Essay on the Great Financial Crisis: Lehman Brothers Bankruptcy

Introduction

The Great Financial Crisis: Lehman Brothers Bankruptcy

The financial disaster resulting from the fall of Lehman Brothers hurt the entire global economy. When Lehman brothers collapsed, 26000 employee lost jobs and millions of investors lost all or almost all of their money triggering a financial crisis and the worst economic downturn in seventy years. Lehman Brothers bought up huge amounts of real estate which they could not unload when the market went south and it also had borrowed $44 for every $1 it had in the bank to finance the deals (PR, 2015). Furthermore, Lehman executives began manipulating balance sheets and financial reports when investors began losing confidence and competitors closed in. In addition, Lehman Brothers quarterly reports did not provide fair and accurate picture of the company’s financial condition and there were claims that this is fraud by its top executives including its CEO, Richard Fuld for overseeing and certifying misleading financial statement. Lehman’s accountant, Ernst and Young also played a pivotal role in their demise for failure to challenge Lehman’s numbers. Lehman’s involvement in massive property investments and with the crash in the market, shareholders were dumping stock and other banks were holding credits. Lehman has lost 6.5 billion already by mid of 2008 and its share prices has been dropping since May and in the last ten days prior to its bankruptcy, its stock prices were in freefall and by the Friday afternoon, it was losing about 8 million a minute. Moreover, confidence in the bank has been evaporating under the glare of the media spotlight.

History of Lehman Brothers

Humble beginnings

Henry Lehman, an immigrant from Rimpar, Germany, opened a small shop selling groceries, dry goods, and utensils to the local cotton farmers in Montgomery, Alabama. His two brothers, Emanuel and Mayer Lehman, accompanied him into the business and soon named it Lehman Brothers. Their small merchandising endeavor later turned into brokering commodities where cotton were bought and sold for the planters living in and around Montgomery, Alabama. A partnership with a cotton merchant John Wesley Durr allowed them to participate in much larger sales and trade and eventually the opening of the New York office in 1858 (PR, 2015). Twelve years later in 1870, Lehman Brothers commenced the New York Cotton Exchange, the very first commodities future trading venture. The expansion of the railroad industry sparked the transformation of Lehman Brothers from a mere commodity business into including the sales and trading of securities laying the grounds for the entrance of the firm into the New York Stock Exchange (Hines, Kreuze, & Langsam, 2011).

American Express Acquisition

In 1984, American Express acquired Lehman Brothers. This acquisition came after the arrival of all the brothers in the United States. The acquisition of American Express came with a merger with their retail brokerage firm Shearson to form an association known as Shearson Lehman brothers. The organization proceeded with its operations till the year 1992 when they began to diversify their investments. In the year 1993, the business revert its name back to Lehman brothers. The specific interaction on acquisition of American Express involves various players. In the year 1984 American Express made an acquisition of a Trading firm and an investing banking (Hines et al 2011). This association involved Lehman Brothers. The association gave birth to Shearson Lehman/American Express firm. Lehman firm was already under the leadership of Pete Peterson. However in the1980s the firm experienced various levels of hostilities. The hostilities involved investment bankers and trader; which had an impact on the profitability of the firm. With this influence, Peterson saw the need to promote Lewis Glucksman to be the president of the firm. American Express with the new president in place injected $1.09 billion capital into Lehman. In exchange the firm will get Shares in Lehman’s future prospects (PR, 2015). However with the influence of a global financial crisis, spinoff became necessary. American Express eventually sold Shearson to travelers. Since Lehman segment, which specialized in Investment banking, was not needed, it was being prepared for sale.

Richard Dick Fuld, the home grown CEO

Richard Dick is perhaps the most formidable C.E.O who worked for Lehman brothers. The man is an American banker whose history associates with Lehman brothers’ investment since 1994. In his career, Dick oversaw the company through its spinoff period. Since the year 1994 Richard has been the groups’ C.E.O until the year 2008 when Lehman brothers made sale of its assets. Richard Dick is a homegrown C.E.O. Born in a Jewish family, he received a B.S and B.A degree from the University of Colorado (Hines et al 2011). In the year 1969, he got an MBA from New York University’s Stern School of Business. He even got a chance to train as an Air force pilot.

His interaction with Lehman brothers came in the year 1969. He became loyal to Lehman brothers for over 40 years. He could have continued his interactions with the brothers had the firm not gone into bankruptcy. He participated in various mergers of the company, acquisition of the American Express and even the eventual spinoff. Richard became the longest serving C.E.O in the history of Wall Street. His contribution to Lehman investment includes saving the firm from the Asian Financial Crisis. In the year 2006 the C.E.O gets the credit for being among the most influential C.E.O on Wall Street. In respect to compensation, Richard made more than half a billion dollars from the years 1993 to 2007. His other earnings in the year 2007 were $20,030,534. This value includes a stock grant of $16,877,365. According to reports on Richard, he made liked to tie up his wealth around the company. He is famous for purchasing Lehman Brothers shares on the margin (Hines et al 2011).

Growth and Expansion

Aggressive Growth Strategy

Lehman brothers’ aggressive strategy came as a result of various changes in the market. There were various emerging opportunities at the period. The railroads were at its inception, the communication system was at its infancy. The goal of the firm was to support various industries. One of its support points was the communication sector (Fernando, May, & Megginson, 2012).. During the great depression, even the strongest companies were not able to raise capital. However Lehman had an ingenious way of financing. The method of financing was by private placement. This would see lending firms suffer less risk while offering loans to private individuals.

Mortgage Backed Securities

The fall of Lehman brothers firm came as a result of the subprime mortgage market. With the great depression Lehman hurriedly ventured into the Subprime- Mortgage security. However this form of investment was not beneficial to the firm since it lost over $10 trillion. The crisis of the firm began in the year 2007 when it was not able to bear stern hedge funds. It further eliminated over 2500 mortgage related jobs (Fernando et al 2012). Even though the mortgage market was gaining popularity, Lehman underwrote its Mortgage values. This led to the accumulation of $85 billion in form of market portfolio.

Alt-A residential mortgages

In the year 2008 Lehman reports that it will unwind its Alt-A residential mortgages. This comes as a result in the drop of its values in the market. The firm registers a $2.8 billion in net loss by the quarter of the year. It also absorbs over $2.4 billion as mark-to market activity. It further reduces its residential mortgage rate of exposure from $31.8 to $24.9 billion (Swedberg, 2010).

Derivatives

Lehman utilized derivative to satisfy customers’ needs at the time of its bankruptcy. This method was not a good customer service approach by the firm. This therefore meant that clearing dealers of Lehman brothers faced the costs of all its creditors.

Short- Selling

This is a form of selling stock that you do not own individually. One borrows stock from another individual and the sell it to another party. The other method that Lehman utilizes is the borrowing of shares that they do not own from a buyer and eventually fail to deliver. This method is also known as naked short selling (Swedberg, 2010).

Bad Bet

Countercyclical stocks

While investing in the market, investors make various risk decisions. These decisions are known as bets. Investments face various risks. This may be informing of legislations, market fluctuation or the financial situation of the market. This unending pattern is known as market stocks. The countercyclical stocks are dependent on the economic cycle of the market. This may come under the influence of depression, high interest rates or demand of consumers (Swedberg, 2010).

References

PR, N. (2015). Examining the Largest Bankruptcy in History. PR Newswire US.

Hines, C., Kreuze, J., & Langsam, S. (2011). An analysis of Lehman Brothers bankruptcy and Repo 105 transactions. American Journal Of Business (Emerald Group Publishing Limited), 26(1), 40-49.

Fernando, C. S., May, A. D., & Megginson, W. L. (2012). The Value of Investment Banking Relationships: Evidence from the Collapse of Lehman Brothers. Journal Of Finance, 67(1), 235-270.

Swedberg, R. (2010). The structure of confidence and the collapse of Lehman Brothers. Research in the Sociology of Organizations, 30(A), 71-114.