20
Lehman Brothers
Founded by Henry Lehman and his two brothers in 1850
Core business: buying and selling shares
buying and selling fixed income assets
Merger with American Express (1969–94)
In 1994 it spun off from American Express
In 2003, aggressively re-entered the asset-management business
4th largest U.S. investment bank at time of collapse
25,000 employees worldwide
IPM 2011-16, IBH Group 10 A, IIM INDORE
Lehman Brothers
Survived financial shocks: Railroad bankruptcy – 1800’s
Great Depression – 1930
Two world wars
Capital shortage – 1944
Russian debt default – 1998
Securitized $146 billion of mortgages in 2006
Reported record profits from 2005 to 2007
In 2007, Income: $4.2 billion, Revenue: $19.3 billion
Stock reached $86.18 in Feb 2007
Largest victim of financial crisis
IPM 2011-16, IBH Group 10 A, IIM INDORE
IPM 2011-16, IBH Group 10 A, IIM INDORE
Taking Risk
Distributing Widely
System Derisked
Build up Confidence of Market
RewardsModern Financial Model
IPM 2011-16, IBH Group 10 A, IIM INDORE
Housing Bubble
Home ownership
Government supported: Good for America
Good for families
Good for economy
House prices raised steadily after WWII
Rocketed after 9/11, when interest rates were slashed
Boom fuelled by loans with tempting int. rates to more risky clients
Subprime mortgage scramble was born
IPM 2011-16, IBH Group 10 A, IIM INDORE
Crisis of credit
Leverage
Sub-prime Mortgages: No down payments
No proof of income
No documents
Collateralised Debt Obligations (CDO)
Credit default swaps
Frozen credit markets
IPM 2011-16, IBH Group 10 A, IIM INDORE
Economic Meltdown
IPM 2011-16, IBH Group 10 A, IIM INDORE
Homeowners
Mortgages
Houses
Investment Banks
Institutions(Pension Funds, Insurance
companies, Sovereign Funds, Mutual Funds)
Money
Investors
Economic Meltdown
IPM 2011-16, IBH Group 10 A, IIM INDORE
Family Broker
Mortgage Mortgage Lender
Investment Bank
Investors
CDO(Credit Default
Swap)
Family
Family
Family
Family
Family
Family
Family
Family
Economic Meltdown
IPM 2011-16, IBH Group 10 A, IIM INDORE
Credit Rating Agency
Safe
Okay
Risky
Credit Default Swap
Money
CDO
4% return
7% return
10% return
AAA
BBB
Unrated
Economic Meltdown
Family Broker
Sub-PrimeMortgage
Mortgage Lender
Investment Bank
Investors
CDO(Credit Default
Swap)
House
House
House
House
House
House
House
House
Bankrupt
BankruptBankrupt
IPM 2011-16, IBH Group 10 A, IIM INDORE
Causes for the fall
Rush into subprime mortgage market
Alt-A loans (without full documentation)
NINJA Mortgages (No Income No Job or Assets) : More risky clients
Relyed solely on appreciation of housing prices
Misjudged impact of rising home delinquencies on firm’s earnings
Didn’t trim its massive mortgage portfolio during temporary rebound
High degree of leverage
Spike in credit default swaps
IPM 2011-16, IBH Group 10 A, IIM INDORE
Causes for the fall
Too late in its measures
Balance sheet manipulations (Repo 105)
Inability to predict future government actions, inconsistent government policy
Korea Development Bank deal dashed
Federal government went against bailout
IPM 2011-16, IBH Group 10 A, IIM INDORE
Its effect
Contributed to depression
Mortgages dried up
Stock markets tumbled
Catalyst for purchase of Merrill Lynch
Greatly intensified the 2008 crisis
Erosion of $10 trillion from global equity market
Governments around the world came together to prevent financial catastrophe
Central banks resorted to provide liquidity support to financial institutions
IPM 2011-16, IBH Group 10 A, IIM INDORE
Its effect
People in power were profited
Central banks resorted to rate cuts to aid world economy
National Stabilization Act, 2008
Bailout packages, Government guarantees and outright nationalisation
Taught that confidence of financial market, once shattered, can’t be quickly restored
Protective laws placed
IPM 2011-16, IBH Group 10 A, IIM INDORE
Lehman could have saved itself if
Have been more conservative in its borrowing
Borrowed money for longer periods of time (paying higher interest)
Borrowed less money at a time (less "leverage")
Try for additional time, try to operate on its own
Vote down proposal, Sell off part of business to possible suitors
IPM 2011-16, IBH Group 10 A, IIM INDORE
• Loan out $17Bn capital
• Provide breathing space for operations
JP MORGAN CHASE
• Relaxing collateral norms
• Revenue charge for operation will be reduced
FEDERAL RESERVE
• Sceptical about bad assets on balance sheet of Lehman
• Had an option to acquire Meryill Lynch BANK OF AMERICA
• UK regulators concerned of systemic risk
• Uncertainty in its own operationsBARCLAYS
• Asian financial stability was bad
• Only interested to purchase firm’s Asian assets
KOREAN DEVELOPMENT BANK
• Should consider infusing capital
• Criticism from public.FEDERAL RESERVE
Alternatives
IPM 2011-16, IBH Group 10 A, IIM INDORE
Conclusion
It is understood the many firms failed to understand the inherent risks associated with various instruments viz, Mortgage backed securities and had to pay heavily.
Few firms couldn’t limit their balance sheet exposure to these dicey instruments. There was no proper mechanism for dealing with balance sheet consolidation.
Early signs liquidity risks have surfaced which have called for the need of emergency lending mechanism.
The management of better performing firms were able to enforce active controls over their balance sheet and liquidity
Need for strong risk management system is untenable, which could have averted this crisis.
IPM 2011-16, IBH Group 10 A, IIM INDORE
References
The collapse of Lehman Brothers. Investopedia
Norbert J. Michel. Lehman Brothers Bankruptcy and the Financial Crisis: Lessons Learned
Lehman Brothers’ Bankruptcy: PWC
Lehman Brothers’ rise and fall: From hero to dust :Pranvera Latifi (Epoka University, Albania)
Lehman Brothers - The big failure: Umar Gurkhanov
The Global Financial Crisis: Causes and Consequences: Franklin Allen
The global crisis Causes, responses and challenges: ILO
IPM 2011-16, IBH Group 10 A, IIM INDORE
Group 10 A:
Gaurav SainiGaurav JharwalGupta Taru Dilip
IPM 2011-16, IBH Group 10 A, IIM INDORE
