Lehman Couldn’t Handle the Risk Management Truth

“On paper, on the company’s organizational chart, the company had a risk management function, but not in practice,” an expert on the defunct investment bank explained.

During the financial crisis beginning in 2008, risk management–or the lack of it–was examined, questioned, and sometimes blamed for the financial state of banks and other financial institutions, some of which were bailed out by the Troubled Asset Relief Program (TARP).

In at least one institution, Lehman Brothers, risk management was demoted in status and brushed under the rug as the company ran itself into the ground, refusing to look at the truth behind massive profits being made from mortgage-backed securities. That was the message of Mark T. Williams, an executive-in-residence and master lecturer at Boston University and author of  Uncontrolled Risk (McGraw Hill) a 2010 book examining the causes of the financial crisis and the rise and fall of Lehman.

Williams, who spoke at CFO’s Corporate Performance Management Conference in Philadelphia last week, notes that from a risk perspective, “the key for any company is looking at the factors in creating trust, honesty, and integrity – what are the things that can undermine reputation?”

Williams told CFO, “I would argue that risk management in banking is still not at a level where it needs to be. In regard to other industries, you have to look at yourself. If you are a nuclear energy company with power plants, for example, then you’re in the risk management business.”

When Lehman cut ties with American Express, with which they were merged from 1984 to 1994, the investment bank set up its own risk management function. Lehman named Maureen Miskovic, a former treasurer of Morgan Stanley, as Lehman’s first chief risk officer in 1996, a post at which she served until 2002. Miskovic had also worked at Goldman Sachs and “had not only managed risk, but had traded mortgage-backed securities,” Williams noted. “So she was both sides of the coin: perfect for the job.”

Adds Williams “Just in the last decade we’ve had a huge movement towards CROs. More companies are moving risk to an enterprise-wide level and looking at risk across the whole company.”

In 1999, Lehman hired Madelyn Antoncic, a former Goldman mortgage trader with a Ph.D. in economics from New York University, to assist Miskovic. “Antoncic was a top-notch risk professional, a highly trained quantitative analyst who had extensive experience involving the risks of the more complicated products that Lehman had begun to structure, trade, and sell—principally mortgage-backed and asset-backed securities,” Williams wrote in his book, noting that by 2000 Miskovic left as CRO and was replaced by Antoncic, “her logical successor.”

In 2006 she was named Risk Manager of the Year by Risk Magazine. “Since her appointment in September 2002, [Antoncic] has swelled Lehman’s risk management ranks to 170, with 50 new staff added over the course of 2005,” Risk reported then. Most notably, she recruited Paul Shotton from JP Morgan to head Lehman’s market risk unit, he says.

But by 2003, Lehman Brothers had become “a real estate hedge fund disguised as an investment bank. Later, Antoncic got into trouble when she warned Dick Fuld, the company’s chief executive officer. that the company was “too risky.” In 2007, as the true extent of risky mortgage-backed security bets became evident, “the CRO’s warnings were ignored by senior management,” he says. As a result, in 2007 CRO Antoncic was fired.

“On paper, on the company’s organizational chart, the company had a risk management function, but not in practice,” Williams explains. “The biggest flaw was that they listened to the risk manager in good times–but the most important time to listen to your risk manager is in bad times.”

Risk professionals, he notes, “are not there to be like a marketer, saying the company is wonderful and everything will be great, they are there to look at alternative, the low profitability that is occurring. In other words, their job is to give the company a reality check.”

Antoncic was replaced by CFO Chris O’Meara. “The new CRO had two important qualifications,” Williams said, “He was Fuld-Friendly and he had no formal risk management training. A dangerous combination and hardly an adequate counterbalance against oversized risk taking.” Through its actions, he said, Lehman demonstrated it had a weak risk management culture.

In March 2009, the Dow hit a 12-year low (6,500). As a result, trillions in capital evaporated, 8 million U.S. jobs were lost, policymakers realized that not saving Lehman “was a disastrous mistake and Lehman’s Collapse supported the ‘Too Big to Fail’ doctrine,” he observed.

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