IntroductionOn September 15, 2008, Lehman Brothers, one of the mostinfluential players of Wall Street, filled for bankruptcy.
At the time LehmanBrothers had numerous divisions such as investment banking, capital marketsresearch, sales & trading, private banking, private equity and investmentmanagement. It was the oldest and fourth largest investment bank in the USA,holding assets of $639 billion and $619 billion debt. Lehman’s bankruptcy wascaused due to the bank’s high vulnerability to the subprime mortgage market andthe US financial crisis of 2008 and was the largest in history, leading 25.000people to unemployment.An important fact in Lehman’s history is that it managed tosurvive many crises, including the American Civil War, the Great Depression,two World Wars, the Oil crisis, the dot-com bubble and the destruction of theWorld Trade Center by the 9/11 attack. HistoryHenry Lehman immigrated from Germany to Montgomery, Alabama in1844 and he established a small retail shop serving the local cotton market. Henry’stwo younger brothers, Emanuel and Mayer, joined the business by 1850 and renamedit to Lehman Brothers.
Henry Lehman suddenly died in 1855 at the age of 33leaving Emanuel and Mayer running the business. Their time running the companywas characterized by their policy that only members of the Lehman family were allowedas partners.Very soon, apart from retail commerce, Lehman Brothers alsoentered the commodity market, trading cotton and placed itself on the top ofthe 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 toexpand to other markets like coffee and petroleum commerce.Lehman’s first experience in the financial world was, due toits origin, its nomination to sell Alabama’s state bonds and also to manage thestate’s financial transactions. This was a difficult task because of the lowcredit rating of southern states at the time.The rapid industrialization of the USA, thanks to therailway system development, created the demand for financing of American firms.Railroad bonds were made very popular and their underwriting was a commonprocedure. Following this trend, Lehman Brothers began to the sell and tradesecurities, introducing itself to investing activities under the leadership ofRobert Lehman, whose name is connected with the rapid growth of the companyduring the mid 20th century.
After this milestone, Lehman graduallystarted financing many emerging industries, including oil industry, computersand electronics and other promising areas. Exaggerating expansionAlready deep into the financial world, in 1962 Lehmancombined its forces with Salomon Brothers, Merrill Lynch and Blyth and Company,creating an association nicknamed “the fearsome four”. Following various othermergers and expansions during the 1970’s, Lehman was acquired by AmericanExpress in 1984 and became public in 1994.As the promising mortgage market was rapidly growing in theUS, Lehman could not be drawn by it.
Thus, in 1997 Lehman acquired “Aurora LoanServices”, a Colorado-based Alt-A lender and in 2000, the West Coast subprimemortgage lender “BNC Mortgage LLC”. In 2003 and 2004, it acquired three moremortgage lenders, expanding its mortgage related portfolio and becoming animportant player in the market. Indicatively, by 2003 Lehman made $18.2 billionin loans and ranked third in lending., while by 2004 this number topped $40billion. By 2006 Aurora and BNC were lending almost $50 billion per month.
At first, these decisions seemed successful with the firmreporting record profits every year from 2005 to 2007. From 2004 to 2006,Lehman’s revenues from capital markets increased by 56%, facing a higher growthrate than the other activities of the group. In 2007, Lehman presented netincome of $4.
2 billion and revenue of $19.3 billion.However, in order to finance its investments, Lehmanborrowed large amounts, significantly increasing company’s risk.
Indicatively,asset to equity ratio vastly increased from 24:1 in 2003 to 31:1 by 2007. Inaddition, 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 fallDespite that during the beginning of 2007 Lehman’s stock wasreaching at a record high of $86.18 per share, so did the subprime mortgagesdefaults, reflecting the collapse of the US housing market.
The increase ofsubprime mortgages defaults heavily affected Lehman’s stock, which faced itsbiggest one-day drop in five years on March 13, 2007. Concerns that risingdefaults would affect the company’s profitability, led Lehman to announce thenext day the reported revenues and profit for its fiscal first quarter. It isnoticeable that the CFO of Lehman Brothers stated that the risks posed byrising home delinquencies were well contained and would have little impact onthe firm’s earnings. In August 2007, following the failure of two Bear Stearnshedge 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 theseevents, Lehman remained a major player in the mortgage market, underwritingmore securities than any other company in 2007.
In September 2007, its stocktemporally rebounded, although this was not enough to save the company. The bankruptcyFor the second fiscal quarter of 2008, Lehman reportedlosses of $2.8 billion and decided to raise $6 billion in additional capital byoffering new shares. In the first half of 2008 alone, Lehman stock lost 73% ofits value. InAugust 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 managementunsuccessful efforts to close a deal a number of potential partners over thesummer, led its stock to further diminish by 77% in the first week of September2008. The financial world heavily criticized Lehman’s CEO Richard Fuld and hisintend to keep the firm independent by selling only part of its assetmanagement unit and spinning off commercial real estate assets.
The news that the Korea Development Bank withdraws itsinterest to take a stake in Lehman on September 9, the pull-out of Lehman’s fundclients, the cut of credit lines and the announcement by Moody’s for a potentialdowngrade unless Lehman should sell its majority stake reflect the critical situationof the company.Lehman’s option and time were limited with the companyholding only $1 billion in cash by September 12. Unsuccessful last-minute effortsover the weekend of Sept. 13 between Lehman, Barclays PLCand Bank of America Corp., led Lehman Brothers to file for bankruptcy on September15, 2008. This was and still is the biggest filing in history, with Lehmanholding 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 Brothers. Impact of bankruptcyLehman’s bankruptcy heavily affected the US and global economy,as the concept “too big to fail” was shaken. Investors, governments, companiesand individuals adopted more conservative economic views in respect to complexfinancial instruments as a tool of financing, changing the regulations and habitsof the economic world.Among the impact of the bankruptcy is the investors’ willingnessto keep cash instead of investing it, leading on a fund run.
Indicatively, on thesame day as the bankruptcy, AIG experienced a vast decrease on its stock priceof 61 percent. In addition, shareholders also fled from major players of the financeworld, such as Goldman Sachs and Morgan Stanley.