The bankruptcy examiners’s report on Lehman Brothers should finally put to an end the long-running debate about the role of short-sellers in the collapse of the firm.
As the headline in the Wall Street Journal put it “Lehman Torpedoed Lehman.”
In other words don’t blame the shorts.
Former chief executive Dick Fuld blamed the shorts for “rumour monger” and market manipulation both before Lehman went bankrupt and afterward.
“The naked shorts and rumour mongers succeeded in bringing down Bear Stearns. And I believe that unsubstantiated rumours in the marketplace caused significant harm to Lehman Brothers,” Fuld told a Congressional panel investigating the financial crisis.
Fuld reportedly believed that a cable of hedge fund short sellers led by Goldman Sachs were conspiring to bring down his firm. David Einhorn of Greenlight Capital, who had publicly criticised Lehman’s accounting in three speeches and announced he was shorting the stock, was a particular target of Fuld’s ire.
Einhorn was pilloried in the media for his anti-Lehman stance.
Brad Hitz said the short concerns were “overdone.” An analyst on CNBC said Einhorn was “inexperienced” and called his research “flimsy.” The New York Times published a story that was widely read as a criticism of Einhorn’s stance.
“Critics say he is needlessly fanning fears about the precarious health of the financial industry at the very moment executives are struggling to stabilise their ailing companies,” Louise Story wrote.
Of course, we now know that that the executives were not struggling to stabilise the ailing Lehman. Instead, they were struggling to deceive markets about the true financial condition of Lehman Brothers. It wasn’t hedge funds spreading false rumours about balance sheet problems at the banks. It was the executives at Lehman who apparently were making false statements about their balance sheet.
Indeed, even in Story’s article we can see the Lehman executives lying.
Lehman, like its counterparts, is racing to use less leverage. The bank had a gross leverage ratio of 31.7:1 at the end of the first quarter, meaning it had borrowed $31.70 for each dollar of equity. Lehman has whittled that ratio down to 25:1 through its more than $100 billion in asset sales, said the person close to the company who was given anonymity because he was discussing a pending financial filing.
Who was the unnamed person feeding misleading information to Story?
It’s now clear that Einhorn greatly under-estimated the market manipulating deceptions Lehman was employing to prop up its stock and keep credit flowing. Einhorn’s basic argument was that the number Lehman was reporting seemed to jump around a lot–in a couple of weeks in the spring of 2008 the company went from reporting a loss of $875 million to a gain of $230 million–and that its executives were offering explanations for this that made little sense. “What does this imply for the internal controls of the company?” he asked. He never suspected–at least publicly–the scale and scope of the real balance sheet manipulation that was occurring.
One thing is for sure: Einhorn and those who made the short case against Lehman’s accounting stand completely vindicated.