The Curse of the Public Investment Banks

Jim Surowiecki is quite convincing when he blames Lehman’s demise on the fact that it was a public company:

The perception of weakness exacerbates the reality of weakness. And although there are myriad measures of a company’s health, nothing looks scarier than a stock price that’s heading toward zero.

On the other hand, the main dynamic here is that it was the public investment banks which took the most risk, and it was the riskiest investment banks (the ones with balance sheets in the hundreds of billions of dollars) which failed.

Being public is not, in and of itself, a bad thing for an investment bank: Greenhill stock is trading at an all-time high. As Surowiecki says,

Companies like Lehman and, earlier, Bear Stearns saw going public as an excuse to take on more risk and act more recklessly, when in fact becoming a public company makes caution more important, since the margin for error is smaller, and the punishment for failure swifter.

This is the main reason why there are still big question marks hanging over the future of Morgan Stanley and Goldman Sachs. If you’re a private hedge fund, like LTCM, you have to actually lose money in order to fail. If you’re a public hedge fund, like Goldman Sachs, all that’s necessary for your stock to go to zero is that investors worry that you might lose money.

In Lehman’s bankruptcy filing, its assets significantly exceeded its liabilities; I think it’s fair to say the risk of going bankrupt while solvent was not something which Dick Fuld historically worried overmuch about.

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