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Countdown to the
Global Financial Crisis
Countdown to the
Global Financial Crisis:

A Story of Power and Greed

By

Paul Mazzola
Countdown to the Global Financial Crisis: A Story of Power and Greed

By Paul Mazzola
Edited by Dr Celeste Rossetto

This book first published 2022

Cambridge Scholars Publishing

Lady Stephenson Library, Newcastle upon Tyne, NE6 2PA, UK

British Library Cataloguing in Publication Data

A catalogue record for this book is available from the British Library

Copyright © 2022 by Paul Mazzola

All rights for this book reserved. No part of this book may be reproduced,
stored in a retrieval system, or transmitted, in any form or by any means,
electronic, mechanical, photocopying, recording or otherwise, without
the prior permission of the copyright owner.

ISBN (10): 1-5275-8281-7

ISBN (13): 978-1-5275-8281-1
This book is dedicated to my father, Rosario, from whom I drew much
encouragement and inspiration and who always provided well-timed and
sage advice.
There are never wanting some persons of violent and undertaking natures,
who, for they may have power and business, will take it at any cost.

(Francis Bacon)
 CONTENTS

Table of Figures .......................................................................................... xi

Foreword ................................................................................................. xvii

By Chris Whitehead

Acknowledgements ................................................................................... xx

Chapter 1 .................................................................................................... 1
Introduction

PART ONE: HISTORY OF US INVESTMENT BANKING

Chapter 2 .................................................................................................. 14
War to War (1776-1815)
American War of Independence (1775-1783) .................................... 16
The War of 1812 ................................................................................. 20

Chapter 3 .................................................................................................. 37
Banking on Rail
American Railroad Expansion (1830-1850) ......................................... 37
The Role of Bonds in Funding Railroads .............................................. 41
Needy Americans ................................................................................ 45

Chapter 4 .................................................................................................. 48
Bankers and the Civil War
American Civil War (1861-1865) ......................................................... 56
Formal and Real Power ....................................................................... 70

Chapter 5 .................................................................................................. 73
The Pendulum Swings
“Our Crowd” and the “Yankee Houses”.............................................. 73
The Panic of 1907 ................................................................................ 75
The Pujo Committee of 1913 .............................................................. 81
viii Contents

Post-Depression prudential legislation ............................................... 84

Post-World War II Transformation ..................................................... 88
Transformation from Partnership to Corporation .............................. 91
The Capital Problem for Risk Taking ................................................... 95
Regulation – Post WWII .................................................................... 100

Chapter 6 ................................................................................................ 104

The GFC
Background to the GFC ..................................................................... 104
Insufficient Capital Regulation .......................................................... 111
Capital Regulation ............................................................................. 113
Neo-Liberal Approach to Financial Market Legislation ..................... 119

PART TWO: THE LEHMAN STORY

Chapter 7 ................................................................................................ 126

The Pre-Fuld Era (1850-1994)
The Founders .................................................................................... 126
Normative Influence of the Jewish Connection (Our Crowd) ........... 132
Dispositional Power from Board Directorships ................................. 134
Profiting from the American Civil War .............................................. 134
Transformation to the Business of Investment Banking –
an Exercise of Power ................................................................... 136
Retention of Power through Family Control ..................................... 137
Bobbie Lehman: Head of Lehman Brothers Partnership 1925-1969 .. 139
Peter Petersen: Chief Executive Officer 1973-1983 .......................... 141
Lewis Glucksman Chief Executive Officer 1983-1984 ....................... 144
The American Express Takeover ....................................................... 147
The Sticky Web of Power and Culture .............................................. 150

Chapter 8 ................................................................................................ 153

The Post-Fuld Era (1994-2008)
Richard Fuld ...................................................................................... 153
Fuld’s New Team ............................................................................... 156
 Countdown to the Global Financial Crisis: A Story of Power and Greed ix

Chapter 9 ................................................................................................ 170

Hubris: The Terminal Disease
The CDO Rating Route....................................................................... 171
Warehousing and the Process of Securitisation ............................... 172
Resisting Warnings ............................................................................ 181
Selling and Shorting Lehman Brothers shares as Mimetic
Isomorphism................................................................................ 183
Talking Heads .................................................................................... 184
Fuld’s Response to Market Disquiet ................................................. 187
Bear Stearns – Failure of the Hedge Funds and then the Firm ......... 195
Fannie Mae and Freddie Mac’s Rescue............................................. 197
Lehman Brothers’ Last Weekend ...................................................... 198
The Shifting Nature of Power and Institutional Influence ................ 203
Economic Climate ............................................................................. 206
Political Atmosphere ......................................................................... 210
The Wash-up ..................................................................................... 213

Chapter 10 .............................................................................................. 215

Models and Numbers
Lehman Brothers’ Business Model ................................................... 216
Similarities in the Peer Group’s Business Model .............................. 221
Lehman Brothers’ Financial Structure .............................................. 228
Risky Business ................................................................................... 237
Follow the Leader: Financial Structure ............................................. 241

PART THREE: CONNECTIONS & INFLUENCE

Chapter 11 .............................................................................................. 248

Bedfellows
The US Financial Network ................................................................. 250
Political Contributions....................................................................... 254
Lobbying ............................................................................................ 267
Political Contributions and Lobbying as Coercive Pressure .............. 282
Revolving Door .................................................................................. 284
Empirical Evidence that Connections Count ..................................... 292
Knowledge Asymmetry ..................................................................... 294
Credit Rating Agencies ...................................................................... 296
Institutional Influence over FASB ...................................................... 304
x Contents

Chapter 12 .............................................................................................. 324

Window Dressing
Repo 105 Transactions ...................................................................... 325
Offshoring and impact of Lehman Brothers’ Repo 105
Transactions ................................................................................ 331
Linklaters’ True Sale Opinion Letter .................................................. 333
Concealment as Power ..................................................................... 334

PART FOUR: CORROSIVE CULTURE

Chapter 13 .............................................................................................. 342

Governance
Corporate Governance...................................................................... 344
Board Structure ................................................................................. 359
“Self-interest” and “Short-termism” ................................................. 365

Chapter 14 .............................................................................................. 367

Internal Relationship
CEO and the Board ............................................................................ 367
Fuld’s Power over the Board ............................................................. 395
CEO and the Employees .................................................................... 397
Communication as a Window ........................................................... 419
Code of Ethics – What ethics?........................................................... 441

Chapter 15 .............................................................................................. 447

Conclusion

Appendices ............................................................................................. 453

References .............................................................................................. 468

 TABLE OF FIGURES

Figure 1.1: New Institutional Theory Framework ....................................... 4

Figure 1.2: Diagram of Clegg's Circuits -of Power ....................................... 6
Figure 1.3: An Institutional View of Lehman Brothers Impacted by
Three Circuits of Power and Institutional Influences ............................ 7
Figure 2.1: US Banking Crises: Historical Summary .................................. 16
Figure 2.2: Evolution of the US Investment Banking Industry (1775-
1815) ................................................................................................... 18
Figure 2.3: US Public Debt as % of GDP: 1790 to 2010 ............................. 20
Figure 2.4: Haym Salomon ........................................................................ 21
Figure 2.5: Bill drawn by French Government in 1781 to Bearer
or Haym Salomon................................................................................ 23
Figure 2.6: Advertisement in The Pennsylvania Journal and Weekly
Advertiser 1782 ................................................................................... 25
Figure 2.7: Portrait of Albert Gallatin ....................................................... 29
Figure 2.8: David Parish Source: Hough 1853 ........................................... 33
Figure 2.9: Stephen Girard........................................................................ 34
Figure 3.1: US Railroad active mileage by region between 1830
and 1890 ............................................................................................. 38
Figure 3.2: Portrait of Nicholas Biddle ...................................................... 39
Figure 3.3: Portrait of Nathaniel Thayer ................................................... 43
Figure 3.4: Portrait of James Gore King .................................................... 44
Figure 4.1: Portrait of Anthony Joseph Drexel (CC) .................................. 48
Figure 4.2: Portrait of Enoch Clark (founding partner of Clark Dodge) .... 51
Figure 4.3: Picture of John Pierpont Morgan ........................................... 53
Figure 4.4: Military Costs of Major US Wars 1775-1900 (current and
constant dollar values) ........................................................................ 57
Figure 4.5: Portrait of Salmon Chase, Secretary of the Treasury between
1861 & 1864 ........................................................................................ 59
Figure 4.6: Portrait of Jay Cooke, Financier to the Union. ........................ 59
Figure 4.7: Civil War Five-dollar Greenback issued in March 1863 .......... 61
Figure 4.8: Log Price of Gold between 1790 and 2010 ............................. 61
Figure 4.9: A One Thousand-dollar 5/20 Bond featuring the face
of Salmon Chase.................................................................................. 62
xii Table of Figures

Figure 4.10: Article by Jay Cooke & Co. regarding distribution

of the 5/20 Bonds ............................................................................... 63
Figure 4.11: An announcement advertising 7-30 Bonds .......................... 66
Figure 4.12: USD 1,000 Confederate Bond ............................................... 67
Figure 4.13: 10-dollar Confederate Currency ........................................... 69
Figure 5.1: Portrait of Fritz Augustus Heinze ............................................ 76
Figure 5.2: Articles on Suspension of Knickerbocker ................................ 78
Figure 5.3: Timeline of the Panic of 1907 ................................................. 79
Figure 5.4: Front page of Puck magazine dated 2 February, 1910 ........... 80
Figure 5.5: Picture of Arsene Pujo ............................................................ 81
Figure 5.6: US Non-Financial Corporate Equities Outstanding,
1949-2013 ........................................................................................... 95
Figure 5.7: US Debt Instruments Outstanding 1949-2013 ....................... 96
Figure 5.8: Ranking of major US investment banks by market
capitalisation in 2007 .......................................................................... 98
Figure 6.1: US House Price Index 1991 to 2008 ...................................... 107
Figure 6.2: US Home Loan Volumes for Period 1998 to 2008 ................ 109
Figure 6.3: US Financial Institution Failures 2007-2014 ......................... 112
Figure 6.4: Regulatory Umbrellas for Banks versus Investment Banks .. 113
Figure 6.5: US House Prices and selected US legislation 1975 to 2011 .. 123
Figure 7.1: Pictures of the Lehman Brothers .......................................... 128
Figure 7.2: Newspaper Advertisements Promoting Lehman Brothers’
Trading Business ............................................................................... 130
Figure 7.3: Lehman Brothers Branch at 119 Liberty Street, New York ... 131
Figure 7.4: Picture of Robert (Bobbie) Lehman ...................................... 139
Figure 7.5: Peter Petersen ...................................................................... 141
Figure 7.6: Chart of Mergers & Acquisitions Forming Lehman
Brothers Inc. ...................................................................................... 143
Figure 7.7: Picture of Lewis Glucksman .................................................. 145
Figure 7.8: Picture of Harvey Golub........................................................ 148
Figure 7.9: Leadership of Lehman Brothers 1850-2008 ......................... 149
Figure 8.1: Picture of Richard Fuld CEO of Lehman Brothers 1993-
2008 .................................................................................................. 154
Figure 8.2: Chris Pettit: Chief Operating Officer Lehman Brothers,
1996 .................................................................................................. 158
Figure 8.3: Bradley Jack .......................................................................... 160
Figure 8.4: Picture of Joseph Gregory..................................................... 161
Figure 8.5: Picture of Thomas Russo ...................................................... 162
Figure 8.6: Picture of Ian Lowitt ............................................................. 163
 Countdown to the Global Financial Crisis: A Story of Power and Greed xiii

Figure 8.7: Picture of Michael Gelband .................................................. 164

Figure 8.8: Picture of Herbert ‘Bart’ H. McDade III................................. 165
Figure 8.9: Hugh E. ‘Skip’ McGee III ........................................................ 166
Figure 9.1: Warehoused Mortgage Assets and Other Investments
as % of Total Assets ........................................................................... 171
Figure 9.2: Typical CDO Structure ........................................................... 173
Figure 9.3: Total Number of Structured Finance Tranches Issued ......... 174
Figure 9.4: Total CDOs Issued 2000-2007 ............................................... 174
Figure 9.5: Credit Rating Downgrades, Upgrades and Withdrawn......... 177
Figure 9.6: Lehman Brothers Global Strategy Offsite Presentation–
March 2006 ....................................................................................... 179
Figure 9.7: Introduction of Lehman Brothers Global Strategy Offsite
Presentation, 2006 ............................................................................ 180
Figure 9.8: Structured Asset Write downs for Lehman Brothers, 2008 ... 181
Figure 9.9: Lehman Brothers Holdings Inc. Adjusted Closing Share
Price, 1994-2008 ............................................................................... 182
Figure 9.10: US Economic Growth 1994-2008 ........................................ 206
Figure 9.11: US GNI per Capita 1994-2008 ............................................. 207
Figure 9.12: Fed Funds Rate 1987 to 2008 ............................................. 208
Figure 10.1: Operational Structure of Lehman Brothers ........................ 219
Figure 10.2: Major US Investment Banks 2007 by Market Value
and Number of Employees ............................................................... 221
Figure 10.3: Business Segment Classifications Used in Investment
Bank Annual Reports......................................................................... 224
Figure 10.4: Net Revenue: Investment Bank Peer Group Segment
Reporting for 2007/2008 .................................................................. 225
Figure 10.5: Average Business Segment Size Based on Consolidated
Net Revenue for Lehman Brothers and Peer Group, 2007 ............... 227
Figure 10.6: Selected Financial Ratios for Lehman Brothers for
the Financial Years 2004 to 2007 ...................................................... 229
Figure 10.7: Key Financial Data for Lehman Brothers for the Financial
Years 2004 to 2007 ........................................................................... 230
Figure 10.8: Lehman Brothers NPAT and Total Revenue for Period
2004-2007 ......................................................................................... 233
Figure 10.9: Lehman Brothers’ Quarterly Financial Data-2008 .............. 234
Figure 10.10: Lehman Brothers’ Securities Issues in 2008 ..................... 235
Figure 10.11: Trend of Lehman Brothers’ Principal Transactions
and Trading Revenue ........................................................................ 238
Figure 10.12: Revenue Volatility of Lehman Brothers’ Trading Division .. 239
xiv Table of Figures

Figure 10.13: Selected Financial Ratios for Peer Group for the Financial
Year Ended in 2007 ........................................................................... 240
Figure 10.14: US Investment Banks’ Leverage Ratios (Debt to Equity) .. 242
Figure 10.15: Return on Equity of Investment Banks 1998 to 2007 ....... 243
Figure 11.1: The Interrelationships within the US Financial Network .... 252
Figure 11.2: Cost of Running the US Federal Election in the 2016
Election Cycle as represented by Total Contributions ...................... 254
Figure 11.3: Total Political Contributions from Investment Banking
Industry 1998-2008 ........................................................................... 255
Figure 11.4: Top 10 Recipients of Campaign Contributions 1998-2008 ... 257
Figure 11.5: Political Views of Selected US Recipients of Large Political
Donations .......................................................................................... 261
Figure 11.6: Top 10 donors (excluding lobby groups) of political
contributions in 2004 US election ..................................................... 263
Figure 11.7: Political Contributions per Political Party over USD
100,000 in 2004 Election................................................................... 265
Figure 11.8: Top 20 Donors of Political Contributions to George W.
Bush in 2004 US Election .................................................................. 265
Figure 11.9: Examples of Defeated US Government Bills 2000-2008 ..... 271
Figure 11.10: Total Lobbying Expenditure by the Investment Banking
Industry ............................................................................................. 274
Figure 11.11: Lehman Brothers’ Lobbying Spending from 1998
to 2008 .............................................................................................. 275
Figure 11.12: Lobbying Spending of Major US Investment Banks
1998-2008 ......................................................................................... 277
Figure 11.13: Lobbying Spending of Major Industry Associations
1998-2008 ......................................................................................... 278
Figure 11.14: Number of Investment Banking Clients of the Lobby
Groups............................................................................................... 279
Figure 11.15: Number of Lobbyists Working for the Investment
Banking Industry ............................................................................... 280
Figure 11.16: “Revolving door” Staff of Regulatory Agencies ................ 285
Figure 11.17: Selection of US Treasury Secretaries Passing through
the “Revolving Door” ........................................................................ 287
Figure 11.18: Top 12 US Mortgage-Backed Securities (including CDOs)
Underwriters in 2007 ........................................................................ 302
Figure 11.19: Process for Establishment of US Accounting Standards
Source: Information was extracted from Financial Accounting
Standards Board (2017) .................................................................... 305
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