The collapse of Lehman Brothers: a case study

Lehman Brothers filed for bankruptcy protection on September 15, 2008.Hundreds of employees, mostly dressed in suits and boxes in their hands, left the bank office one by one. This is a gloomy reminder that nothing is eternal-even in the abundance of the world of finance and investment.

At the time of its collapse, Lehman Brothers was the fourth largest investment bank in the United States, with 25,000 employees worldwide. It has assets of 639 billion U.S. dollars and liabilities of 613 billion U.S. dollars. The bank became a symbol of the excessive financial crisis in 2007-08. The subprime mortgage crisis swept the financial market and the economic output loss was estimated to be US$10 trillion.of

In this article, we will study the events that led to the collapse of Lehman Brothers.

Key points

  • Lehman Brothers started as a dry goods store, but eventually set foot in the field of commodity trading and brokerage services.
  • The company survived many challenges, but eventually went bankrupt due to the collapse of the subprime mortgage market.
  • Lehman Brothers first ventured into mortgage-backed securities in the early 2000s and subsequently acquired five mortgage lending institutions.
  • The company has made losses several times in a row, and its stock price has fallen.
  • Lehman Brothers filed for bankruptcy protection on September 15, 2008, with assets of US$639 billion and debts of US$619 billion.

Lehman Brothers history

Lehman Brothers was born humble, and its roots can be traced back to a grocery store founded in 1844 by German brothers Henry, Emanuel and Mayer Lehman in Montgomery, Alabama. Farmers use cotton to pay for their goods, which leads the company to get involved in the cotton trade. After Henry’s death, other Lehman Brothers expanded their business scope to commodity trading and brokerage services.

As the US economy grew into an international power, the company flourished in the following decades. But over the years, Lehman Brothers has faced many challenges. The company survived the railroad bankruptcies of the 1800s, the Great Depression, the two world wars, the 1994 American Express (AXP) initial public offering of capital shortages, the collapse of long-term capital management companies, and Russian debt. By default, it was 1998.

Although it was able to survive past disasters, the collapse of the US real estate market eventually brought Lehman Brothers to their knees, as its plunge into the subprime mortgage market proved to be a disastrous step.

The culprit

The company, along with many other financial companies, is involved in mortgage-backed securities and mortgage debt. In 2003 and 2004, as the real estate bubble in the United States spread, Lehman Brothers acquired five mortgage lenders as well as BNC Mortgage and Aurora Loan Services, which specialize in Alt-A loans. These loans are provided to borrowers without complete documentation.

At first, the Lehman Brothers acquisition seemed to be prescient. The real estate business of Lehman Brothers increased the revenue of the capital markets department by 56% from 2004 to 2006. The company securitized $146 billion in mortgage loans in 2006, a 10% increase from 2005. Lehman Brothers reported that from 2005 to 2007, annual profits set a record. In 2007. , It announced net income of 4.2 billion U.S. dollars and revenue of 19.3 billion U.S. dollars.

Huge misjudgment

In February 2007, Lehman Brothers’ share price reached a record high of US$86.18 per share, and its market value was close to US$60 billion.But by the first quarter of 2007, rifts in the US real estate market had begun to appear. The default rate of subprime mortgages began to rise to the highest point in seven years. On March 14, 2007, due to concerns that an increase in the default rate would affect Lehman Brothers’ profitability, the stock posted its biggest one-day decline in five years. The company reported record revenue and revenue for the first quarter. profit. After the earnings report was released, Lehman Brothers stated that the risk of rising housing delinquency rates has been well controlled and has little impact on the company’s earnings.

Beginning of ending

In August 2007, following the collapse of two Bear Stearns hedge funds and the outbreak of the credit crisis, Lehman Brothers’ stock fell sharply. That month, the company laid off 1,200 mortgage-related jobs and closed the BNC department.It also closed the offices of Alt-A lender Aurora in three states. Even if the adjustment momentum in the US real estate market strengthens, Lehman Brothers is still a major participant in the mortgage market.

In 2007, Lehman Brothers underwritten more mortgage-backed securities than any other company, with a cumulative investment portfolio of US$85 billion, four times its shareholder equity. In the fourth quarter of 2007, as global stock markets reached new highs, fixed-income asset prices temporarily rebounded, and Lehman stocks rebounded. However, the company did not take this opportunity to reduce its huge mortgage portfolio, and in retrospect, this will be its last opportunity.

Heading for failure

In 2007, Lehman Brothers had a high leverage ratio of 31, and its large mortgage securities portfolio made it extremely vulnerable to deteriorating market conditions. On March 17, 2008, due to concerns that Lehman Brothers would become the next Wall Street company to fail after Bear Stearns was on the verge of bankruptcy, its stock price plummeted by nearly 48%.of

By April, after issuing preferred shares (convertible to Lehman shares, a 32% premium over the same period) with a gain of US$4 billion, confidence in the company had recovered.However, as hedge fund managers began to question the valuation of Lehman Brothers’ mortgage portfolio, the stock continued to fall.

On June 7, 2008, Lehman Brothers announced a loss of US$2.8 billion in the second quarter, the first loss since it was split by American Express, and reported that by June 12, it had raised funds from investors. 6 billion U.S. dollars.According to David P. Belmont, “The company also stated that it increased its liquidity pool to approximately US$45 billion, reduced total assets by US$147 billion, and reduced residential and commercial mortgage loans. The exposure has been reduced by 20% and leverage has been reduced. The coefficient is around 32 to 25.”of

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Too little too late

People think that these measures are too few and too late. Throughout the summer, the management of Lehman Brothers made unsuccessful proposals to some potential partners. In the first week of September 2008, as investors questioned CEO Richard Fuld’s plan to maintain the company’s independence by selling part of his asset management department and divesting commercial real estate assets, the stock plummeted as the global stock market plummeted That’s 77%. Hopes of the Korea Development Bank to take a stake in Lehman Brothers were shattered on September 9 because the South Korean state-owned bank shelved negotiations.of

This devastating news caused Lehman Brothers’ stock to fall by 45%, while the company’s debt and credit default swaps increased by 66%.Hedge fund clients began to abandon the company, and short-term creditors followed suit. The fragile financial situation of Lehman Brothers was best reflected in the dismal results of its third fiscal quarter report on September 10.of

Faced with a loss of US$3.9 billion, including a write-down of US$5.6 billion, the company announced an extensive strategic corporate restructuring. Moody’s Investor Services also announced that it is reviewing the credit rating of Lehman Brothers and found that the only way for Lehman Brothers to avoid a downgrade is to sell a majority stake to a strategic partner. By September 11, due to these developments, the stock fell sharply again (42%).of

By the end of that week, Lehman Brothers had only $1 billion in cash left, and soon there was no time. On the weekend of September 13th, Lehman Brothers, Barclays Bank and Bank of America (BAC) made their final efforts to facilitate the acquisition of the former, but none of them succeeded in the end.On Monday, September 15, Lehman Brothers declared bankruptcy, causing its share price to plummet 93% from its previous closing price on September 12.

From the close of trading on September 12, 2008 to the day of bankruptcy, Lehman Brothers’ stock plummeted 93%.

Where are they now?

Former Chairman and CEO Richard Fuld runs the Matrix Private Capital Group he founded in 2016. The company manages assets for high-net-worth individuals, family offices and institutions. According to reports, he sold an apartment in New York City for $25.9 million and sold a series of drawings for $13.5 million.

In the years after the bankruptcy, Fuld admitted to the bank’s mistakes, even though he still criticized the government for forcing Lehman Brothers to file for bankruptcy while helping others. In 2010, he told the Financial Crisis Investigation Committee that the bank had sufficient capital reserves and a sound business at the time of bankruptcy.

Erin Callan (now Erin Montella) became CFO at the age of 41 and resigned in June 2008 because of suspicion that she had leaked information to the media. Her LinkedIN profile lists her as an advisor to Matrix Investment Holdings. Other positions include six months as the head of a Credit Suisse hedge fund and co-founding a non-profit organization that provides paid maternity leave for mothers. In 2016, Montella published an autobiography, The complete circle: Memoirs of leaning too far and returning, About her experience in the financial industry.

Bottom line

Given the size and position of Lehman Brothers in the United States and the world, the collapse of Lehman Brothers has stirred up global financial markets for several weeks. At its peak, Lehman Brothers had a market value of nearly $46 billion, but it was evaporated in the months before bankruptcy.

Many people questioned the decision to allow Lehman Brothers to fail. In contrast, the government’s tacit support for Bear Stearns, which was acquired by JPMorgan Chase (JPM) in March 2008. Bank of America had negotiated the acquisition of Lehman Brothers, but after the government withdrew and refused to help Lehman Brothers deal with the most difficult assets. Instead, Bank of America announced that it would acquire Merrill Lynch on the same day that Lehman Brothers filed for bankruptcy.


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