Collapse of Lehman Brothers Essay

Collapse of Lehman Brothers Lehman Brothers was an investment bank that went back to the 1850s, surviving the Civil War, two World Wars, the Great Depression and any other great misfortune that this 160 year old company’s history had gone bankrupt. Lehman brothers were an important part in the financial and commercial industries in the United States. People may have thought that leverage was a bad thing; they should have realized that a dry-goods store turned into a huge investment bank then years later bringing attention to the whole world.

Lehman brothers began when an immigrate by the name Henry Lehman came from Germany and settled in Montgomery, Alabama where he started a small shop selling groceries, dry-food and utensils to local farmers. By the late 1840s early 1850s both of his brothers Emanuel and Mayer joined him in the business and named the company Lehman Brothers. After the death of their brother Henry the two younger brothers took over the business for the next forty years. During that policy only family members were allowed as partners whom continued until the 1920s.

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Lehman brothers grew from being regular merchandising business to a commodities broker which bought and sold cotton to planters around the area of Montgomery, Alabama. The business grew and formed a small partnership with John Wesley Durr to build a warehouse which helped Lehman brothers to take on larger sales. Lehman brothers opened a New York office giving them a stronger presence in commodities. Lehman brothers had to rebuild their firm due to the civil war, but wanted to focus on their operations in the New York office.

Mayer Lehman was the first person appointed as the board of directors. Lehman Brothers commodities and trading business grew that they help establish the Coffee and Petroleum Exchange. Robert Lehman became a partner in the firm during the 1920s and he moved to the leadership role. He led the firm from the 1929 to 1969 which that time there was a significant growth for the firm. Robert’s business philosophy was centered around his beliefs on consumption, not production would determine America’s future prosperity. The firm was guided to help emerging ndustries geared to mass consumption. Robert Lehman’s commitment to recognize growing industries is what led the firm to become active especially in the airlines and the motion picture industries. Many U. S. companies started expanding internationally and Lehman Brothers increased its global presence as well, opening offices in Europe and Asia in the 1960s and 1970s. In the 1980s, financial advisory centered on mergers and acquisitions as major corporations moved to expand both domestically and internationally. Lehman Brothers acted as an advisor on several large U.

S. and cross-border transactions, including Bendix/Allied, Chrysler/American Motors, General Foods/Philip Morris, and Genentech/Hoffman-LaRoche. In the late 1980s, Lehman brothers were active in helping new companies especially Cetus and they also bought into Intel, which the company introduced the very first microprocessor rose its funds to expand the business to meet the demands of the personal computer market. In 1975 the firm merged with Kuhn, Loeb and Company to form at the time the 4th largest investment bank.

The merger didn’t go quite as planned and trouble arose in the firm. The firm was sold to American Express. AMEX started to break away from banking and brokerage operations and sold off operations to Primerica which in 1994 was broken off as an IPO for the current Lehman Brothers ticker. The firm did exceptionally well purchasing fixed income such as Lincoln Capital Management and Neuberger Berman. Lehman had steadily increased revenues and grew in employees from 8,500 to approximately 28,000 in 1994.

In the article, Collapse of Lehman Brothers on September 15, 2008, Lehman Brothers filed for chapter 11 bankruptcy protection. Lehman’s bankruptcy filing was the largest in history; their assets exceeded other bankrupt giants such as WorldCom and Enron. Lehman was the fourth largest U. S. investment bank at that time of its collapse. Lehman’s collapse greatly intensified in the 2008 crisis and contributed to the wearing down of the $10 trillion in market capitalization. The main cause of the collapse was the boom of the housing market in 2004.

Lehman obtained mortgage lenders and subprime lenders BNC Mortgage and Aurora Loan Services. Lehman real estate recorded revenues in the capital markets which increase 56% from 2004 to 2006 which grew faster than any other investment bank. Every year Lehman recorded profits which they reported net income of $4. 2 billion on revenue of $19. 3 billion. In 2007 the housing market begins to show signs of slowing down with the defaults of the subprime mortgages which at the time was at a seven year high.

After the stocks had the biggest drop in March 14, 2007 Lehman chief financial officer made a comment on the increase concerns of defaults that can affect their profits, he said” that the risks posted by rising home delinquencies were well contained and would have little impact on the firm’s earnings” and as well he said, “he did not foresee problems in the subprime market spreading to the rest of the housing market or hurting the U. S economy”. When the credit crisis burst with the failure of hedge funds in Lehman’s stock dramatically dropped.

They had to shut down the BNC unit and unemployed about 2,000 people. Lehman publicizes a second-quarter loss of $2. 8 billion which was the first loss since they merged with American Express in the 1990s, but Lehman reported an increase of $6 billion from their investors. Lehman Brothers tried to find solutions to repair the plummeting of the stocks but the company’s hedge fund clients began to take out while the creditors were cutting credit lines. On September 10, Lehman announced a gloomy fiscal third-quarter of how they are financially. They reported a loss of $3. 9 billion, which had a write-down of $5. billion, and announced a way to find a strategic move to fix their business. Also on September 10 Lehman Brothers had to sell off Neuberger Berman to raise capital. Lehman had no option but to file for bankruptcy. That same day, Moody’s Investor Service said, “that they were going to review Lehman’s credit ratings, and also said that Lehman would have to sell a majority stake to a strategic partner in order to avoid a rating downgrade”. This progress led to a 42% plunge in the stock on September 11. Lehman only had $1 billion left in cash by the end of that week; they were beginning to run out of time.

The weekend of September 13 Lehman, Barclays PLC and Bank of America, aimed at assisting to takeover of Lehman, but ended up to be unsuccessful. That Monday Lehman had to declare bankruptcy, ensuing in the stock to plummet to 93% from its previous close on September 12. Besides having problems with mortgage and credit problems most of Lehman’s problems were holding on to low credit tranches and holding way too long on to subprime mortgages. The second quarter lost about $2. 8 billion and they had to liquidate $6 billion in assets. Here is a graph of Lehman Brothers tock from October 2007 to September of 2008. The main problem of collapse of Lehman Brothers was debt. Most of the debt was secured by residential housing but also in the commercial real estate. The balance sheets of these companies were weaker than anyone expected. In the article was the Great Panic of 2008 Preventable, Lehman went under the economy began a downward spiral the housing and mortgage market started a recession. First Banks didn’t want to lend to each other but only for very expensive interest rates some corporate bonds went from seven percent in August to almost ten percent by October.

Secondly the stock market plummeted after its historical high of more than 14,000 in October 2007, the Dow Jones trading around 11,400 before the bankruptcy. By October, it was about 8,400 and by March 2009, it was 6,600. Lastly employment collapsed with five million jobs vanished in about eight months following Lehman’s collapse unemployment rate was at 6. 2% in September and went to 9. 5 % in June 2009. The government failed to help out Lehman Brother but helped out AIG with a huge loan and panic followed because no one knew which firm was going to be helped out and who wasn’t.

The Federal Reserve refused to help out Lehman Brothers because legally they couldn’t do anything but to let Lehman Brothers fall under. The Treasury said “it lacked authority to make an investment; the Federal Reserve could lend but only if Lehman had adequate collateral, which was allegedly missing. ” Given this bias, there was no Plan B once Barclays withdrew its offer. An excerpt of what Paulson and Bernanke said when they were testifying in Congress: “I never once considered that it was appropriate to put taxpayer money on the line in resolving Lehman Brothers,” Paulson said.

Indeed, his position initially drew praise as standing up to Wall Street. Bernanke gave similar justifications. Testifying to Congress on Sept. 23, he said that “the troubles at Lehman had been well known . . . [and] we judged that investors . . . had had time to take precautionary measures. ” In truth, an informal consensus had formed against using government funds to save Lehman. Harsh criticism of the earlier rescue of Bear Stearns — done with Bush administration support and Fed money — had left a deep scar. The Financial Crisis Inquiry Commission as published e-mails reflecting the mood. On Sept. 9, Treasury chief of staff Jim Wilkinson wrote that he couldn’t “stomach us bailing out Lehman. Will be horrible in the press. ” When Lehman Brothers collapsed there was a domino effect with the world’s market beginning to panic. According to, Lehman Brothers collapse sends shockwave around the world, they explain on how the collapse affected the world’s economy. When shares fell central banks began to unveil urgent measures when the economy was entering a new dangerous phase. The Bank of England lent out ? 5 billion for the money market.

Nouriel Roubini, a leading international economist said, “Investors were fretting over the financial health of banks that had lent Lehman money and the fear that more big institutions would be wiped out. “It’s clear that we are one step away from a financial meltdown”. American International Group (AIG) made an approach to the US Federal Reserve for $40 billion in an emergency funding. The Federal Reserve then asked Goldman Sachs and JP Morgan Chase for help keep AIG on the brink of going under. According to, Lehman Brothers collapse sends shockwave around world; some of the central banks try to stabilize.

Especially in Frankfurt’s banks they had to put in €30 billion in emergency funds for the eurozone markets. Lehman collapsed because of $60 billion in bad debts and they held about $639 billion in assets against debt of $613 billion so which it made this the largest bankruptcy since 2002 when WorldCom collapsed. A financial panic threatened to shatter the global capitalist order, then came an unprecedented, and unprecedentedly expensive, effort by governments on both sides of the Atlantic to patch things up. Three main lessons present themselves.

First, our complex financial system is awfully fragile. Second, government action is capable of keeping a financial panic from snowballing into a complete economic disaster along the lines of the Great Depression. Third, the government has — in large part because of its success in averting disaster — found it difficult to take any actions that would make the financial system less fragile in the future. There was a run on money-market funds after one big money-market fund revealed that it owned a lot of suddenly worthless Lehman debt.

London-based hedge funds that relied on Lehman for day-to-day financing found themselves unable to do business because their accounts with Lehman’s U. K. subsidiary were frozen. They simply didn’t trust each other anymore, and didn’t want to lend to each other. The financial system proved too fragile to handle the stress. The early 1930s, the Treasury and Federal Reserve argued that the deep pain of financial crisis was a necessary economic corrective. The cost was a bailout that placed trillions of taxpayer dollars at risk. It was expensive, it was messy, it was unfair.

It struck many people as downright un-American. But it worked. “I’ve abandoned free-market principles to save the free-market system,” is how President George W. Bush described it last December. The financial reforms that the Obama Administration wants to push through Congress before year-end — creating a Consumer Financial Protection Agency, giving the Federal Reserve the job of systemic risk regulator, and establishing a “resolution regime” to wind down troubled nonbank financial institutions (like Lehman) and complex bank holding companies in an orderly fashion.

A federal investigation into the demise of Lehman Brothers is now focusing on the firm’s use of a controversial accounting technique to allegedly disguise its financial problems, and which senior executives were responsible for giving the final approve for its use. Investigators are also looking at whether there was any pressure placed on mid-level accounting executives to accept the use of accounting gimmicks during this time, these people add. The questioning by the SEC during these interviews, which occurred through late September, also involved which senior executives were behind giving the final approval to use Repo 105.

The case, according to people with direct knowledge of the investigation, has broadly centered on whether senior executives at the firm were properly disclosing the firm’s financial problems before its 2008 bankruptcy. The recent focus of the SEC’s questioning suggests that investigators believe their best chance at proving misconduct involves the facts and circumstances behind Lehman’s use of Repo 105. The controversial accounting technique first came to light in a report filed by the trustee of the Lehman Bankruptcy, Anton Valukas, who cited its use just months before Lehman’s implosion.

Lehman’s use of the accounting technique hid the deteriorating nature of the firm’s finances during those critical months before the bankruptcy when the firm was shopping for a potential buyer, and raising more capital from investors to stay alive. He said that the use of the gimmick means that there are “colorable claims” against senior officials at the firm, including former CEO Dick Fuld. A colorable claim means that there is a chance that a civil claim against an individual might be successful in.

The sole purpose of using Repo 105 is if someone hides or deceives investors about the true nature of the company’s finances it is considered to be fraud. Lawmakers assail regulators over failure to catch accounting maneuver at Lehman A week after the disclosure that Lehman Brothers used an unconventional accounting technique to make its balance sheet look stronger than it was in the months before its collapse, lawmakers Wednesday attacked the federal regulators who failed to detect and halt the practice.

The head of the Securities and Exchange Commission accepted primary responsibility on behalf of her agency for shortcomings in its oversight of Lehman at a congressional hearing. And at a separate hearing, Federal Reserve Chairman Ben S. Bernanke faced tough questions on why Fed examiners monitoring Lehman in spring 2008 failed to catch the accounting tactics, which helped the bank hide $50 billion in liabilities from its quarterly reports.

According to the examiner’s report, Lehman engaged in transactions at the end of each quarter that temporarily moved $50 billion in risky assets off its balance sheet, with an agreement to repurchase them later. The maneuvers made the firm appear stronger financially in its quarterly reports than it was. Although the SEC had primary responsibility for regulating Lehman, the Fed had also had examiners working inside the firm since the March 2008 decision to bail out Bear Stearns. Those officials also failed to raise red flags about Lehman’s accounting.

The Fed had only two staff members on-site at Lehman during that period and that they were focused mainly on ensuring that the Fed would be repaid for emergency loans made to Lehman under a program started after the Bear Stearns bailout. “We had only a couple of people in the company whose primary objective was to make sure we got paid back the money we were lending to Lehman,” Bernanke said. “We were not the supervisor. And in any case, we would not have the authority to address accounting and disclosure issues in that context. The failure to detect questionable accounting comes as Bernanke and the Fed seek to defend their role overseeing banks more broadly against efforts on Capitol Hill to limit that authority. As many as a dozen government officials were provided desks, phones, computers — and access to all of Lehman’s books and records,” said Rep. Spencer Bachus (R-Ala. ), the ranking Republican on the House Financial Services Committee. “Despite this intensive on-site presence, the New York Fed and the SEC stood idly by while the bank engaged in the balance sheet manipulations. . . This raises serious questions regarding the capability of the Fed to conduct bank supervision. ” The episode shows some hazards of the Fed’s expansive moves to support the financial system. Before the Bear Stearns bailout, the Fed would have had no role overseeing investment banks, but that action left it open to criticism for mistakes in that industry. Similarly, the Fed has been criticized for actions by the insurance company American International Group — which it had nothing to do with before it bailed that firm out in September 2008.

Lehman’s collapse roiled global financial markets for weeks, given the size of the company and its status as a major player in the U. S. and internationally. Many questioned the U. S. government’s decision to let Lehman fail, as compared to its implicit support for Bear Stearns which was acquired by JPMorgan Chase in March 2008. Lehman’s bankruptcy led to more than $46 billion of its market value being wiped out. Its collapse also served as the means for the purchase of Merrill Lynch by Bank of America in an emergency deal that was also announced on September 15 Work Cited ttp://www. library. hbs. edu/hc/lehman/history. html http://www. investopedia. com/articles/economics/09/lehman-brothers-collapse. asp http://www. newsweek. com/2010/09/14/was-the-great-panic-of-2008-preventable. html http://business. timesonline. co. uk/tol/business/industry_sectors/banking_and_finance/article4761892. ece http://www. time. com/time/business/article/0,8599,1923197,00. html http://www. foxbusiness. com/markets/2010/10/07/sec-focusing-lehmans-approval-repo-use/ http://www. washingtonpost. com/wp-dyn/content/article/2010/03/17/AR2010031704047. html