The last days of

Lehman Brothers

 Lehman

Brothers considered too big to fail actually failed

on September 15, 2008. It was believed that company this
big would be saved but was never saved.
Why
What
When
How

Agenda
History
Backstage
The

last days
What led to this collapse?
Impact of the collapse
How this collapse could have been prevented?
Lessons learned

History
1. 1850 - 1969
Founded in 1850
Started as a dry-goods store then to a cotton trader.
By 1884 started financial advisory services and underwriting
2. 1969 - 1984
Merged with Kunh, Loeb & Co was the 4th largest investment bank.
3. 1984 - 1994
Shearson acquired Lehman Brothers
4. 1994 - 2008
Went public for the first time.
CEO Richard S Fuld
14 straight years of profit

Backstage

The main business areas of Lehman was typical investment banking as well
as equities, fixed income, capital markets and investment management.
Their investment banking business provided financial services such as
mergers and acquisitions, underwritings and issuing securities.
After 9/11 attacks there was a long period of low interest rates.
Shifted from lower risk brokerage model to high risk capital intensive IB
model.
8 months from 4th largest investment bank to bankruptcy.
Broke the myth that even too big can fail.

Timeline

1850: Henry Lehman and brothers Emanuel and Mayer opened a cotton
trading business in Montgomery, Alabama, naming it Lehman Brothers.

2007: The firm bypasses smaller rival Bear Stearns Cos. as the largest
underwriter of mortgage-backed securities.

2007: Closes BNC Mortgage LLC subprime-lending unit, eliminates 1,200

jobs.

2008
March 17: Lehman shares fall as much as 48 percent on concern it would
be the next Wall Street firm to collapse after Bear Stearns was forced to sell
itself for 7 percent of its market value the day before.

May, 21: Hedge fund manager David Einhorn questions Lehman's

earnings report, saying the bank under-reported its problems in its first
quarter.

June 9: The firm announces its first quarterly loss since going public and
sells $6 billion of stock to bolster capital.

Aug. 19: Lehman shares drop 13 percent on reports that the firm solicited
buyers for its investment-management division and that third-quarter
write-downs would be worse than estimated.

Sept. 9: Lehman shares plunged 45 percent after talks about a capital

infusion from Korea Development Bank ended.

Sept. 10: Lehman reports a $3.9 billion third-quarter loss, the largest in its
history, on $5.6 billion of write-downs.

Sept. 12: Lehman shares sink 42 percent after Moody's Investors Service
said the firm must find a stronger financial partner or it will downgrade
the company's credit rating.

Sept. 13: Finance leaders meet at the Federal Reserve Bank of New York
seeking a solution

Sept. 14: Barclays pulls its bid after failing to secure guarantees against
losses, Bank of America withdraws hours later. Firms meet to net trades, or
cancel those that offset each other, as Lehman liquidation or bankruptcy
draws near.

Sept. 15: Lehman petitions for Chapter 11 bankruptcy, listing $639 billion
of assets in the largest filing in U.S. history.

Sept.16: Barclays announces $2bn deal to buy a large part of Lehmans

US business out of bankruptcy.

Causes
1. Repeal of the Glass Steagall Act 1933
The act allowed commercial banks to carry out investment banking
activities.
Lehman Brothers in order to compete with other companies acquired
many commercial and investment banks which exposed them to
several risks.
2. Complex capital structure
Acquired various firms to compete in the market.
Conducted business over 3000 different legal entities.
Expansion strategy

3. Losses
$2.8 billion in second quarter and $3.8 billion of third quarter of 2008.
Heavily exposed to the U.S real estate market.
4. Liquidity
Unable to meet short term obligations.
Lost market confidence.
5. Leverage
Leverage ratio increased from 20 to 44 to 1 shareholder equity.
Coupled with sliding of prices of assets due sub- prime crisis.

6. Sub prime mortgage crisis

Banking panic
Excessively lent loans to unqualified borrowers without full
documentation.
To capitalize on speculative opportunities and to reduce risk Lehman
entered into derivatives (credit default swaps).
Fall in the prices of collateralized debt obligations.
7. Unethical management practices
Use of Repo 105 & Repo 108
Violated Sarbanes-Oxley Act.
Financial statement fraud
Payment of excessive bonuses to directors.

8. Risks
Market risk
Credit risk
Liquidity risk
Operational risk
Reputational risk
9. Unsuccessful bailout & takeover attempts
Korean Development Bank
Failed takeover attempts by Bank of America & Barclays.

Impact
Key Highlights :

Almost 6 million jobs were lost.

Unemployment rate almost doubling to 10%

Popular index DOW JONES fell by 5000 points.

57% drop in stock prices from 2007 peak, coupled with homes now
worth tens of thousands of dollars less.

1. Impact on banks
Subject to greater govt. regulations
Inter banking lending rates spiked.
Operating with less borrowed money.
2.Impact on economy
Reduction in retail sales & employment opportunities.
Skimpier profits of U.S based companies.
Cost of borrowings also increased.

3. Impact on Global economy

GDP fall to 4.8%
Banks of Japan, Germany & England faced huge losses.

4.Impact on investors
Turned conservative
Stared shifting to CDs and money market funds.
5. Impact on consumers
Way of spending got interrupted.
Uplifted the level of savings among households.

Prevention

Proactive risk management

Do not do business which you cant understand.

Control greed

Look for early threat signs.

Stricter regulations

Lessons learned

The myth too big to fail was broken.

Any company even as big as Lehman Brothers should follow
some basic rules.
Greed is good but not always.
Always invest in securities which you can understand.
Relation between strict regulations and good corporate
governance.
Goals are good, try hard to achieve it but never overdo it.

References

Wikipedia
Various case studies
The last days of Lehman Brothers (BBC television film)
Too big to fail (film)