Lehman Brothers Saga – A Root Cause?

Lehman Brothers Saga – A Root Cause?

Perhaps the first subject to zero in on is the Lehman Brothers saga.

Should those who know the Book do differently from what was done by the Relationship Managers or Financial Advisers who recommended and even pushed the product to their clients?
Proverbs 10:22 is a verse many wealthy people like very much.

“The blessing of the Lord brings wealth, and the Lord adds no trouble to it.”
This verse means that wealth which is a blessing of the Lord comes without any troubling side effects or undesirable consequences.

Many people have traded their health for wealth.

Many people have gotten into a lot of trouble in their desire for wealth.
1 Timothy 6:9

“People who want to get rich fall into temptation and a trap and into many foolish and harmful desires that plunge men into ruin and destruction.

For the love of money is the root of all kinds of evil. Some people eager for money, have wandered from the faith and pierced themselves with many griefs.”

Even Christians of many years and especially those who have tasted of the pleasures of wealth can be sorely tempted by the “golden calf” of materialism.
Hebrews 13:5

“Keep your lives free from the love of money and be content with what you have.”

One of the hardest lessons is “Enough is enough”.
Wealth obtained other than from godly wisdom and the blessing of God will usually breed greed and develop wings, here today and gone tomorrow.

The recent collapse of Lehman Brothers and the crisis faced by AIG and many other financial institutions have a financial cause, but perhaps there is a root cause.
There are many questions that can be asked of the practices of both investment banks like Lehman Brothers and the banks and other distributors of the product like structured notes and minibonds.

Based on news and commentaries by economists, greed or “easy money to be made” was probably the root cause. If banks can lend out money and transfer the risks of the loan repayment to others, then there is a lesser need to assess the creditworthiness of borrowers. The sub-prime housing bubble was due to easy credit and also the banks banking on the opportunity to make easy money quickly.

The credit default swap (CDS) allowed the banks to pass on the risks to counterparties (like AIG) which took the can when the cans of worms were opened. The slicing and dicing of the home loans into collaterized debt obligations (CDOs) and selling these off to other institutions across the world further allowed the originating banks to make even more money while also passing on the risks to others.

Whether you call it “unbridled capitalism”, “financial engineering” or plain greed, the effect was that when the original card of the subprime mortgages fell, the other cards also fell like dominoes.

Unfortunately, the buck has to stop somewhere and this led to the fall of the financial institutions which held the eventual risks.
In retrospect, this whole thing is like an accident waiting to happen. A lot of business was generated by the derivative products but it is businesses which stand or fall with the original product. In this case the original product was the home mortgage. Arguably, if the home mortgages were all done properly (i.e. only creditworthy home buyers qualify), there wouldn’t have been a crisis. But Alan Greenspan’s years of low-interest rates could logically be expected to lead to easy credit and sub-prime loans which became the “toxic assets” of today.

Governments will have to grapple with the issues of whether derivatives have their role and how their trade should be regulated.

I am more concerned about how we should view the financial products that have been manufactured and how these are marketed and to whom.

The things which all of us like to see are transparency, full disclosure of the benefits and disbenefits and risks, identification of the needs and financial objectives of the client, attention to the investor’s risk appetite and tolerance and the investment time horizon. Another important factor is respect for clients’ confidential information and also not taking advantage of any of their weaknesses or vulnerabilities.

Many of these important requirements stipulated in the Financial Advisers Act were not kept.

If what I am informed about banks getting their RMs to get their clients to agree to sale option 4 is correct, then it is clear that the recommended approach of financial needs analysis and the proper recommendation was not followed. Option 4 states that the clients does not need advice and means that he is making the decision on his own without relying on the advice of the RM.

If the structured products are high risk and complex products, how fair is it for the distributors to state that no advice is required? It is no wonder that the banks are asked by the authorities to do what is right and not what is legal, to resolve the claims for compensation. For legally speaking, any client who has signed Option 4 has weak legal legs to stand on. He can go for misrepresentation or misselling, but these are harder to prove, especially if the clients are educated and can be reasonably expected to know what they bought.

It is interesting that the typical Financial Adviser Representative takes a minimum of two to three meetings of a few hours each to complete the sales process for even a simpler medical product or life insurance product. The objective of the banks is to close the client in one meeting. Is the “reasonable advice” stipulation in the FAA observed?

Clients should also be informed that the banks are not required to provide fair and objective advice and a choice of products, when the Independent Financial Adviser Representative is required to do.
Why then was there so much sales of structured products and even life insurance products through banks?

Many reasons have been given – trust, the banks knew the financial standing and amount of money the clients have with the banks, the convenience of just filling in some simple forms.

The main factor is trust. Banks are known to be big, strong and friendly. But in the recent crisis, client’s need to pay excessive tuition fees to learn that banks are also motivated to make money. Many clients were not aware that generally banks charge bigger upfront fees than Financial Advisers. Banks also have sales people who are driven by quotas and threat of termination. In fact the quotas set by banks are higher than that set by some FAs and insurance companies, to recover the salaries that are paid to the RMs.

The lesson learnt from this recent Lehman Brothers saga is that power lies with the Financial Institution or the Financial Adviser. What can be done to ensure that advisers use all their knowledge of products and process in only recommending products which are in the best interests of clients?