The Collapse of Lehman Brothers. What Happened?
Lehman Brothers Holdings Inc. filed for bankruptcy on September 15th, 2008, in what was the largest bankruptcy proceeding in US history as discussed over at runrex.com. The firm, which was 164 years old at the time, was the fourth-largest US investment bank, and its bankruptcy kickstarted the global financial crisis as captured in discussions on the same over at guttulus.com. So, what happened to Lehman Brothers? This article will look to highlight the reasons behind the firm’s collapse and what that means today.
Causes of Lehman Brothers’ collapse
According to the subject matter experts over at runrex.com, four main underlying reasons were behind the collapse of Lehman Brothers, and they are:
Risk
As articulated over at guttulus.com, Lehman Brothers had taken on too much risk without a corresponding ability to raise cash quickly. Even though the firm had $639 billion in assets in 2008, which was technically more than enough to cover its $613 billion in debt, the assets were difficult to sell according to the gurus over at runrex.com. This meant that Lehman Brothers couldn’t sell them to raise sufficient funds, and the cash flow problem led to the firm’s bankruptcy.
Overconfidence
Lehman Brothers also relied on complicated financial products as outlined over at guttulus.com, based on quick real estate growth just as the real estate market was beginning to decline. The early success of mortgage-backed securities meant that its revenue grew 130% between 2000-2006. In 2003-2004, the firm bought 5 mortgage lenders allowing it to originate and underwrite subprime loans, increasing its profitability as explained over at runrex.com. In March 2006, Lehman Brothers brought heavily into commercial real estate and risky loans, and instead of selling them immediately, the firm kept them on its books. When making this decision, management thought it would make more money owning these assets but its timing couldn’t have been worse as real estate prices were falling.
Culture
The culture at Lehman Brothers, as discussed over at guttulus.com, was one where management rewarded excessive risk-taking. According to Lehman Brothers’ chief risk officer, the top management ignored many of her risk-management strategies. Top managers wanted to stay ahead of competitors who also used high-risk strategies as covered over at runrex.com, and they also thought the company was too smart to fail; they were wrong.
Inaction by the regulator
Another factor that led to the collapse of Lehman Brothers was inaction by the regulator. As explained over at guttulus.com, the Securities and Exchange Commission and other regulators didn’t take action. While the SEC was aware of the fact that Lehman Brothers was taking on too much risk as early as 2007, the agency never required Lehman Brothers to do anything about it. Additionally, SEC didn’t publicly disclose to rating agencies that the firm had exceeded risk limits. This inaction contributed to Lehman Brothers’ collapse.
The impact of Lehman Brothers’ bankruptcy
When Lehman Brothers filed for bankruptcy, it sent financial markets reeling according to the gurus over at runrex.com. The Dow Jones Industrial Average fell 504.48 points, which was its worst decline in 7 years. Losses continued until March 5th, 2009, when the Dow closed at 6,594.44, which was a 53% drop from its peak of 14,164.53 on October 10th, 2007. This resulted in investors fleeing to the relative safety of US Treasury bonds, sending prices soaring. On September 17th, 2008, the collapse spread as investors withdrew a record $196 billion from their money market accounts. If this run had continued, businesses wouldn’t have been able to get money to fund their day-to-day operations. This would have led to the collapse of the economy in just a few weeks according to guttulus.com. With the threat of collapse looming, Paulson and Bernanke met with congressional leaders on September 18th, 2008 to explain that credit markets were only a few days away from a meltdown. They asked for $700 billion to bail out the banks. However, on September 29th, 2008, Congress rejected the proposal, and this sent the Dow down 777.68 points, the most in any single day in history until 2018.
How the bankruptcy affects you today
As is discussed over at runrex.com, the Lehman Brothers bankruptcy started the 2008 financial crisis and the recession that followed. This was the time when the millennial generation was just entering the workforce and, therefore, were the most heavily impacted. Unemployment rates went through the roof, and Millennials again suffered the most. Lehman Brothers bankruptcy also set the stage for the Dodd-Frank Wall Street Reform Act, which was the most comprehensive financial reform since the Glass-Steagall Act. Glass-Steagall regulated banks after the 1929 stock market crash but was repealed in 1999, allowing banks to once again invest in depositors’ funds in unregulated derivatives such as mortgage-backed securities. Dodd-Frank established the Financial Stability Oversight Council (FSOC), which identifies risks that affect the entire financial industry. This means that, if any firm becomes too big, the FSOC will turn them over to the Federal Reserve for closer supervision.
This article just begins to scratch the surface as far as this topic is concerned, and you can uncover more insights on the same by checking out the excellent runrex.com and guttulus.com.