Financial Scandal Lehman Brothers

Abstract

This report presents an outline and in-depth analysis on the financial scandal Lehman Brothers and the impact of Lehman Brothers’ bankruptcy on different sectors and individual wealth worldwide. It examines the after effects of the bankruptcy of Lehman Brothers on several brokerage firms and the overall market which included individuals of different income group whose money was invested by the institutional investors. The study suggests that the brokerage firm suffered negative stock prices followed by the bankruptcy of the Lehman Brother. The research shows that the stock prices of the firm started dropping 24 days prior to the announcement of bankruptcy and continued to drop further. Drop in stock prices supports that the market at that time was semi-strong and anticipated the collapse of the firm.

 

 

 

 

 

 

 

Introduction:

 

The collapse of the large investment firm Lehman Brothers was the result of subprime mortgage crisis showing the sign of the weakening of U.S. housing market which resulted in rapid drop in

Housing prices and sending the rippling effect across the globe. The tragic bankruptcy exposed how interconnected the international market had been becoming. One of the largest companies who were affected was AIG. AIG had had backed huge amount of credit default swaps by Lehman Brothers. So it also suffered heavily apart from other companies who backed Lehman. Lehman Brothers were the dealing in fixed-interest trading and they were heavily invested in sub-prime mortgage market.

 

 

 

 

 

 

 

 

A  Literature review of the Financial Scandal:

The aim of writing this case study paper is to discuss the case of fall of Lehman Brothers which enjoyed several years of the glorious past and reach to a financial tragedy leading to its collapse in 2008. The crucial part of the question that “Why did Lehman Brothers fall?” is reviewed with the aid of making a qualitative analysis with some facts. Also other possible reasons behind the fall of the investment giant are also put forward. I have provided and simplified qualitative & quantitative framework of the professional public view on this matter and tried to find out what went wrong for Lehman rather in reexamining selective pieces of evidences.

The bankruptcy of Lehman Brothers had brought a devastating effect for economies and the financial markets worldwide. The fall of Lehman Brothers was not just a banking failure but it was far more and had its effect in the worldwide economy. This was a human failure that leads to the greatest tragedy in the field of investment and real estate market and lead to a severe financial crisis and global recession.

On 15 September 2008, approximately four years later from their bankruptcy ,in order to prevent another such Lehman Brothers bankruptcy case

in the future a number of  research papers and analysis had come forward to find the root cause of the event including its consequences to the economy, causes of failure etc. Also some suggestions were also provided to get lessons from every dimension of the above said scandal

 

 

Background:

 

 

In the year 1844, a 23-year-old Henry Lehman come to Birmingham, Alabama from Bavaria and opened a dry-goods store, named as “H. Lehman”. In 1847, Emanuel Lehman arrived and the company is further named as “H. Lehman and Bro” .The Company was basically founded in the year 1850 when Mayer Lehman arrived to Montgomery, Alabama, USA and it is renamed as Lehman Brothers. Accepting cotton as payment and reselling them was the most important part of their business. In 1969 Robert Lehman died, and the company had been led by non-Lehman’s ever since. In 2008, The Company was headquartered at New York, USA under the Chairman and CEO, Richard S. Fuld Jr when it became bankrupt.

 

 

The core business of Lehman Brother was buying and selling of shares, fixed income assets, trading, research, investment banking, investment management and private equity. Lehman Brothers bank was a major player in the U.S. Treasury Security Market, acting as a primary dealer. The firm was dealing with governments, companies and other financial institutions and operating at wholesale level. It was the fourth largest bank in USA in terms of investment.

The firm had worldwide presence employing more than 25,000 people worldwide, including 5,000 in the UK till 2008. There were some subsidiaries of the bank from time to time and they are as follows:

Lehman Brothers Inc., Eagle Energy Partners, Aurora Loan Services, Inc., Neuberger Berman Inc.,   Crossroads Group, FSB and  Lehman Brothers Bank.

 

 

The scandal:

Lehman Brothers Holdings Inc. was the fourth largest investment bank in the USA. The firm was doing its trade on the NYSE with the symbol LEH. Some of the areas and the product of the investment giant included fixed income sales, trading the treasury of the US securities, private equity, global financial services in investment banking, investment management and banking. It was September 12, 2008 when the Lehman found itself under the financial predicaments. The investment giant was filed for bankruptcy case. The Lehman Brothers was filed for Chapter 11 bankruptcy protection on September 15, 2008.  LEH stands as the largest bankruptcy in world history with over $600 billion in debt. The case filing was the largest bankruptcy filing in the whole history of the U.S.A. The case of the bankruptcy of Lehman Brother brought into light some of the negative ethical practices that affected the whole financial crises in the United States. The cause of the fall of the Lehman Brothers was their mortgage loans business which started giving heavy losses as the time passed.

 

 

 

 

Why did Lehman fail?

The reason behind the bankruptcy filing of Lehman Brothers was their failure to secure enough capital to clear their debts.

The three Ls that killed Lehman:

Leverage, Liquidity and Losses

 

1. Leverage

The best way to improve one’s returns during the good times is to gear the returns up by borrowing money and investing in the assets that are rising in value. This helps individual to ‘leverage’ (magnify) one’s returns. This is useful when interest rates are low. Leverage also magnifies losses and gets magnified when asset prices fall.

This is what happened exactly in case of Lehman Brother when in 2004 it was leveraging at the running of 20 to reach to an incredible 44 in the year 2007. Thus the investment giant was leveraged 44 to 1 at a time when asset prices began heading south. This situation was something bit like someone on a wage of $100,000 buying a house using a £4,400,000 mortgage. Lehman was facing a similar situation.

2. Liquidity

Most of the businesses in the world collapse not only because of the lack in profits but also because of the problems in cash-flow. Lehman was an upturned pyramid balanced on small cash didn’t have enough liquidity in its way. In one hand other others were easily selling assets while on the other hand the bank was lacking in ready cash. Thus Lehman started losing liquidity at fast pace.

3. Losses

After the terrorist attacks of 9/11, the interest rates in US started dropping. This caused a five-year boom in domestic and commercial property prices in US. This boom ended in 2006 and after that U.S. housing prices started fallen for three years.

Lehman Brother was heavily open to the U.S. real-estate market. Lehman Brother had over $60 billion invested in commercial real estate market and was very big in subprime mortgages which were the loans to the risky homebuyers. As property prices crashed Lehman Brother was caught in a perfect storm. In 2008, the loose of Lehman came to about $6.5 billion.

Some other possible reasons behind failure are as follows:

  • Subprime Mortgage crisis.
  • Boom and then burst in the housing market.
  • Policies of the Central Bank.
  • Indulgent in high risk mortgage loans, lending and borrowing.
  • Boom and then fall of shadow banking system.
  • The debt levels and incentives of the financial institutions.
  • Inaccurate credit ratings and securitizing practices.
  • Credit default swaps.

 

Impact of failure of Lehman Brothers:

  • Stocks fell across Europe & Asia.
  • The US stock fluctuated with over $300 Billion in market value.
  • The dollar lost the most against the yen in a decade & as a result treasuries surged.
  • Depreciation in the price of commercial real estate was to be noticed.
  • Liquidity prospect of Lehman’s $4.3 Billion in mortgage securities started a selloff process in the commercial mortgaged-backed securities market.
  • An atmosphere of fear started to sell securities in commercial real estate.
  • The pension funds of the employees which holds bond in the firm, had lost most of their values causing a risk of losing their pensions.

 

 

 

 

 

Conclusion:

 

 

´The study showed the possible reasons behind the failure of the firm. It showed how the international market was interrelated.

´This study examined the impacts of the bankruptcy of Lehman Brothers that affected the wealth and income of all the individuals who are directly or indirectly were added with the firm as the money of the individuals was invested with the bank.

´The Impact of the financial crisis was felt worldwide resulting in global recession.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

References:

 

 

Sharp, A. WealthDaily.Accounting Gimmick or Outright Fraud? (2010). Retrieved March 15, 2010, from http://www.wealthdaily.com/

 

Janeneel. The Effect of Lehman Brothers and its Effect on Global Credit Crisis (2013). Retrieved January 11, 2009, from http://janeneel.wordpress.com/

 

Cooper, L. Forexlive. Top Ten Lessons from the Lehman Collapse (2013), Retrieved September 14, 2013, from http://www.forexlive.com/

 

 

Sorkin, A.R, The New York Times. Lehman Files for Bankruptcy; Merrill Is Sold (2008). Retrieved September 14, 2008, from http://www.nytimes.com/

 Do My Math Homework, acemyhw.com

The Collapse of Lehman Brothers (2009). Retrieved April 02, 2009, from

http://www.investopedia.com/articles/economics/09/lehman-brothers-collapse.asp