Case Analysis : Lehman Brothers

A Colossal Failure of Common Sense was one of many books to be published in the aftermath of the Financial Crisis of 2007. After seeing the global economy stall in the face of massive losses in word financial markets, many Americans sought to better understand the crisis and its causes. This book, written from the perspective of a financial market insider, provides a glimpse into the world of global finance and also seeks to explain how the players in this world were involved in the crisis. In the words of the author Lawrence McDonald, “My objective in writing A Colossal Failure of Common Sense was twofold. First, to provide … a close-up, inside view of how markets really work…..And, second, to give… as crystal clear an explanation as possible about the real reasons why the legendary Lehman Brothers met with such a swift end”1. By writing about his personal experience at Lehman Brothers and recounting stories from within the famous investment banking firm, Mr. McDonald largely succeeds at his first goal. However, the elements of personal biography and the chronological order of the book make it difficult for the reader to fully appreciate all of the varied causes of the financial crash. I believe that the main value of reading this book is in understanding these causes, with Lehman Brothers acting as a microcosm of the greater financial universe. As such, in this review I have isolated elements from Mr. McDonald’s book which highlight how the crisis

Lewis Glucksman who scrapped his way up through Lehman's unprestigious but increasingly profitable stock-and bond trading department, was able to take control of the firm after a bitter power struggle against its former CEO, Peter Peterson. Glucksman was victorious in the end as he proved himself to be an indispensible part of Lehman’s operations.

For this pre-crisis intelligence project, I examined JPMorgan Chase and the banking and financial services industry to identify warning signs of crises that could seriously impact its business. The banking industry is bouncing back after the financial crisis of 2007-2008. However, recent drop in oil prices, developments in the Chinese economy, and promises made by a presidential candidate, are all key potential risk factors for JPMorgan Chase.

The definitive effects of the securitization of subprime mortgages on the financial crisis accentuated the prominent failure of institutions to follow proper risk management and investment guidelines. Financial institutions, failed to aligned company goals with risk management practices and instead fueled greed by issuing monetary incentives based on the quantity of subprime loans issued or securities sold, rather than concentrate on the quality. Investment banks such as Lehman Brother, Bear Stearns and Merrill Lynch all participated in risky investment practices, which compounded the institutions risk and involvement in the securities. In 2006 Merrill Lynch doubled their endeavors in mortgaged backed securities and by the

After destroying an estimated $19.2 trillion of household wealth, costing an estimated 8.8 million jobs domestically, and preventing unknown trillions of dollars in productivity, ethics in the capital markets industry has become a topic of great debate (U.S. Department of the Treasury, 2012). This section will look at the events and behaviors that contributed to the 2008 Financial Crisis and attempt to answer the question: Who is to blame for the Financial Crisis?

When the situation in the book is examined, the concepts that came to mind were the Fraud Triangle

In 2007, the bursting of the housing bubble of the U.S was at its peak. The bursting resulted in plummeting of security values tied to the U.S. real estate pricing. The complex interplay of policies that provided easier lending of loans, overpricing of sub-prime mortgages, on a theoretical basis that the prices would continue to increase, and inadequate capital holdings from insurance companies and banks to back their financial commitments contributed to the bursting of the bubble (Boatright, 2010). During 2008, securities suffered huge losses due to

Countrywide Financial got its start back in the late 1960’s by Co-Founder Angelo Mozilo. The company was one the largest lenders in the US, specializing in low-income homeowner mortgages. With the business doing exceptionally well in 1992, Countrywide decided to create a program called “House America”, which qualified more potential home buyers to establish loans. Because of their success, Countrywide was delivering up to 23,000 percent return to their investors, making them a considerable company to invest with. However with great success there will be downfalls. “Countrywide’s Angelo Mozilo was blind to the risky mortgages that eventually wound his firm and contributes to the global financial crisis” (Olster, 2010). Because of Countrywide’s

On September 10, 2008, Lehman Brothers announced the lowest decline as the shares dropped to 45%. It left the market value at $5.4 billion after the Korea Development Bank rejected to make an investment deal that could rescue Lehman. The company would seek capital from other investors in order to recover their financial situation. These efforts faltered and the situation grew more severe, even after the US government had already saved the Bear Stearns and Fannie Mae and Freddie Mac. Though it is less likely that the US government will keep Lehman's bailout, there should be a resolution from the Federal Reserve System to bolster Lehman’s finance so as to prevent the US economic declination.

Many financial entities experienced financial trouble as the housing bubble burst and mortgage-backed securities lost significant value, specifically the investment bank Lehman Brothers. The Lehman Brothers filed for Bankruptcy in September 2008. Before filing for bankruptcy and years prior to the housing bubble burst, the Lehman Brothers’ balance sheet was growing rapidly during the beginning of 2006. This was mainly due to the many long-term investments financed through short-term borrowing. These assets included a significant amount of residential and commercial mortgage-backed securities, the same type of securities that precipitated the 2008 financial crisis. Although the market for mortgage-backed securities was showing signs of trouble during 2007, Lehman continued its aggressive growth expecting to benefit from the countercyclical crisis (Hines, Kreuze, and Langsam 2011). During this time, Lehman took on more risk, ignoring its own risk models, while also excluding some assets from their risk analyses. These assets became a lot more difficult to sell without incurring significant losses. Lehman was able to maintain acceptable leverage ratios through questionable accounting methods, which allowed Lehman to paint a perfect picture of its leverage ratios and to allegedly mislead investors.

The Lehman Brothers scandal is what many consider to be the catalyst that started the financial meltdown of 2008. This paper is meant to look at what took place during the start of the meltdown and what caused Lehman to fail. Who was involved? What caused one of the largest banking institutions in history to fail? What could have been done differently? These are a few of the questions I’d like to address in the next few pages.

For more than a century, the Lehman Brothers have played an important part in the financial and commercial history of the United States. Throughout history, the Lehman brothers gave growth to American industry and technology as well as the establishment of the Modern Corporation we all know today. With the growth of the American economy, there were always challenges such as the great depression or both the world wars. The company managed to survive all of these challenges but when the housing bubble began to burst in 2007; its risky subprime mortgages would force them to into bankruptcy. To understand why a company of this magnitude would take this risk, it is imperative that the history of this mighty empire be examined. Throughout history, the company diversified its investments which included cotton; coffee and petroleum which in turn helped them survive major conflicts such as the Civil war. Lehman Brother’s decision to leave its long practice of smart investments, by participating in the mortgage banking business through the use of Federal Reserved-backed advances, and subprime mortgages; led to the failure of the company with an impact on the stock market not since September 11th.

In the second half of 2007, the banking industry and financial market showed signs of considerable stress by raising the default rate of mortgage and the decline in the value of residential mortgage-backed securities. This had led to a re-pricing of many debt instruments. By the end of 2007, Citigroup declared that the fair value of its U.S. sub-prime related direct exposure could decline by 20%. This affected Citigroup’s financial results and would incur further losses in the future.

Until 2007, Lehman Brothers has generated a significant portion of its revenue through the issuance of mortgage-backed and asset-backed securities. Lehman Brothers had grown increasingly reliant on its fixed income trading and underwriting division which served as the primary engine for its strong growth throughout the first half of the decade as shown in Exhibit 1 (Stowell, 2010). When the collapse of the U.S. subprime mortgage industry started, it result in credit crisis and the mortgage default rates began to rise and the demand for these securities began to disappear. Lehman Brothers was left with billions of dollars of rapidly depreciating securities on its balance sheet,

On 6 May 1982 Hungary became a member of the International Monetary Fund (IMF, 2016) and shortly after on 7 July 1982 the World Bank as well (World Bank, 2016).