Lehman lifer loses shot at the top
If Erin Callan was the public face, Joe Gregory was the man behind a long boom - and a painful bust. Now both are out.
NEW YORK (Fortune) -- Given the ballooning questions about Lehman Brothers' health, the departure of finance chief Erin Callan, frequently the public face of the firm in recent months, comes as no great surprise.
But the fall of COO Joseph Gregory, a lifetime Lehman employee, caught many observers off-guard, given his status as CEO Richard Fuld's right-hand man and publicly designated heir apparent.
Gregory helped Lehman thrive after the debt crisis of 1998 and the collapse of the dot-com bubble by overseeing the firm's aggressive expansion into residential mortgage lending, commercial real estate, leveraged lending and structured products. Since the credit crisis began last summer, Gregory and his mentor Fuld were justly praised for steering Lehman away from the massive exposure to risky debt instruments known as collateralized debt obligations, which devastated rivals Merrill Lynch (MER, Fortune 500) and Citi (C, Fortune 500). Gregory was certainly well-compensated, earning a little over $59 million in the past two years.
A Lehman spokesperson told CNNMoney.com that Gregory, like Callan, is not leaving the firm.
For all of Gregory's deft management, the calculus of his demotion made cold sense since the executive, who was named president in 2004, bore ultimate responsibility for many of the firm's now-dubious business decisions of the past decade.
Lehman (LEH, Fortune 500) began acquiring mortgage lenders and other real estate-related properties earlier in the decade, when the housing boom was in full swing. The firm acquired five mortgage lenders in 2003 and 2004, and posted 30% year-over-year gains in mortgage originations and mortgage-backed securities issuances during fiscal 2005. Those gains helped to fuel record profit growth and stock-price gains at Lehman through last year.
But like so many firms, Lehman continued dancing the residential real estate dance even after the music stopped and house prices started falling. Last year, Lehman joined with Tishman Speyer Properties to pay $22 billion for real-estate investment trust Archstone-Smith. It also set a joint venture with California developer SunCal to sell house lots to builders across the already-overheated Southern California market.
Even now, after Lehman took some writedowns of undisclosed size on those deals, there are mounting concerns about the value of Lehman's real estate portfolio and private-equity investments. Skeptics believe Lehman may need to write those investments down further.
But based on trading Thursday, it's not clear the reassignments of Callan and Gregory are having the desired effect. Lehman shares aren't plunging, but they aren't up sharply, either, as you might expect if investors were relieved by the departures. Instead, Lehman shares were trading flat mid-day Thursday.
A better barometer of investor sentiment about Lehman's creditworthiness continues to be troubling. Prices on Lehman's credit default swaps - derivative contracts in which investors pay a premium in exchange for the right to receive payment in the event the firm defaults on its debt - are at high levels.
Since Friday, the cost of insuring a $10 million block of Lehman debt for five years has jumped 20%, to around $270,000. While these levels remain sharply below the cost of insuring Bear's debt when it suffered a run on the bank in mid-March, it is telling nonetheless because Lehman has direct access to emergency borrowings with the Federal Reserve. Bear didn't.
Moreover, as Fortune.com noted Tuesday, Lehman's much-touted $130 billion deleveraging push - so avidly touted this week by Callan - has taken on a slightly comic sensibility, given that the firm is merely returning to the balance sheet size it had in late August last year.
Whether Gregory played a role in the firm's decision to build assets by $100 billion between last August and early this year is unknown. But it's hard to ignore the fact that, at the time, practically all other major financial market players were racing to cut their risk - for reasons (massive writedowns and credit impairments) that have since become all too apparent.
Under the leadership of Fuld, Gregory and Callan, Lehman was going in the wrong direction. 
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