On September 15, 2008, Lehman Brothers, one of the most
influential players of Wall Street, filled for bankruptcy. At the time, Lehman
Brothers was active in numerous activities of the banking industry and was the
oldest and fourth largest investment bank in the USA. Upon collapse, it was
holding assets of $639 billion and $619 billion debt. Lehman’s failure was
caused due to the bank’s high vulnerability to the subprime mortgage market and
the US financial crisis of 2008 and was the largest in history, leading 25.000
people to unemployment.
An important fact in Lehman’s history is that it managed to
survive many crises, including the American Civil War, the Great Depression,
two World Wars, the Oil crisis, the dot-com bubble and the destruction of the
World Trade Center by the 9/11 attack.
Henry Lehman immigrated from Germany to Montgomery, Alabama in
1844 and he established a small retail shop serving the local cotton market. Henry’s
two younger brothers, Emanuel and Mayer, joined the business by 1850 and renamed
it to Lehman Brothers. Henry Lehman suddenly died in 1855 at the age of 33 leaving
Emanuel and Mayer running the business. Their time running the company was
characterized by their policy that only members of the Lehman family were allowed
Very soon, apart from retail commerce, Lehman Brothers also
entered the commodity market, trading cotton and placed itself on the top of
the most influential players of the market. Dominating the southern US market,
it soon expanded to New York, a decision to be later proven crucial for the
company, as the southern operation were vastly affected by the American Civil
War. Nevertheless, after the War the company managed not only to grow but also
to expand to other markets like coffee and petroleum commerce.
Lehman’s first experience in the financial world was, due to
its origin, its nomination to sell Alabama’s state bonds and also to manage the
state’s financial transactions. This was a difficult task because of the low
credit rating of southern states at the time.
The rapid industrialization of the USA, thanks to the
railway system development, created the demand for financing of American firms.
Railroad bonds were made very popular and their underwriting was a common
procedure. Following this trend, Lehman Brothers began to the sell and trade
securities, introducing itself to investing activities under the leadership of
Robert Lehman, whose name is connected with the rapid growth of the company
during the mid 20th century. After this milestone, Lehman gradually
started financing many emerging industries, including oil industry, computers
and electronics and other promising areas.
Already deep into the financial world, in 1962 Lehman
combined its forces with Salomon Brothers, Merrill Lynch and Blyth and Company,
creating an association nicknamed “the fearsome four”. Following various other
mergers and expansions during the 1970’s, Lehman was acquired by American
Express in 1984 and became public in 1994.
As the promising mortgage market was rapidly growing in the
US, Lehman could not be drawn by it. Thus, in 1997 Lehman acquired “Aurora Loan
Services”, a Colorado-based Alt-A lender and in 2000, the West Coast subprime
mortgage lender “BNC Mortgage LLC”. In 2003 and 2004, it acquired three more
mortgage lenders, expanding its mortgage related portfolio and becoming an
important player in the market. Indicatively, by 2003 Lehman made $18.2 billion
in loans and ranked third in lending., while by 2004 this number topped $40
billion. By 2006 Aurora and BNC were lending almost $50 billion per month.
At first, these decisions seemed successful with the firm
reporting record profits every year from 2005 to 2007. From 2004 to 2006,
Lehman’s revenues from capital markets increased by 56%, facing a higher growth
rate than the other activities of the group. In 2007, Lehman presented net
income of $4.2 billion and revenue of $19.3 billion.
However, in order to finance its investments, Lehman
borrowed large amounts, significantly increasing company’s risk. Indicatively,
asset to equity ratio vastly increased from 24:1 in 2003 to 31:1 by 2007. In
addition, with the indications of the housing bubble already visible from 2004,
Lehman’s aggressive expansion made it highly vulnerable to external factors,
finally leading to the imminent bankruptcy, as will be presented later.
(Not) handling the fall
Despite that during the beginning of 2007 Lehman’s stock was
reaching at a record high of $86.18 per share, so did the subprime mortgages
defaults, reflecting the collapse of the US housing market. The increase of
subprime mortgages defaults heavily affected Lehman’s stock, which faced its
biggest one-day drop in five years on March 13, 2007. Concerns that rising
defaults would affect the company’s profitability, led Lehman to announce the
next day the reported revenues and profit for its fiscal first quarter. It is
noticeable that the CFO of Lehman Brothers stated that the risks posed by
rising home delinquencies were well contained and would have little impact on
the firm’s earnings.
In August 2007, following the failure of two Bear Stearns
hedge funds, Lehman’s stock price further sharply declined. Consequently,
Lehman decided to close BNC Mortgage, eliminating 2,500 jobs in 23 locations.
Moreover, Lehman shut down Alt-A lender Aurora in three states. Despite these
events, Lehman remained a major player in the mortgage market, underwriting
more securities than any other company in 2007. In September 2007, its stock
temporally rebounded, although this was not enough to save the company.
For the second fiscal quarter of 2008, Lehman reported
losses of $2.8 billion and decided to raise $6 billion in additional capital by
offering new shares. In the first half of 2008 alone, Lehman stock lost 73% of
its value. In
August 2008, Lehman reported that it intended to release 6% of its work force,
1,500 people, just ahead of its third-quarter-reporting deadline in September.
However, these measures were not enough. Lehman’s management
unsuccessful efforts to close a deal a number of potential partners over the
summer, led its stock to further diminish by 77% in the first week of September
2008. The financial world heavily criticized Lehman’s CEO Richard Fuld and his
intend to keep the firm independent by selling only part of its asset
management unit and spinning off commercial real estate assets.
The news that the Korea Development Bank withdraws its
interest to take a stake in Lehman on September 9, the pull-out of Lehman’s fund
clients, the cut of credit lines and the announcement by Moody’s for a potential
downgrade unless Lehman should sell its majority stake reflect the critical
situation of the company.
Lehman’s option and time were limited with the company
holding only $1 billion in cash by September 12. Unsuccessful last-minute efforts
over the weekend of Sept. 13 between Lehman, Barclays PLC
and Bank of America Corp., led Lehman Brothers to file for bankruptcy on
September 15, 2008. This was and still is the biggest filing in history, with
Lehman holding assets of $639 billion and $619 billion debt. Finally, on September
16, Barclays announces a $1.37 deal to acquire the core business of Lehman
Impact of bankruptcy
Lehman’s bankruptcy heavily affected the US and global
economy, as the concept “too big to fail” was shaken. Investors, governments,
companies and individuals adopted more conservative economic views in respect
to complex financial instruments as a tool of financing, changing the
regulations and habits of the economic world.
Among the impact of the bankruptcy is the investors’
willingness to keep cash instead of investing it, leading on a fund run.
Indicatively, on the same day as the bankruptcy, AIG experienced a vast
decrease on its stock price of 61 percent. In addition, shareholders also fled
from major players of the finance world, such as Goldman Sachs and Morgan
Estimations of losses higher than $1 trillion of toxic assets
by American and European banks followed the bankruptcy. Furthermore, it is
linked to the Great Depression of 2008 and 2009 and Sovereign Debt Crisis in
Europe. Therefore, more rigorous regulation was adopted. More specifically, in
Europe the “Basel III” framework was proposed, while the US government
introduced the Dodd-Frank Wall Street Reform and Consumer Protection Act in
2009. They both basically enhance supervision in the financial system.
In the end, the failure of Lehman drastically affected the
following months of global economy, increasing uncertainty and lack of trust in
the financial system and the decision to let Lehman collapse is questioned by