning of the end for Lehman and all the top players in the space back to Bear Stearns.

In late 2007, Bear Stearns, the scrappy investment bank had risen to the number five largest Wall Street bank. They had over 15,000 employees specializing in Capital Markets, Investment Banking and Wealth Management.

The firm had been an institutional trading powerhouse, clearing trades for many of the top hedge funds on Wall Street at the time.

The Bear Stearns High Grade Credit Fund

Jimmy Cayne was a Wall Street boss. The Chairman and CEO of Bear Stearns had held the title since 2001, although he had been the CEO since 1993, one year before Dick Fuld took the reigns over at Lehman.

Cayne was born on Valentine’s Day in 1934, during the Great Depression.

He was known to hire people who were poor, smart and had a deep desire to be rich. The bank’s culture was a bit different from the other Wall Street banks who had their pick of top college talent. Bear Stearns had to find the diamonds in the rough, the undervalued future stars.

Ace Greenberg, the CEO before Cayne would comment: If somebody with an MBA degree applies for a job, we will certainly not hold it against them, but we are really looking for people with PSD degrees. Poor, Smart, and a Deep desire to be rich.

The culture at Bear Stearns was one of risk taking. It was encouraged from top down and embedded in the minds of the employees.

Mr. Cayne, or Jimmy as some of the desk bosses would call him, had a penchant for playing Bridge. He would routinely be playing at tournaments, and happened to be playing in one in Nashville, Tennessee at the time of the first spark that lit the fire for the Great Balance Sheet Recession.

The Bear Stearns High-Grade Structured Credit Strategies Fund had been knee-deep investing in synthetic securities. Their 2006 financial statement had this to say about their exposure to Collateralized Debt Obligations:

The Master Fund enters into investment grade bonds backed by a pool of variously rated bonds, including junk bonds. CDOs, CBOs and CLOs are similar in concept to Collateralized Mortgage Obligations (CMOs), but differ in that CDOs, CBOs and CLOs represent different degrees of credit quality rather than different maturities. Underwriters of CDOs, CBOs and CLOs package a large and diversified pool of bonds, including high risk high yield junk bonds, which is then separated into tiers. Typically, the top tier represents the higher quality collateral and pays the lower interest rate; a middle tier is backed by riskier bonds and pays a higher rate; the bottom tier represents the lowest credit quality and, instead of receiving a fixed interest rate, receives the residual payments (Bear Stearns High Grade Structured Credit Strategies Enhanced Leverage Master Fund Financial Statement, 2006)

As you can see, the fund spelled out exactly what they were investing in, in black and white. A mix of synthetic securities with low liquidity and no secondary market.

They would use borrowed money to lever up and buy these synthetic securities. If they could borrow at a rate lower than the return, the managers thought they could safely buy as much as they possibly could afford. Because if you borrow at 1% and make anything higher, the more you borrow, the more you make.

The strategy didn’t stop there, mainly because it was a bit too risky to buy synthetic junk bond portfolios with no insurance. That is why each manager would protect their investments with Credit Default Swaps. If anything went wrong in the credit markets, these insurance instruments were supposed to protect against losses.

Perhaps the final warning from the Bear Stearns High Grade Credit Fund Financial Statement in the financial disclosures was the most ominous:

CDOs, CBOs, and CLOs are subject to credit, liquidity and interest rate risks. In particular, investment grade CDOs, CBOs, and CLOs will have greater liquidity risk than investment grade sovereign or corporate bonds. There is no established, liquid secondary market for many of the CDO, CBO, and CLO securities the Master Fund may purchase. The lack of such an established, liquid secondary market may have an adverse effect on the market value of such CDO. CBO and CLO securities and the Master Fund’s ability to sell them. Further, CDOs, CBOs, and CLOs will be subject to certain transfer restrictions that may further restrict liquidity. Therefore, no assurance can be given that if the Master Fund were to dispose of a particular CDO, CBO, and CLO held by the Master Fund, it could dispose of such investment at the previously prevailing market price. (Bear Stearns High Grade Structured Credit Strategies Enhanced Leverage Master Fund Financial Statement, 2006)

The structured credit fund was borrowing money to buy CDOs, CBOs and CLOs. They warned everyone about how illiquid the market could become and how there was no secondary market for many of these products.

They spelled out the fact that any range of market forces could adversely affect the price and liquidity of certain illiquid products. It was all plain to see if anyone ever bothered reading it. But they were all too busy trying to get rich.

As the housing market began to implode, so did the bids on some of these synthetic bond structures. The delinquency rates on some of the subprime bonds were causing losses to cascade down to other tranches of the securities. These Credit Default Swaps did not properly insure these layers and were useless in protecting the fall in value as the market dried up. Many investors began to hedge the lower grade bonds but did not do so in the higher-grade tranches.

Nobody was insuring the AAA tranches at the time. These were where the losses stemmed from, and with no secondary buyers, the CDO market began to bleed red.

Things got so bad that on June 22nd, 2007, then CEO Jimmy Cayne intervened to provide a $3.2 billion loan when no other Wall Street bank would lend money to the Bear Stearns High-Grade Credit Fund.

The fund was stuffed with stated income, and high loan-to-value loans in homes with prices that had been falling for over a year. In bad zip codes. Just because they were sliced and diced into highly rated securities did not make them marketable when the rain began to fall.

The loans had been steadily losing value, and with them the value of the lowest level tranches. These are the investments with the highest likelihood to default if any of the payments are not received in a timely manner. They are also the securities with the highest yields.

When Bear Stearns bailed out their hedge fund, they took on a lot of assets that would later be deemed too risky. The move would soon prove to be the fatal error for the scrappy 85-year-old investment bank.

Two months later, in August of 2007, investors joined a class action lawsuit against Bear Stearns for misleading investors about the risks of investing in thinly-traded Collateralized Debt Obligations.

Bear Stearns was now loaded to the ceiling with illiquid mortgage assets, and the other entities were on notice to limit their exposure to the small Wall Street bank.

It was only a few months later that Bear Stearns reported a $1.2 billion write-down on mortgage assets and posted a 61% profit loss, mostly due to hedge fund losses.

By March of 2008, the floor was falling from folks’ feet fast. Short sellers were circling, and the rumor mill was swirling.

As the Bear Stearns balance sheet was loaded with illiquid assets, there wasn’t really a price that everyone could agree on to value them.

The banks who owned the paper would guess high. And the banks who were lending against it would guess low.

Usually they would agree somewhere in the middle and continue to do business. But as soon as one Wall Street bank deems you too risky to do business with, they pull your trading permissions, and you are finished.

That is what happened to Bear Stearns.

Was it a fix? Who knows. Probably. When the big boys turn off their phones, the next step is that the hedge funds get nervous that their money could get stuck there. They all call up the at-risk bank and ask for wire transfers of all their positions.

As soon as one goes, they all go. The hedge fund community is tight knit. If one smells smoke, everyone bets on fire.

The hedge funds, called Prime Brokerage clients, did tons of business with all the Wall Street banks, and cleared most of their trades through these third parties. If their money got locked up, for any reason, they were essentially out of business. Who could take the risk of being wrong?

Nobody, so the hedge funds began taking decisive action. Hedge funds began sending requests to transfer their money to stronger banks who were not at risk of having their trading permissions cut off.

It was a hedge fund bank run. Instead of cash, they came for the marketable securities.

Ironically, in 1998, Bear Stearns famously did not join the 14 other investment banks in the Long-Term Capital Management rescue. Long-Term Capital Management was a hedge fund that blew up in 1998 and had to be bailed out by the Fed and a consortium of 14 banks.

Bear Stearns was famous for getting through the 1929 crash without laying off a single employee.

They were now fighting for their financial life.

Bear Stearns Bailout

On March 14th, 2008, the Federal Reserve had to inject $25 billion into Bear Stearns.

The rest of the Wall Street banks had made the decision to refuse to do business with Bear Stearns.

With trading partners cut off, their prime brokerage customers were just about to transfer their accounts out.

The only lifeline Bear had was somebody buying them out. If not, they were going to have to start selling stuff to the highest bidder.

Mark-to-market be damned.

It was the preview of a forced liquidation of every asset backed security in their book.

Next in the line of fire would be Lehman Brothers, Merrill Lynch and Morgan Stanley. Bank runs coupled with trying to sell assets into illiquid markets at fire-sale prices are what caused the Bank Holiday of 1934 during the Great Depression. The Fed was determined not to let it happen again.

Many of the securities that were most difficult to value also traded in some of the most illiquid markets. That meant that firms were all valuing their bonds closer to the hold-to-maturity price, than the fire-sale price. A critical point to make when every dollar counts on your balance sheet.

Then Federal Reserve Chairman Ben Bernanke explained the crisis to Congress in simpler terms. He noted that each security had two prices. One if the securities were held to maturity, and one if they had to be dumped into the market at fire-sale prices. (Bernanke, The Courage to Act, 2015)

Ben Bernanke was trying to highlight the importance of dumping bonds at the fire-sale price, ultimately leading other firms to mark their bonds to the new, lower market price.

Everything had to do with how long you could hold the securities. If you could hold them through the panic, you might stand to make some money.

Ben Bernanke had a very keen understanding of what type of distress these banks could come under if the price of the lowest rated securities came under pressure.

If true price discovery occurred in public markets, it could be detrimental to the recovery.

That meant the Fed had to be a big buyer in the mortgage backed security market, not paying the fire-sale price, but also buying low enough where there was still some money to be made holding the loans to maturity.

They could encourage investors to buy the securities, with the Fed being a major player in the market. If the price stabilized and began to rise, there might be a long-lasting recovery in the Mortgage Backed Security market.

If the Fed did not buy up these assets, the banks would have had to auction them off. And as prices continued to plunge, so would available collateral for bank balance sheets.

It was better to control the market as the big buyer. The Fed was certainly the big buyer.

The Fourteen Families

The Wall Street banks had a very close-knit relationship with each other. So cozy in fact, that former Treasury Secretary Hank Paulson would commonly refer to the group as the Fourteen Families, like the Organized Crime Families in New York.

Each member of the Syndicate specialized in different areas. Some were focused in trading. Others in mergers and acquisitions. Some were bond houses, others were equity traders. Each bank carved out their own niche to serve the investment community.

Goldman Sachs boss Lloyd Blankfein and JP Morgan chief Jamie Dimon were widely recognized as the Bosses over everybody in the whole Family. John Mack was the Morgan Stanley boss. Vikram Pandit ran Citibank. Dick Kovacevich led Wells Fargo. Ken Lewis was the Bank of America CEO at the time.

Together the Wall Street banks served the world’s appetite for investment products. From IPO’s to CDO’s, the banks would buy, sell, and create securities to trade on the open market.

The symbiotic relationship allowed these firms to circle their wagons in bad times, protecting the weakest firms from the speculators.

In good times, each bank gave others a piece of their proverbial pie. Cutting the other big banks in on valuable IPO business during the dot-com boom.

This time the Family got caught up in CDOs. The opaque mortgage products infiltrated every level of investment. From pension funds looking to increase their yield, to hedge funds looking to lever up and go for a ride, there was an unlimited demand for AAA rated fixed income products with very high yields.

Since each pension and institutional fund had restrictions on credit quality, the rating agencies still using the hallowed AAA rating for some of these securities really led to the fall.

AAA rating is the highest credit score you can have as an entity or investment. It was the most coveted rating a bond could have. US Treasury bonds are AAA. $100 bills are AAA. Very few other securities are AAA.

If the bonds were rated AAA, investors had the appetite. When they started to slip in quality, and then in price, nobody could sell them. Not even in a fire-sale. Certainly, nobody wanted to buy them anymore.

The other banks stopped accepting some of this paper as collateral for bank loans, and that is when the game, as they say it, was up.

The repo market is essentially a pawn shop for securities. Banks and investment managers will pledge certain securities for cash. They take a haircut on the values, depending on the quality and promise to either buy them back at a future date (1 year usually), or just use them as collateral for cash in the short-term.

It is very much like a home equity line on your bond portfolio. Like the pawn shop, you can always get your bonds back if you re-deliver the cash loan. Well, most of the Wall Street banks would dabble in this type of funding market, using CDO’s as collateral. As the values of these bonds fell, so did the amount of money that could be borrowed against them.

The ABX Index

The ABX Index played an important role in the crisis because it was essentially the one public market for these bonds. Prices printed on the ABX index determined Credit Default Swap contract prices. They acted as the insurance market for various Asset Backed Securities.

It would be like the big used car auction for junk bonds.

In 2006, Markit launched a new product called ABX.HE. This was the Home Equity version of the Asset Backed Security market, with a key distinction. This would allow traders to bet on home prices without owning any of the bonds.

As the Markit prices in the ABX.HE index fell, the corresponding price to insure those bonds rose, in lock step.

This was where most of the money was made by the hedge funds who predicted the housing crash, like John Paulson & Company.

They would use this new insurance market to buy fire insurance on the poor neighborhoods that were about to burn down around the country. They owned insurance on bonds they didn’t own, hoping for them to default.

One of the most famous synthetic investment pools was the Goldman Sachs Synthetic CDO, ABACUS 2007-AC1. This was a CDO which was rumored to be hand selected by hedge fund manager John Paulson, choosing the riskiest tranches he thought were most likely to detonate. The official story is that Paulson had nothing to do with the selection, and in the legal battles that ensued, it was found that: Goldman brought in a 3rd party to aid in the selection of securities, but in the end consisted mainly of subprime mortgages (Whalen, 2010)

On the very front of the Pitchbook it says: Selected by ACA Management.

After Goldman assisted in creating the CDO, they sold it to IKB Bank in Germany. This created a market for John Paulson to buy Credit Default Swaps in the newly formed ABACUS CDO. It would be like going to the track and being able to bet on a horse coming in last. With leverage.

The ABX index for AAA securities would usually trade near par (100) in the good times. It was supposed to be hundreds of prime credit mortgages, bundled together. Their prices would rarely vacillate, allowing investors to increase their leverage significantly.

But as housing prices collapsed, the AAA tranche began to price in the possibility of Prime Borrowers walking away from their homes because they fell too far underwater.

Ironically, a look beneath the hood shows a familiar group of market makers for the ABX indices, including many of the banks from the Fourteen Families.

Goldman. Morgan Stanley. Citi. All the Skippers had a seat around the table.

If the Families could control the price, they could make sure no fire-sale figures would hit the tape.

Soon, the Abacus structure, and virtually any CDOs created in 2007, began to take on water, as the home values submerged under a sea of negative equity.

As the price for the various tranches of CDO’s fell in value, the corresponding Credit Default Swap bonds rose. Very slowly at first, then in giant gaps, as the asset backed security towers came down.

These were the profits for the trade that will forever be known as The Big Short.

The bet against America that paid off in the billions. Every homeowner in the country paying their part each month. ABACUS 2007-AC1. It was only a $2 billion CDO until everyone started betting derivatives.

A Sweetheart Deal

When Bear Stearns had to be bailed out by the Fed, the deal was struck for $2 a share. That even included all the real estate. It was a lesson to the rest of the Wall Street titans.

Nobody is Too Big to Fail. And, you can and will lose all your money if we have to come and bail you out, was the message the Fed was sending.

But another lesson was secretly sent to the CEOs of the Big Box banks.

There is money to be made if you get to pick the carcass of one of the other Wall Street banks clean.

The Fed knew they had to shotgun marry some of the weakest banks to some of the strongest to protect the financial system from short sellers. Those were the investors betting against the banks in the stock market.

The hedge fund sharks.

As the Fed tried to tie up ships, they allowed for moral hazard to enter the conversation. It appeared, to the public and to the other Skippers of the Family, that the deal that JP Morgan got was a sweetheart one. An inside job where JP Morgan got to devour the Bear Stearns assets and be protected from losses in the event of a downturn.

We now know that Jamie Dimon did try to say no to Hank Paulson, and that is when the Fed sweetened the pot. (Paulson Jr., 2010) The Fed came in to accept some of the losses above and beyond a pre-determined level. A Fed backstop. A safety net for losses.

The Fed would provide $30 billion to a stand-alone entity named Maiden Lane LLC that would buy Bear’s assets and manage them.

Perhaps the most overlooked part of the deal was that JP Morgan guaranteed Bear’s trading book. More than illiquid mortgages, there were billions in stocks and bonds that were going to have to be liquidated at fire-sale prices if there was a bankruptcy.

Taking over Bear’s trading books guaranteed that there would be no contagion for the time being. It also became the standard ask from the Fed. If you were going to buy a bank, you were going to have to stand behind the assets.

Like buying one of those storage lockers just by what you can see from the door. There could be some really good stuff in there. But it could all turn out to be worthless. That was the chance you had to take if you were looking for the big payday.

To the public, it looked like a story of Fat Cat Bankers getting an inside deal from their Goldman Sachs counterparts at the Fed.

Behind the scenes it looked more like a crisis was averted. The economy was hurtling down the tracks at increasing speeds with no brakes to slow the runaway train.

The Fed would fulfill their duty as the lender of last resort to prevent a bank run, despite the moral hazard.

Everyone on Wall Street began to talk about how Jamie Dimon made out like a bandit. How JP Morgan was given a gift. Free money. Even the media picked up on it, perpetuating the mystique of the Fat Cat Banker narrative. He was the face of the Elite Bankers. He is the only one left standing from the crisis. After the Goldman Skipper Lloyd Blankfein steps down, Jamie Dimon will have outlasted them all.

There were reports that surfaced later that the Bear Stearns building was worth over a billion dollars alone. Their Headquarters at 383 Madison Avenue is still being occupied by JP Morgan all these years later. Months later, the Bear Stearns deal was adjusted to $10 a share, but that was all after the fact. On that fateful day in March 2008, Bear got sold for $2 a share. Building and all.

The stage was set for a crisis. A big bank had already been bailed out, and all the Wall Street banks were transacting in these illiquid securities.

If a fire-sale were to ever emerge, a collapse in prices and subsequent solvency issues could happen.

The Bear Stearns sale was just a dry run for what would become the Lehman Brothers crisis.

Lehman Brothers

When it comes to Big Wall Street investment banks, Lehman Brothers was always on the outside looking in.

They didn’t command the top investment bankers like Goldman Sachs, or the top wealth management like Merrill Lynch. They didn’t have the best bond traders, like Morgan Stanley, and they didn’t particularly do mergers or acquisition deals.

Lehman Brothers became a pioneer in the mortgage backed security business. Before any of the other Wall Street banks did, they bought their own mortgage companies to start making and selling sausage sandwiches.

These artisan sandwiches would be constructed with the sliced and diced cuts of meat (loans) they trimmed from the bank’s originate to distribute mortgage company, Aurora Loan Services, among other sources. The Colorado lender was one of the leaders in Alt-A originations.

Those were the popular no income verification loans from the pre-2007 vintage. They liked to grade the loans by vintage. Like wine, it expressed a certain level of quality.

To put it in perspective, in 2003, the small investment bank made $18.2 billion in loans. In 2004, it was $40 billion.

By 2006, Lehman Brothers subsidiaries were producing over $50 billion a month, or $600 billion a year in loans.

All those loans were written at the top in market prices. The 2006 fruit was ripe. It was all downhill for prices for any vintage of loans after 2006.

Dubious borrowers with inflated prices on long-term amortized debt. What could go wrong?

The bank would originate these loans, and then take the time to stack them into appropriate towers before selling them. Many of the banks would wait to receive the first payment and season the loan for a month before selling it. If they needed time to structure the security, why not wait 30 days and get the first payment?

However, when the market began to deteriorate, the risk of holding the bonds while their price plunged was too great.

The movie Margin Call exemplified what many believe to be the events at Lehman Brothers on those days.

I believe they were selling the last of their Aurora Loan Services bonds that day. When they finally broke the seal on the lower printed prices, the Private Label Mortgage Backed Security market was finished.

I knew exactly what kind of loans were in those pools. I had just left the mortgage business after Indymac Bank was taken over by the FDIC. I had been a mortgage broker for 5 years beforehand and knew of the Aurora Loan Services bank well.

The Colorado lender would specialize in Alt-A originations. The bank was one of the most aggressive lenders in non-owner occupied (investor) properties. Landlord loans.

They were big into stated income, or no-doc, where you don’t talk about your income, so you don’t have to lie.

They wouldn’t care if you had 4 or 7 loans already, and consequently they would get dozens of first-time flippers and small LLC’s who utilized straw buyers. Since Lehman was selling these investments almost as soon as they were originated, quantity trumped quality.

What I am trying to point out is that there were banks who did not care about stuff like that. They were in the sandwich business, and sales had never been so strong. They just wanted to close the loans. Let the defaults be somebody else’s problem. If there was demand for 600 FICO, Stated Income, 90% LTV investor property loans, the bank was going to deliver those loans.

Below 600, your credit report comes out of the printer already ripped in half. For a while they could get 90% financing on jumbo mortgages with stated income.

The rest of Wall Street had been resting on the idea that The Fed came in to save Bear Stearns, the 5th largest Wall Street Bank.

Lehman Brothers, the 4th largest bank by size must have felt comfortable that no matter what happened, they could find a seat before the music stopped.

If that didn’t happen, they could get the Fed to stake them. That was the thinking back then.

The Fed had a critical decision to make. Do they pave the road of moral hazard with taxpayer money?

Or let the hard lessons be learned?

Lehman Brothers was not exactly acting like a stodgy Investment Bank should.

They had turned their balance sheet into a veritable real estate hedge fund.

In late 2008, Lehman Brothers held over $680 billion worth of assets, only supported by a piss poor $22.5 billion in firm capital.

The 31X leverage ratio would be too high to overcome the tsunami that would make landfall in September 2008.

Investment banks were not limited to the same reserve ratios as commercial banks before the crisis.

A 4% loss would have bankrupted any firm with 31 times leverage. The Lehman stock price would ultimately end up going to zero, with only 25% of the creditor’s claims recovered in bankruptcy. (Bernanke, The Courage to Act, 2015)

The Gorilla

Dick Fuld was the Skipper of the Lehman Brothers ship when they went down on September 15th, 2008. He was a scrappy fixed income trader who had worked for Lehman for more than 40 years.

As he ascended the corporate ladder, he was affectionately known by many who knew him as, the Gorilla.

The Gorilla ate his own cooking, in CEO parlance, as he was famously known to keep most of his wealth in Lehman Brothers stock.

His annual stock-based compensation in the crisis years skyrocketed, as he took home over $22 million in equity compensation in 2007. The firm made a record $4.2 billion that year, mainly from the growth of their Residential Mortgage Backed Securities business.

Lehman Brothers had turned into a mortgage hedge fund, under the guise of a conservative Wall Street bank.

Mr. Fuld had profited handsomely from the strategy over the years, with total compensation over $500 million in some estimates.

Much of that money in stock, if the Fed came in to bail out Lehman Brothers, most of that money might find its way back to Mr. Fuld. The Fed would be bailing the Gorilla out, indirectly protecting the value of his massive equity holding.

On the other hand, Bear Stearns was forced to sell for $2