What Happened To Lehman Brothers Holdings

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02 Nov 2017

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Introduction 2

What happened to Lehman Brothers Holdings Inc. ? 3

Resilience and the impact on world finance 7

Conclusion 10

Reference 11

Introduction

Lehman brothers,which was founded in 1850,has been a eminent investment bank in Wall Street for decades.It operates at a wholesale level, employing 28,000 people worldwide, including 5,000 in the UK,dealing with governments, companies and other financial institutions. As used to be the fourth-largest investment bank in the United States,Lehman Brothers was a global financial services firm and a primary dealer in investment banking,investment management,buying and selling shares and fixed income assets, research and trading, private equity and private banking.Since 2000, like other investment banks,it was heavily invested in securities linked to the sub-prime mortgage market. At that time, dominate this industry was 5 investment banks: Lehman Brothers, Goldman Sachs, Merrill Lynch, Morgan Stanley and Bear Stearns

Who can believe that such a great investment bank was bankrupt overnight. Lehman brothers has run out of cash by 12th September, 2008,and then filed for bankruptcy protection on 15th in the same month.After that the entire investment banking industry has been influenced. The fall of Lehman brothers shocked the global market and led to the outbreak of the financial crisis in 2008. Then what happened to the Lehman brothers? What causes the collapse?

What happened to Lehman Brothers Holdings Inc. ?

As the financial derivatives become more and more popular in recent years, Lehman focused on the new system of mortgage. The new system has its own Securitization food chain (as shown in figure 1). ‘Lenders sold the mortgages to the investment banks, the investment banks combined thousands of mortgages and loans including car loans, student loans and credit card debt to create complex derivatives called collateralized debt obligations(CDO). The investment banks then sold the CDO to investors.’(Inside Jobe, 2010) Now when the home owners pay the mortgages, the money went to investors all around the world. The investment banks pay the rating agencies to evaluate CDOs and many of them were given a ‘AAA’ rating- the highest possible investment grade. These made CDO popular with retirement funds which could only purchase highly rated securities.

(Figure 1)

Lenders did not care any more their borrowers could repay, so they started to make risky loan. The investment bank, like Lehman brothers and Goldman Sachs did not care either, ‘the more CDOs they sold, the higher their profits,’(Inside Job, 2010)and the rating agency was been paid by investment banks had no liability if their ratings of CDOs prove wrong. This is the beginning of the disaster.

By selling CDOs, Lehman made a huge amount of profit(as shown in figure 2). But this is not enough for them. American International Group, Inc (AIG) , the world biggest insurance company, sold a huge mount of a new derivative called ‘Credit Default Swap’ (CDS) which is an insurance policy for those investors, who owns CDOs. CDS is deferent from regular insurance, speculators can also buy CDS from AIG in order to protect the CDOs they did not own.’Borrowers were needlessly placed in expensive subprime loans,and many loans were given to people who could not repay them.’(Inside Job, 2010)

We can see clearly from figure 1 the leverage rate (asset/ equity) is up to 31 to 1, in fact that the regulated to leverage rate is no more than 15 to 1. In order to create more CDOs, the heads of investment banks asked SEC to lift the leverage limits. On april 28,2004,the SEC met to consider lifting leverage limits on the investment banks, then the leverage rate is lifted up to 33 to 1. Compare with 2003,the leverage rate reach such a incredible level in 2007.(Figure 3) High leverage could magnify your returns, when interest rates are low. However, it also magnifies your losses when asset prices fall. If property prices become to move downwards, or interest rates moved upwards, this would be doomed to failure.

The other reason to explain why Lehman brothers collapse is they did not have enough liquidity to meet the need. As markets fell, other banks started pulling Lehman's lines of credit to protect their own interests . This made Lehman losing liquidity fast, and it sunk into a dangerous state.

Cliff D'Arcy (2009) said that ‘Believing that Lehman did not have enough liquidity at hand, other banks refused to trade with it. Once a bank loses market confidence, it loses everything. Being unable to trade meant that Lehman and its business ceased to exist in other banks' eyes.’

Figure 2

Figure 3

Figure 4

Resilience and the impact on world finance

After it second-quarter loss, because of Lehman Brothers’ own risk management strategy failed to detect risky, non-compliant practices and lack of feedforward behaviour. It had been set at an unhealthy state. Though the firm announced that it had increased its liquidity to an estimated $45 billion, decreased $147 billion of gross assets , reduced its exposure to real -estate mortgages by 20%, and cut the leverage down to approximately 25, these were too late.Lehman brothers shares down to 0 as it bankrupt and it is down over 95 percent from its January peak in 2008.

In fact that they made wrong decision at the beginning. They were greedy to seek immediate interest and ignored the outside world warnings. Failure in preparedness strategies ‘Neither lehman nor the federal government had done any planning for bankruptcy’(Inside Job,2010).

The reason why they didn't put decision making at the top of the priority list is because of their intended goal. From the start, they acted from a individual perspective yearning personal gain instead of thinking from the company's perspective. This crucial mistake led to the eventual destruction of LB. While reading through these articles, one might ask, what is crisis management? Crisis management is a tactic often put in place by corporations or governments in a time of disaster. It is placed to respond and recover from a major failure or accident that has a large scale. impact on the well being of the company (Derek L.Waller,2003). The company relied a significant amount of their time and capital on sub-prime mortgages as its sole source of revenue. In all honesty should have seen the outcome from the start. From a investment financial institution like LB, the risk of sub-prime mortgage should have been obvious to them. In a market where risk is a major factor for success and revenue, LB could have avoided this disaster by backtracking out at the appropriate time. Any changes to the market is an obvious sign that a shift is incoming. The best way to defend against this type of crisis is to set a liquidity and leverage cap. The cap insures that the company would not over step the boundary and take on excessive risk.

There are several ways to help us when doing a crisis management, like the SWOT analysis, which could make sense on crisis preparedness. As we take a look at an overview of the diversified sectors of Lehman Brothers, we can characterize them into strengths and weaknesses. One of the first strength we need to analyze is the fact that revenues are coming from a wide range of operations. Revenues are coming from different part of the world from diverse categories of operations. Strength for Lehman Brothers is the R&D-like sector of the company. Lehman Brothers provide "expert fundamental, quantitative and strategic research in the field of fixed income and equity market." Equity research for Lehman Brothers is definitely a important aspect and spreads over their upstream and downstream sectors. As far as weaknesses, there are also two important ones that stand out. The first of these weaknesses is legal issues. The company has gone under multiple attacks and complaints filed on behalf of different clients. In June of 2006, 40 shareholders of Nova Star Financials jointly filed an allegation against Lehman Brothers on disputable charges of illegal stock market manipulation. Because of these direct attacks, the company has taken its toll with their brand image.

Looking from an external perspective we can also relate strengths and weaknesses by the company. In term of strengths, we can look at the company's acquisition history. In the year 2007, Lehman Brothers completed the acquisition of EAGLE ENERGY PARTNERS. Lehman Brother expands the company in various geographical locations around the world that show potential growth opportunities. Another strength is its rapid growth in asset management industries. The industry as a whole grew by 7.8% in 2006 and a compounded annual growth rate of 11.3% from 2002 to 2006. The lucrative industry is giving Lehman Brothers a competitive edge. The third and final external related strength is its new trading opportunities with foreign exchange indices. These indices are a set of rules that keeps a track of performances of G10 currencies against the US dollar. These important data are published on Lehman live client websites and can be tracked to see the currency performance. Again, with strength there are always certain negative aspects. One of these negative aspect for the Lehman Brothers is that their residential mortgage Business taking a dip during that time period. According to recent data, the decline continuously decreased from 2.1 million in the first quarter of 2006 to 1.5 in the first quarter of 2007. The dramatic dip affected the business of Lehman Brothers in some unforeseeable ways.

Lehman’s failures cause the collapse of commercial paper market wich many companies depend on to pay for their operating expenses like salaries. This led to a large mount of employees had been layed-off. A big global recession is on the way. The unemployment rate quickly rose as 10% in both the US and Europe. Chinese manufacturers overseas sale decreased since the US residents did not have enough separate money on consuming. It did shocked the global economy in short terms. ’In the long run I continue to believe that investment banking will be a very profitable business" said Philip Augar (2010),Former investment banker and author. In fact, ‘after enormous losses in 2008, most of the world's leading investment banks made big profits again in 2009.’(BBC NEWS, 2010)

Conclusion

It failed simply because it took on too much risk in a booming market.

To sum up the above analysis, although there were many causes for the Lehman Brothers collapse such as lack of liquidity and high rate of leverage. Those could have been avoided if Lehman Brothers had paid attention towards their own problems. To avoid a bankruptcy in the future, certain restriction should be set up so that the leverage ratio remains at a safety level.There should be a limit according to the size of the banks which have a large impact on the financial world. It is crucial for firms to pay close attention to crisis management. It is an absolute for international corporations like the Lehman Brothers. One of the ways a company could accomplish this is through SWOT analysis to look at the different sectors within the company and see where are the high risk factors. It is absolutely critical in a high risk market such as the one I've described in this paper. It is also a decisive role for companies to increase their resilience capacity when dealing with market changes. when dealing with disturbance from global and domestic market, a company would have enough resources to come out on-top.Apart from all this there is an urgent need of a global controlling authority which should look after the stability of the global system. And if this would have been done on time then the effects of Lehman Brothers bankruptcy could have been limited.



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