Lehman Brothers (CMC, Thursday, Week 11)
coming-of-managerial-capitalismyear-twoA German Jewish immigrant started a tiny grocery store in Montgomery, Alabama in 1844. Two of his brothers came over from Bavaria to join him. They called their business "Lehman Brothers." Seriously.
Their business went broke in 2008 --- the largest bankruptcy in American history. What the heck happened?
(Sidenote: William Sharpe --- creator of CAPM and the Sharpe ratio --- reminds us that there are still other brothers: "The wrong financial advisor")
Middle men: Outsiders with an appetite for risk and the capability to deal with it
Why do merchants become investment bankers?
Avenue to scale, industry/product-agnostic anyway, culture of apprenticeship
KFS for merchants: Competence, broad network, relationships, TRUST
Why so many German Jews? Historical precedent, international connections, and serious consequences to breaking trust (ostracism in small community)
The evaluation of Lehman Brothers:
Merchants => State bonds => Stocks/bonds => Investment funds => International expansion => Financial instruments
Consistent trends: filling a void, provisioning capital to growth industries
The financial industry changes too: Professionalization, greater scale, CONSOLIDATION (many benefits; spurs growth)
BUT: empire-building, declining competition, information asymmetry
Why do investment banks start off as partnerships?
-- Signal of commitment and diligence to customers => partners have skin in the game
-- Solves agency issues => no principal-agent problems
-- VALUE RESIDES IN HUMAN CAPITAL => What the heck is the "capital" that shareholders could own in a law firm or a consulting firm or an investment bank? The employees? They walk out the door at night...
What went wrong?
-- Technology "makes human judgment redundant"
-- Structural changes (public companies)
-- Competition on a transactional basis (vs. enduring relationships)
-- Managing risk through (purported) diversification => false sense of security?
-- GREED => downside borne by the public