Corporate Review

World’s Biggest Financial Crisis – Lehman Brothers’ Collapse

World's Biggest Financial Crisis - Lehman Brother's Collapse

On September 15, 2008, Lehman Brothers declared bankruptcy. Hundreds of employees, most of whom were dressed in business suits, exited the bank’s offices one by one, carrying boxes. It served as a grim reminder that nothing lasts forever, even in the realm of finance and business.

World's Biggest Financial Crisis - Lehman Brothers' Collapse
A man is surrounded by photographers after leaving the Lehman Brothers headquarters carrying a box Monday, Sept. 15, 2008 in New York. Lehman Brothers, a 158-year-old investment bank choked by the credit crisis and falling real estate values, filed for Chapter 11 bankruptcy protection from its creditors on Monday and said it was trying to sell off key business units. (CNBC)
Mary Altaffer | AP

Lehman Brothers was the fourth-largest investment bank in the United States at the time of its demise, with 25,000 workers worldwide. It has assets of $639 billion and liabilities worth $613 billion. The bank was consumed by the subprime catastrophe that spread through financial markets, costing an estimated $10 trillion in lost economic activity, and became a symbol of the excesses of the 2007-08 Financial Crisis.

History of Lehman Brothers

Lehman Brothers began as a small general business in Montgomery, Alabama, in 1844, founded by German brothers Henry, Emanuel, and Mayer Lehman. Farmers used cotton to pay for their commodities, which led to the company’s involvement in the cotton trade. Following Henry’s death, the other Lehman brothers expanded the company’s scope to include commodity trading and brokerage services.

As the US economy grew into an international powerhouse over the next few decades, the company prospered. However, Lehman has faced numerous hurdles over the years. The corporation has weathered railroad failures in the 1800s, the Great Depression, two world wars, a capital shortfall when it was spun off by American Express (AXP) in a public offering in 1994, and the Long Term Capital Management collapse and Russian debt default in 1998. 3

Despite its capacity to weather previous calamities, Lehman Brothers was brought to its knees by the collapse of the US housing market, as its foray into the subprime mortgage industry proved to be a terrible move.

The Main Offender

Many other financial institutions, including the corporation, ventured out into mortgage-backed securities and collateral debt obligations. During the housing boom in the United States, Lehman bought five mortgage lenders, including BNC Mortgage and Aurora Loan Services, which specialized in Alt-A loans, in 2003 and 2004. These loans were made to people who didn’t have all of their paperwork together.

Lehman’s acquisitions appeared to be foresightful at first. From 2004 to 2006, Lehman’s real estate sector drove a 56 percent increase in capital markets revenue. In 2006, the company securitized $146 billion in mortgages, up 10% from 2005. From 2005 to 2007, Lehman Brothers recorded record profits every year. It reported a $4.2 billion net profit on $19.3 billion in revenue in 2007.

Epic Error

Lehman’s stock price hit an all-time high of $86.18 per share in February 2007, valuing the company at about $60 billion.

However, by the first quarter of 2007, the housing market in the United States had begun to show signs of fractures. Subprime mortgage defaults have reached a seven-year high. On March 14, 2007, Lehman Brothers reported record revenues and profits for its fiscal first quarter, a day after the stock had its worst one-day plunge in five years on fears that mounting defaults would hurt the company’s profitability. Following the quarterly announcement, Lehman indicated that the risks posed by rising home delinquencies had been adequately handled and would have little influence on the company’s earnings.

Beginning of an End

World's Biggest Financial Crisis - Lehman Brothers' Collapse

With the fall of two Bear Stearns hedge funds in August 2007, the credit crisis started, and Lehman’s shares plummeted. During the same month, the business laid off 1,200 mortgage workers and shuttered its BNC division. 5 Aurora’s offices in three states were also shuttered. Even when the housing market in the United States began to correct, Lehman remained a prominent player in the mortgage sector.

Lehman Brothers issued more mortgage-backed securities than any other company in 2007, amassing a $85 billion portfolio, or four times its shareholders’ equity. Lehman’s shares rose in the fourth quarter of 2007, as global equity markets reached new highs and fixed-income asset prices temporarily recovered. However, the company did not take advantage of the opportunity to cut its huge mortgage portfolio, which turned out to be its last chance in retrospect.

Getting Ready to Fail

Lehman’s high degree of indebtedness reached 31 in 2007, and its big mortgage securities portfolio rendered it extremely vulnerable to market declines. Concerns that Lehman would be the next Wall Street business to fail after Bear Stearns’ near-collapse drove its stock down nearly 48% on March 17, 2008.

By April, confidence in the firm had returned slightly, thanks to a $4 billion preferred stock offering that was convertible into Lehman shares at a 32 percent premium to their present price.

World's Biggest Financial Crisis - Lehman Brothers' Collapse

However, the price began to fall again as hedge fund managers began to dispute Lehman’s mortgage portfolio value.

On June 7, 2008, Lehman Brothers reported a $2.8 billion second-quarter loss, its first since being split out by American Express, and said it had raised additional $6 billion from investors by June 12. 5 “The firm also said it increased its liquidity pool to an estimated $45 billion, decreased gross assets by $147 billion, reduced its exposure to residential and commercial mortgages by 20%, and reduced leverage from a factor of 32 to around 25”.

It was already too late !!

These actions were thought to be too little, too late. Lehman’s management made fruitless approaches to a number of possible partners over the summer. Investors questioned CEO Richard Fuld’s strategy to maintain the company independent by selling part of its asset management unit and spinning off commercial real estate holdings in the first week of September 2008, amid plunging equities markets worldwide. On September 9, hopes of the Korea Development Bank taking a stake in Lehman were crushed when the state-owned South Korean bank put talks on pause. 

The terrible announcement caused a 45 percent decrease in Lehman’s stock, as well as a 66 percent surge in credit-default swaps on the company’s debt. 8 Hedge fund clients began to leave the company, followed by short-term creditors. The dismal results of Lehman’s fiscal third-quarter report on September 10 highlighted the company’s precarious financial state.

The company launched a significant strategic corporate reorganization initiative after suffering a $3.9 billion loss, which included a $5.6 billion write-down. Moody’s Investor Service also indicated that it was assessing Lehman’s credit ratings and that the only option to avoid a downgrading would be for Lehman to sell a majority ownership to a strategic partner. As a result of these occurrences, the stock had plummeted another 42% by September 11.

Lehman was soon running out of time, with only $1 billion in cash available by the end of the week. Over the weekend of September 13, Lehman Brothers, Barclays, and Bank of America (BAC) attempted a last-ditch takeover of the former, but were unsuccessful. Lehman Brothers filed for bankruptcy on Monday, September 15, causing the stock to drop 93% from its previous closing on September 12.

What happened to them?

Richard Fuld is the founder and CEO of Matrix Private Capital Group, which he started in 2016. Assets for high-net-worth individuals, family offices, and institutions are managed by the firm. He allegedly sold a New York City condo for $25.9 million and a collection of drawings for $13.5 million.

World's Biggest Financial Crisis - Lehman Brothers' Collapse
Protesters hold signs behind Dick Fuld as he prepares to testify at a House oversight and government reform committee hearing on the Lehman Brothers collapse in Washington in 2008. Photograph: Jonathan Ernst/Reuters

Fuld admitted the bank’s failings in the years after the collapse, but he remained critical of the government for forcing Lehman Brothers to declare bankruptcy while bailing out others. He informed the Financial Crisis Inquiry Commission in 2010 that at the time of the bank’s insolvency, it had appropriate capital reserves and a strong business.

World's Biggest Financial Crisis - Lehman Brothers' Collapse
Erin Callan (now Erin Montella)

Erin Callan (now Erin Montella) was named Chief Financial Officer at the age of 41 and resigned in June 2008 amid allegations that she had disclosed confidential material to the press. 11 Her LinkedIn profile describes her as a Matrix Investment Holdings advisor. Other jobs include six months as Credit Suisse’s head of hedge fund coverage and co-founding a non-profit that gives women paid maternity leave. 1213 Full Circle: A Memoir of Leaning in Too Far and the Journey Back, Montella’s autobiography on her experiences in the financial industry, was published in 2016. 

Final Thoughts

Given its size and prominence in the United States and around the world, Lehman Brothers’ failure roiled global financial markets for weeks. Lehman had a market worth of about $46 billion at its peak, but it was wiped out in the months leading up to its bankruptcy.

When compared to the government’s tacit backing for Bear Stearns, which was acquired by JPMorgan Chase (JPM) in March 2008, many questioned the decision to let Lehman fail. After the government refused to aid with Lehman’s most distressed assets, Bank of America dropped out of the deal. Instead, on the same day that Lehman filed for bankruptcy, Bank of America announced it would buy Merrill Lynch.

Leave a Comment