The Fourth Largest Investment Bank Accounting Essay

Before its prostration, Lehman Brothers was the 4th largest investing bank in the US. Founded by three German immigrants in 1850, the investing bank experienced judicious growing over its 158-year history, climaxing in its record public presentation in 2007 when it recorded its highest of all time net incomes, its portion monetary value hit an unprecedented value of $ 86, its market capitalisation breached the $ 60 billion grade. This was non to be durable nevertheless, as the house, overburdened by debts amounting to $ 619 billion, filed for Chapter 11 bankruptcy protection on Sep 15 2008 ( Economic Times, 2010 ) .

This paper takes the place that while the bomber premier mortgage crisis contributed in big portion to the prostration of this one time venerable bank, it is its fiscal policies ( defined by a really aggressive purchase and inordinate funding of debt by short-run adoption ) that delivered the ultimate decease blow.

It traces the beginning and growing of the bank, evaluates its place relation to other participants in the US and planetary markets before its prostration, and analyses its fiscal policy and the function such policies played in the bank ‘s prostration. Finally, it evaluates the impact of the bank ‘s prostration and makes recommendations which can assist prevent the return of such events in future.

2. History:

a ) History and Rise:

Lehman Brothers traced its roots to a dry goods shop started by Henry Lehman, a German immigrant in 1844. In 1850, Henry was joined by his two brothers Emanuel and Mayer, with whom they founded Lehman Brothers ( Investopedia, 2010 ) .

Initially, Lehman Brothers traded in cotton, a major hard currency harvest at the clip, accepting it for the colony of histories from husbandmans. Buoyed by the passage of the American economic system from an agricultural economic system to an industrial one and the rapid enlargement of the American economic system in the latter half of the nineteenth century, the house would venture into the purchase and sale of securities, merchandiser banking, and into fiscal consultative. In 1887, Lehman Brothers became members of the New York Stock Exchange, holding shifted base to New York in 1858 ( Economic Times, 2010 ) .

With clip, Lehman Brothers expanded internationally to run into the demands of an progressively planetary patronage. It opened an office in Paris in 1960, in London in 1972, and in Tokyo in 1973. It enhanced its international footmark by unifying with Kuhn Loeb. In 1975, it acquired Abraham and Co, but was itself acquired by Amex in 1984 and became portion of Shearson. In the 1890ss, American Express would deprive from Shearson, and the house would one time once more go known as Lehman Brothers ( Economic Times, 2010 ) .

It would go an independent company in 1994 through an initial populace offer, and its portions would get down merchandising on the New York Stock Exchange and the Pacific Stock Exchange. Lehman Brothers would open extra offices in Tel Aviv and Mumbai. It joined the S & A ; P Index and became a member of the Amsterdam Stock Exchange. Other acquisitions which the house undertook include Lincoln Capital Management ‘s fixed income concern and Neumann Burger ( Economic Times, 2010 ) .

As Lehman Brothers ‘ history illustrates, its growing has been through a combination of organic and M & A ; A schemes. The organic growing has been made possible through an accurate appraisal of the growing potency of the industries financed ( railway industry in the latter half of the 19th centuries, Television and wireless in the 1930 ‘s, the computing machine industry, and the biotech industry ) . Additionally, the house ‘s growing has been underscored by invention of fiscal solutions ( such as private arrangements in the aftermath of the recognition crunch following instantly after the stock market clang of 1929 and the underwriting of corporate debt over the cyberspace ) . This advanced run is possibly what inspired Lehman Brothers to acquire to a great extent involved in securitization and go a leader in the sub-prime mortgage financing market, finally taking to its prostration on September 15th 2008 ( Swedberg, 2009 ) .

3. Analysis:

a ) Position in the place and international markets:

Before it filed for bankruptcy protection on 15th September 2008, Lehman Brothers was the 4th largest investing bank in the US, behind Merrill Lynch, Goldman Sachs, and Morgan Stanley ( CNN Money 2008a, 2008b, 2008c ) .

Among other awards, Lehman Brothers had been ranked first in Barron ‘s 500 one-year study in corporate public presentation for the prima houses in the US and Canada. It had besides been named the “ Most Admired Securities Firm ” by Fortune in 2007, and the “ Best Investment Bank ” by Euromoney in 2005. Lehman Brothers besides boasted of the differentiation of holding handled the largest of all time M & A ; A dealing ( the $ 98 billion acquisition of ABN AMRO by a pool led by the Royal Bank of Scotland ) ( Economic Times, 2010, p.1 ) .

With some 25,000 employees merely before its prostration, it was ranked 11th among the top 50 investing Bankss in the universe in a 2000 Euromoney Poll of Polls. The top investing Bankss in the universe, as per that study, are shown in the tabular array below:

B ) Milestones ( portion monetary value ) :

The house ‘s portion monetary value rose steadily from the clip the bank was listed in 1994 to make its extremum in of $ 86.18 in February 2007, before immersing downwards to merely $ 0.22 as Lehman Brothers began its descent downwards ( Yahoo Finance, 2010 ) . The motion in the house ‘s portion monetary value since its listing in 1994 is depicted in the graph below:

degree Celsius ) Financial Policies:

Before its prostration, Lehman maintained a really high purchase ( plus to equity ratio ) . It besides placed a really strong trust on short term borrowing to finance debts. The house ‘s fiscal statements in the period taking up to its death, from which its purchase and short term borrowing places can be ascertained, are shown below:

vitamin D ) Causes of Lehman ‘s Collapse:

The prostration of Lehman Brothers has been attributed to the bomber premier mortgage crisis, of which it was the market leader in 2005 and 2006. The subprime mortgage crisis resulted when Bankss and other fiscal establishments, spurred on by a drawn-out low-interest government and lifting house monetary values made out loans to the sub premier section of the market. Zingales ( 2008, p.3 ) writes that for illustration, “ From March 1997 to June 2006 the Case and Shiller national index of existent estate monetary values increased every month, except for two. During the same period the mean addition in existent estate monetary values was 12.4 % per twelvemonth. ” This addition was driven by a sustained upward pacing in the monetary value of existent estate. Correspondingly, the mean T-bill rate between 2002 and 2004 stood at merely 1.3 % , a blunt contrast to the 6.1 % norm for the predating 40 old ages. These are depicted in the graphs below:

This environment of lifting house monetary values and low involvement rates created the semblance among many prospective and existent place proprietors that the upward rise in place monetary values would go on for a long clip to come. With advanced funding tools such as interest-only amortisation, negative amortisation and mortgage options, many sub premier mortgage borrowers were encouraged to take up loans which they were badly equipped to pay ( Zingales, 2008 ) .

The borrowers expected that with lifting place values and low involvement rates, they would be able to refinance their place purchases at low rates and take out their equity for usage in other purchases. When the existent estate bubble explosion, against all outlooks, Lehman Brothers was left keeping one million millions of assets in the signifier of bad debts ( Zingales, 2008 ) .

However, while the bomber premier mortgage crisis played a really instrumental function in the prostration of Lehman Brothers, Lehman Brothers ‘ ain fiscal policies accelerated its death. As shown in the fiscal statements, Lehman Brothers maintained a really aggressive purchase ( which hovered at around 30:1 in 2007 ) . Einhorn ( 2008 ) estimated the house ‘s purchase to be 44:1. What this fundamentally means is that for every $ 100 it held as loans, it had merely $ 3.3 as equity. Therefore, if the value of its assets declined by merely 3.3 % , its full equity would be wiped out and Lehman would go technically belly-up. Indeed, by the clip Lehman Brothers was registering for bankruptcy, it had debts deserving $ 619 billion, and assets worth merely $ 639 billion, doing it the largest bankruptcy filing in the history of the US ( Investopedia, 2010 ) .

Looked at against the background of the bomber premier mortgage crisis where the value of the securitized assets was worsening, this policy subjected the bank to a batch of instability. The job was nevertheless made much worse by the bank ‘s inordinate usage of short term debt to finance its assets. As illustrated above, more than 50 % of the bank ‘s assets were financed by short term debt. While this can work really good for the house in a low-interest rate government, it exposes the house to a really high hazard of sing tallies on its sedimentations. Should the market lose assurance in the bank ( due to for illustration rumours about the bank ‘s solvency ) , many short term loaners would decline to regenerate their loaning and many of them would hotfoot to retreat their financess, farther declining the liquidness job ( Zingales, 2008 ) .

This was the instance with Lehman Brothers, where its stocks plunged downwards as investors became jittery about its chances, monolithic credit-default barters on its debts took topographic point, hedge fund clients withdrew, and short-run creditors cut their recognition lines. By the last hebdomad taking to its turn uping up, the bank had merely $ 1 billion hard currency left ( Investopedia, 2010 ) .

At first, Fuld ( Lehman ‘s CEO ) was apathetic to suggestions that he acquire a purchaser for the troubled investing bank ( rejecting for illustration offers from Warren Buffet, among others ) ( Story and White, 2008 ) , and believing that by puting in commercial existent estate and assets outside the US instead than in the worsening lodging market Lehman would be able to shore up its fiscal place. This worsened instead than helped Lehman ‘s place and as 2008 progressed, the bank ‘s fiscal status worsened. When the gravitation of the state of affairs sunk and Fuld began nearing prospective suers with a position of either raising extra capital or acquiring a purchaser ( Citigroup, Korea Development Bank, and Barclays ) , the possible suers chickened out after taking a expression as the bank ‘s books.

vitamin E ) Effectss of Lehman ‘s Collapse:

The prostration of Lehman Brothers had a immense impact:

  • It caused a rise in the cost of sing hard currency invested in debris bonds ( from $ 4.50 to over $ 6 for every $ 100 invested ) ( Zingales, 2008 ) .
  • It brought about a batch of uncertainness in the money markets and triggered a dramatic loss of assurance in the fiscal sector ( Zingales, 2008 ) as evidenced by the 500 point bead ( a 4.4 % bead ) of the Dow Jones, and the dramatic bead in the value of the portion monetary values of other investing Bankss. As a consequence of the loss in assurance, jittery investors withdrew close to $ 400 billion. The assurance crisis besides affected interbank adoption ( evidenced by the hiking in the LIBER-OIS spread ) , and froze the corporate paper and repo markets, while occasioning a recognition crunch that paralyzed the consumer and industrial adoption ( Swedberg, 2009 ) .
  • It caused monolithic losingss in investor financess around the universe. For illustration, Nipponese Bankss and insurance houses with close ties to the fallen bank announced losingss deserving $ 2.4 billion while the Royal Bank of Scotland announced losingss of up $ 1.8 billion. Pension financess and local authoritiess in the US lost close to $ 1.7bn, while the Sachsen Bank in Germany lost up to half a billion euros ( Swedberg, 2009 ) .
  • It occasioned a dramatic hiking in the monetary value of CDS ‘s ( Swedberg, 2009 ) as shown in the graph below:
  • It has led to monolithic consolidation in the investing banking sector. Consequently, the staying few investing Bankss are likely to exert tremendous power over other participants such as recognition evaluation bureaus to the farther hurt of the fiscal sector and the consumer ( Swedberg, 2009 ) .

4. Decision:

The prostration of Lehman Brothers triggered a monolithic loss of assurance in the US fiscal industry, caused a loss of one million millions of dollars of investor financess, a rise in the cost of sing hard currency invested in debris bonds, lifting CDSs monetary values, and widespread loss of employment for Lehman staff. It besides hit hard the repo and corporate paper markets, and led to a stultifying recognition crunch.

While the subprime mortgage crisis played a function in the prostration of Lehman Brothers, Lehman Brothers ‘ fiscal policy of keeping an aggressive purchase and of inordinate usage of short term borrowing to finance debts accelerated the house ‘s descent into bankruptcy.

To debar similar happenings, several things need to be done:

  • Proper inadvertence of the investing Bankss needs to be carried out. For illustration, while Bankss are non allowed to hold a purchase ratio of more than 15:1, Lehman ‘s purchase stood at 30:1, thanks to the SEC loosen uping preexistent purchase bounds for the large five investing Bankss in 2004 and which resulted in increased liquidness among the Bankss and worsened Lehman ‘s place. This regulation needs to be revised.
  • Increased watchfulness by the inadvertence governments would besides assist debar a state of affairs, such as the 1 that prevailed, when loaning regulations were relaxed in order to suit sub premier borrowers, and where delusory patterns such as the usage of teaser rates were used.
  • The Federal Housing Enterprises Financial Safety and Soundness Act of 1992, which compelled Fannie Mae and Freddie Mac to make hyperbolic demand for securitization and fuelled the bomber premier mortgage crisis demands to be revised.
  • Changes to the just value accounting method which allow for easier rating of mortgage-backed securities utilizing the attacks provided for under FAS 157 demand to be made.


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