Bankruptcy

The case of Lehman Brothers

Presented For: Sharique Mehmood

Presented By: Umer Qasim

Business Law
Final Term Project

Abstract Bankruptcy perhaps is the last thing any company would wish upon itself. It is a legal status of a person or an organization that it cannot repay the debts it owes to its creditors. In the light of bankruptcy, Lehman brothers an investment Bank filed for what became and still remains the largest bankruptcy filed in the US history with Lehman holding over $600 million in assets. The organization borrowed significant amounts to fund its investing in housing-related assets which made it vulnerable to a financial downturn. Further in, we are going to discuss the causes that led to this downturn, the effects it had on the global market, the legal implications and what role did the government play in the entire fiasco.

What is law? As such, there is no single or correct answer to this question. In past no one really questioned lawmakers, law distributors, or the laws themselves. But of late, society has begun to question most legal activities as to their effectiveness and competence. The cause of these reviews has emerged by changing times, changing thoughts, understanding, beliefs, as well as the development of technology and other such new developments within societies. There are 2 sources of law parliament (legislation) and court (case) made law. These laws can be regarded as being purely formal, irrespective of whether they are good or bad. Law can be positivist in nature meaning no judgment is made in regards to the quality of that law - implement it regardless if it is a good or bad. Such a theory does not look at the moral implications of the laws its a amoral view of law. Natural law on the other hand, is the idea that God makes laws. This theory originates as far back as early Greece and the Gods. The most complete account of natural law doctrine can be found by Aquinas St. Thomas. For instance "Nothing else than the rational creatures participation of the eternal law", "Every human law has just so much of the character of the law as it is derived from the law of nature. But if in any point it differs from the law of nature, it is no longer a law but a corruption of a law", "that positive law is a determination of natural law". One natural theorist is Kant Emmanuel "No law can be right merely by convention", "Laws, as such, are to be regarded as necessary a priori that is as following of themselves from the conceptions of external right generally and not as merely established by statues". Bentham Jeremy

He accepted Hobbers identification of law A law is what a sovereign commands (This approach can be associated to the case of Hitler and his power). Principle of utility the ability to way up the benefits of a product or situation and make decisions about it based on its usefulness or cost.

Suggested that certainty in the law could not be had without codification.

In 1832, Austin John published his theory that sought to clarify the distinction between law and morality. He stated that 'commands' are expressions of desire that another shall

forbear, which is accompanied by a threat of punishment (the "sanction") for disobedience. Is law really needed? The disputed question is "is law really needed"? As simplistic as it may seem to answer, it is fundamental that we ask. Personally, laws are guidelines that set out appropriate behavior that has been developed over time, and are based on moral beliefs, a human condition that sets out a purpose that society in general is called upon or required to fulfill. Without the fulfillment of these desired tasks, man simply will become equal to animals or worse still, allow their darker sides (or impulses) to emerge and control their lives. Thus, law acts as a guardian against the inevitable anarchy that would engulf humanity (if you want proof, simply turn to the riots that take place in America when officers of the law go out on strike). On the other hand, we have those who believe that mankind is naturally good, and it is the external forces that surround us that are completely responsible for any wrong doing that takes place for instance, the government. Augustines assertion that law was a natural necessity to curb mans sinful nature held the field for many centuries. But the belief that mans nature might be corrupt and sinful has been at times weighed against the belief that man posses a natural virtue which is capable of development. Leaning heavily upon Aristotles conception of the natural development of the state from mans social impulses, Aquinas held that the state was not necessary evil but was a natural foundation in the development of human welfare. This continued perception of man with no laws or structures to force certain behaviors creating the ultimate utopian society is legally termed (or coined) as laissez faire .But when we think about this supposed utopian society, we can see that it is not possible. The only time it would have ever been a feasible theory would have been at the time of mans conception as in Adam and Eve and history has already show us that their duration in paradise did not last that long. Come to think of it, even Adam and Eve had guidelines, no matter how limited, that they had to follow for their retention in paradise and they failed - as would any other anarchy based, or limited direction society. The most influential of all people that promoted anarchy of sorts, would undoubtedly be Karl Marx. He envisaged the overthrow of the capitalist society by a violent revolution of

the oppressed proletariat. Law was nothing but a coercive system devised to maintain a classless society would be brought into being, and law and the state would whither away as being no longer needed to support an oppressive regime. The Marxist looks forward rather than back to the Golden Age (if it ever really existed) when social harmony will be attuned to the natural goodness of man unimpeded by such environmental snares as the institution of private property. But it can be seen that the introduction of Marxist socialism has always been closely followed by the implementation of more laws and legal repression, rather than having them abolished. It is fact, that even in the simplest of societies, some form of legal rule and guidance is without doubt needed to control the anarchist like environment which ironically counteracts the entire purpose of a lawless society.

Definition The word bankruptcy is formed from the ancient Latin word bancus (a bench or table), and ruptus (broken). Now a "bank" originally referred to as a bench, which the first bankers had in the public places, in markets, fairs, etc. on which they tolled their money, wrote their bills of exchange, etc. Hence, when a banker failed, he broke his bank, to advertise to the public that the person to whom the bank belonged was no longer in a condition to continue his business. As this practice was very frequent in Italy, it is said the term bankrupt is derived from the Italian banco rotto, broken bank. By definition bankruptcy or insolvency is a legal status of a person or an organization that cannot repay the debts it owes to its creditors. Creditors may file a bankruptcy petition against a business or corporate debtor ("involuntary bankruptcy") in an effort to recoup a portion of what they are owed or initiate a restructuring. In the majority of cases, however, bankruptcy is initiated by the debtor (a "voluntary bankruptcy" that is filed by the insolvent individual or organization). An involuntary bankruptcy petition may not be filed against an individual consumer debtor who is not engaged in business. Moreover, on the brighter side bankruptcy also offers an individual or business a chance to start fresh by forgiving debts that simply can't be paid while offering creditors a

chance to obtain some measure of repayment based on what assets are available. In theory, the ability to file for bankruptcy can benefit an overall economy by giving persons and businesses another chance and providing creditors with a measure of debt repayment. Bankruptcy law in Pakistan Bankruptcy and insolvency are a natural phenomenon of doing business in a capitalist economy. Our Islamic economic model is also based on the same principles of private enterprise, trade and sharing of profits and losses. Thus business will flourish, new firms will enter and old firms will die out. Profit making is the essence of capital formation, expansion of economy, employment generation and export growth. First, if profits are privatized then the losses should not be socialized. While the private entrepreneurs in Pakistan gladly appropriate the profits whether normal or windfall-they are always reluctant to bear losses. Second, if the businesses make profits then it is incumbent upon them to pay a portion of their profits as taxes. Third, profits made in Pakistan by utilizing the countrys resources should be reinvested in its economy for maximizing economic activity and employment rather than keeping them away in foreign bank accounts overseas. Fourth, profits have to be generated through competition in a level playing field and not through selective favors, concessions and privileges to a chosen few among the business community. The love of money Greed for a lack of a better word is good. Greed is right. Greed works. Greed clarifies, cuts through and captures the essence of evolutionary spirit greed in all of its forms, greed for life, money, love, knowledge had marked the upward serge of mankind and greed you mark my words will not only save us but that other malfunctioning corporation called the U.S.A. Gordon Gekko Wall Street (movie)

This notion was shared by all during the boom that the entire world saw. Unfortunately, for Lehman Brothers they were the start of the melt down and the global recession. The most unbelievable weekend that they faced before their bankruptcy was untrue for most, but the question is what led up to that. It all started by Alan Greenspan who was the chairman of the Federal Reserve of the U.S from 1987 to 2006. He was known as by far the best chairman in the history of the FED. Moving on to what happened was that after the attacks of 9/11 and the increase of the Chinese economy Alan Greenspan decided for far too long to keep the interest rates too low. What happened due to this was a lot of borrowing started taking place. It was so cheap for banks to borrow money off Wall Street that it was like practically free money for them. So what they decided to do was start making money off that free money. And how they did that was started lending money to everyone. At the time George W. Bush was president of the U.S and he wanted to everyone to have their own homes. And he was focusing on a policy of home ownership. So the banks started lending money to practically everyone. As one banker put it, what anyone needed to qualify for a loan was that if you could chew a gum and walk too. Due to this many loans started bundling up and they were traded amongst banks all over the world. What followed no one was ready for or expected. Hank Paulson the secretary of the U.S treasury at the time called all the big financial institutions and arranged a meeting at an hours notice, expect the team of Lehman Brothers was not invited on the 13th of September 2008. The meeting was to let them know that the government was not going to save Lehman Brothers from the crisis they were facing. It was up to all of them to help their competition. To save them from insolvency. After the meeting the entire audience was shocked. To their amazement Lehman Brothers had altered their balance sheet immensely. Lehman Brothers were on the brink of bankruptcy. The next two days were very interesting. The Bank of America had done the most business with Lehman Brothers over the years and it was said that they would help them and buy them out. But at the meeting the owner of Merrill Lynch, John Thain was also present and he saw if another week had passed and Lehman brothers went bankrupt has bank would be next in line. So the very next day before Lehman Brothers had a chance to

make a deal with the Bank of America, John Thain sold Merrill Lynch to the Bank of America. Lehman Brothers were shocked. The next in line was Barclays to make a deal with Lehman Brothers. They were the plan B. Sunday morning the bankruptcy lawyers of Lehman Brothers were confident that by the afternoon a deal would be struck. They had been working the entire night. Suddenly something went wrong and the deal was off. Bankruptcy was on the verge for Lehman Brothers. The government was not helping them, their ally the Bank of America had not been their for them and a deal with Barclays had not been struck. Their last ditch effort was that a cousin of President Bush was an employee at Lehman Brothers. Sunday night he called the white house to talk to the president to influence him into helping Lehman Brothers. The call ended in the operating telling him that the president was too busy to speak to him. Monday morning the 15th of September 2008, Lehman Brothers filed for bankruptcy. A few months earlier a same situation had originated with another bank, Bear Stearns. U.S Treasury Secretary Hank Paulson at the time had not seen it as a problem and issued $30B to have them nationalized. A week later after the Lehman bankruptcy Hank Paulson again issued an additional $85B to save insurance giants American International Group. But the Lehman Brothers conflict was not solved by the U.S government. They would have had to spend another few billion dollars and inflation would have increased but the global recession that followed would have been stopped. This was the indecisiveness of the policies of the government. A month later seeing the almost bankruptcy of the entire Iceland and many banks all around the world the British government took the initiative and the Americans followed to nationalize most of their banks. If they had just done this a little earlier the damage would have been less. It is said that the final cost of the recession and damage will not be known for decades. Bankruptcy of Lehman Brothers The story of Lehman Brothers takes us back to 1844 when a 23 year old Henry Lehman emigrated to the United States from Bavaria. He decided to settle in all places Montgomery Alabama where he decided to open a dry-goods store. In 1847 another

brother arrived and in 1850 yet another. The firm changed its name in 1850 to the current Lehman Brothers name. Cotton had a high market value and seeing a market for this, the 3 brothers started to accept payment in cotton for goods and also created a secondary market for trading in cotton. It makes you wonder how many tranches can be spun from a shipment of cotton? Seeing the need to be closer to the liquid market of cotton in New York the firm relocated to New York in 1858.It later joined the Coffee Exchange and also the New York Stock Exchange. It was sometime before the initial founding of the firm that Lehman Brothers actually underwrote its first public offering. In 1899 it underwrote a public offering for the International Steam Pump Company. It wasnt until 1906 that the firm started underwriting some bigger public offerings. The names of Sears Roebuck and Company, Woolworth, Macy & Company, and B.F. Goodrich where all part of their earlier team deals with Goldman Sachs. It was making a big name for itself on Wall Street. During the Great Depression, much of the focus of Lehman went toward venture capital as the equity markets were being hammered. In the 1930s Lehman Brothers underwrote the IPO for DuMont and also helped to provide capital to get RCA going. It also had its hand in financing Halliburton. Like I said, Lehman Brothers has a storied past. In 1975 the firm merged with Kuhn, Loeb and Company to form at the time the 4th largest investment bank. The merger didnt go quite as planned and strife arose in the firm. The firm was sold to American Express. AMEX started to break away from banking and brokerage operations and sold off operations to Primerica which in 1994 was broken off as an IPO for the current Lehman Brothers ticker. The firm did exceptionally well purchasing fixed income such as Lincoln Capital Management and Neuberger Berman which still are profitable today. Since the IPO in 1994 Lehman had steadily increased revenues and grew in employees from 8,500 to approximately 28,000. Reason for Collapse In 2003 and 2004, with the U.S. housing boom well under way, Lehman acquired five mortgage lenders, including subprime lender BNC Mortgage and Aurora Loan Services, which specialized in Alt-A loans (made to borrowers without full documentation).

Lehman's acquisitions at first seemed prescient; record revenues from Lehman's real estate businesses enabled revenues in the capital markets unit to surge 56% from 2004 to 2006, a faster rate of growth than other businesses in investment banking or asset management. The firm securitized $146 billion of mortgages in 2006, a 10% increase from 2005. Lehman reported record profits every year from 2005 to 2007. In 2007, the firm reported net income of a record $4.2 billion on revenue of $19.3 billion Lehman's Colossal Miscalculation In February 2007, the stock reached a record $86.18, giving Lehman a market capitalization of close to $60 billion. However, by the first quarter of 2007, cracks in the U.S. housing market were already becoming apparent as defaults on sub prime mortgages rose to a seven-year high. On March 14, 2007, a day after the stock had its biggest oneday drop in five years on concerns that rising defaults would affect Lehman's profitability; the firm reported record revenues and profit for its fiscal first quarter. In the post-earnings conference call, Lehman's chief financial officer (CFO) said that the risks posed by rising home delinquencies were well contained and would have little impact on the firm's earnings. He also said that he did not foresee problems in the sub prime market spreading to the rest of the housing market or hurting the U.S. economy.

The Beginning of the End As the credit crisis erupted in August 2007 with the failure of two Bear Stearns hedge funds, Lehman's stock fell sharply. During that month, the company eliminated 2,500 mortgage-related jobs and shut down its BNC unit. In addition, it also closed offices of Alt-A lender Aurora in three states. Even as the correction in the U.S. housing market gained momentum, Lehman continued to be a major player in the mortgage market. In 2007, Lehman underwrote more mortgage-backed securities than any other firm, accumulating an $85-billion portfolio, or four times its shareholders' equity. In the fourth quarter of 2007, Lehman's stock rebounded, as global equity markets reached new highs and prices for fixed-income assets staged a temporary rebound. However, the firm did not

take the opportunity to trim its massive mortgage portfolio, which in retrospect, would turn out to be its last chance. Hurtling Toward Failure Lehman's high degree of leverage - the ratio of total assets to shareholders equity - was 31 in 2007, and its huge portfolio of mortgage securities made it increasingly vulnerable to deteriorating market conditions. On March 17, 2008, following the near-collapse of Bear Stearns - the second-largest underwriter of mortgage-backed securities - Lehman shares fell as much as 48% on concern it would be the next Wall Street firm to fail. Confidence in the company returned to some extent in April, after it raised $4 billion through an issue of preferred stock that was convertible into Lehman shares at a 32% premium to its price at the time. However, the stock resumed its decline as hedge fund managers began questioning the valuation of Lehman's mortgage portfolio.

On June 9, Lehman announced a second-quarter loss of $2.8 billion, its first loss since being spun off by American Express, and reported that it had raised another $6 billion from investors. The firm also said that it had boosted 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 cut down leverage from a factor of 32 to about 25.

Legal Implications Bankruptcy law is a federal legal process for debtors seeking to eliminate or repay their debts. Bankruptcys governing federal statutory law is contained in Title 11 of the U.S. Code. It provides for a federal system of statutes and courts which permits debtors to place their financial affairs under the control of the bankruptcy court.

Bankruptcy court is the specialized federal court in which bankruptcy matters under the Federal Bankruptcy Act are conducted. There are several bankruptcy courts in each state, which are branches of the District Courts of the U.S., and each one's territory covers several counties.

The most common types of personal bankruptcies for individuals are Chapter 7, which allows debtors to wipe out many debts theyve accumulated in exchange for giving up non-exempt property to be sold to repay creditors, and Chapter 13, which allows debtors to keep all of their property and repay all or a portion of their debts over three to five years. Businesses can file for Chapter 7 or Chapter 11 bankruptcy. Chapter 11 allows a company to reorganize its debt to stay in business and use business income to pay his or her debts. For the case of Lehman Brothers they filed for bankruptcy on the bases of chapter 11 of the bankruptcy law. Their details contained how the creditors and equity security holders committees would be dealt with. The powers and duties of the committees. Moreover, the termination of the trustees appointment. Furthermore, the rights, powers, and duties of the debtors in possession. Rejection of collective bargaining agreements. And finally how unfortunately there would be no severance pay for their employees. The Governments role in the Lehman bankruptcy The Federal Reserves and the U.S treasurys Emergency move to support the financial markets where to widen collateral for loans to security firms. Moreover, to also boost programs for lending treasuries by $25B this made the total to $200B. And according to Ben Bernanke the chairperson of the FED ...this would make the liquidity of primary dealers and financial markets more general. Furthermore according to the CEO of Merrill Lynch John Thain the U.S government would have had to spend about $20B to $30B of the tax payers money to save Lehman Brothers. Though inflation rates would have increased drastically, the catastrophe that followed would not have been inevitable. The United States government was right in principle not to save Lehman Brothers from bankruptcy but it acted too late. It should have forced the industry to address the financial pressures that were simmering for over a year before the Lehman Brothers crisis, through legal and taxation pressures if necessary. By the time of the Lehman Brothers crisis the industry participants were concerned exclusively in safeguarding the future of their own businesses.

The industry had anticipated that the United States government would play a significant role in saving Lehman Brothers from bankruptcy for the sake of the broader financial stability of the national and global financial system. Credit and money markets froze in reaction to the bankruptcy. During the next month, the financial stability of banks and national banking systems suffered from a loss in investors' confidence. Central banks, national governments and financial regulators were obliged to intervene to stabilise the financial systems for the sake of the broader national and global economies by recapitalisation of banks and injection of liquidity into the banking system. Impact (shockwaves) on/around the world Fears of a global financial meltdown grew as the worlds biggest bankruptcy plunged markets into turmoil. Investors were left reeling as the abrupt demise of the Lehman Brothers investment bank sparked the biggest shake-up on Wall Street in decades. Another of US capitalisms biggest institutions, Merrill Lynch, was taken over by Bank of America in a $50 billion takeover to save it from collapse. Shares fell as fear spread through the financial system. Central banks unveiled urgent measures amid concerns that the world economy was entering a dangerous new phase. The Bank of England injected 5 billion of emergency lending into money markets. The 5,000 Lehman staff in Britain were cleared their desks in the countrys biggest single loss of jobs since the collapse of Rover in 2005. The majority of the banks 26,000 staff around the world lost their jobs. Leading shares on both sides of the Atlantic took a battering. More than 50 billion was wiped off Londons blue-chip shares as the FTSE 100 index tumbled by 212.5 points, or more than 4 per cent. It was the darkest day for the stock market since January 21, when it fell 5.5 per cent. Investors were fretting over the financial health of banks that had lent Lehman money and the fear that more big institutions would be wiped out. Its clear that we are one step away from a financial meltdown, Nouriel Roubini, a leading international economist, said.

Londons losses were stemmed as Bank of Americas rescue bid for Merrill Lynch helped to limit sell-off on Wall Street. When London closed, the benchmark Dow Jones industrial average was down 300 points, or 2.6 per cent. Sentiment was also bolstered by steep falls in oil prices, which dropped by more than $5 a barrel to $96, closing under $100 for the first time in six months and raising hopes that cheaper fuel would ease economic stresses on Western nations. However, by close of trading the Dow had fallen by more than 500 points its biggest one-day drop since the reopening after the September 11 attacks as concerns mounted over the worlds largest insurer. Shares in American International Group (AIG), which sponsors Manchester United, fell by 45 per cent after it made an unprecedented approach to the US Federal Reserve for $40 billion in emergency funding. The Fed asked Goldman Sachs and J P Morgan Chase, two of Wall Streets remaining big banks, to head a $75 billion emergency package to keep AIG afloat. As central banks battled to stabilize the system, the Fed eased its rules for emergency lending further. It announced that it would accept company shares in return for crisis loans for the first time. In Frankfurt, the European Central Bank injected 30 billion in emergency funds into euro zone markets. A group of ten global banks also attempted to foster calm, announcing a $70 billion pool of funds, with any one of them able to tap a third of that should they hit difficulty. The collapse of Lehman came after the US Treasury refused to bail out the embattled 158-year-old bank, a crucial shift after its support in March for a Wall Street rescue of the failing Bear Stearns. Lehman was felled by the weight of about $60 billion in toxic bad debts. It went under holding assets of $639 billion against debts of $613 billion, making it the biggest corporate bankruptcy since WorldCom collapsed in 2002.

President Bush, seeking to assuage fears, conceded that in the short run adjustments in the financial markets can be painful. However, he added: In the long run, Im confident that our capital markets are flexible and resilient, and can deal with these adjustments. Henry Paulson, the US Treasury Secretary, insisted last night that the American banking system remained safe and sound. Washington was committed, he said, to minimizing the impact of what he admitted were the painful economic shifts of the present crisis. Conclusion From the south sea bubble to the dot com boom. From 1929 to 2008 every crash is a story of its time. But they have all shared a common theme. A reckless love of money. Bankruptcy can be taken positively and negatively. A new fresh start can be taken or face a financial meltdown. The bankruptcy of the Lehman Brothers was the largest of the world and as Alan Greenspan said many reasons have effected the great recessions of the world but the common thing in all of them was and always will remain will be human nature and a greed for money.

References Global Recession: The love of money 2009 (documentary)The Fall of Lehman Brothers. Lawerence G. Mcdonald (2008). A colossal failure of common sense The inside story of the collapse of the Lehman Brothers. http://www.investopedia.com/terms/b/bankruptcy.asp http://en.wikipedia.org/wiki/Bankruptcy_of_Lehman_Brothers http://business.timesonline.co.uk/tol/business/industry_sectors/banking_and_finan ce/article4761892.ecehttp://www.helium.com/items/1868483-company-bankruptcy http://www.icmrindia.org/casestudies/catalogue/Business%20Strategy3/BSTA075 .htm