Lehman Brothers

Case overview
On September 15, 2008, Lehman Brothers filed for bankruptcy. ith !"#$ billion in assets
and !"1$ billion in debt, Lehman%s bankruptcy filin& 'as the lar&est in history, as its assets far
surpassed those of pre(ious bankrupt &iants such as orld)om and *nron. Lehman 'as the
fourth+lar&est ,.S. in(estment bank at the time of its collapse, 'ith 25,000 employees
'orld'ide. Lehman%s demise also made it the lar&est (ictim, of the ,.S. subprime mort&a&e+
induced financial crisis that s'ept throu&h &lobal financial markets in 2008. Lehman%s
collapse 'as a seminal e(ent that &reatly intensified the 2008 crisis and contributed to the
erosion of close to !10 trillion in market capitali-ation from &lobal e.uity markets in October
2008, the bi&&est monthly decline on record at the time.
The History of Lehman Brothers
Lehman Brothers had humble ori&ins, tracin& its roots back to a small &eneral store that 'as
founded by /erman immi&rant 0enry Lehman in 1ont&omery, 2labama, in 1833. 4n 1850,
0enry Lehman and his brothers, *manuel and 1ayer, founded Lehman Brothers.
hile the firm prospered o(er the follo'in& decades as the ,.S. economy &re' into an
international po'erhouse, Lehman had to contend 'ith plenty of challen&es o(er the years.
Lehman sur(i(ed them all 5 the railroad bankruptcies of the 1800s, the /reat 6epression of
the 1$#0s, t'o 'orld 'ars, a capital shorta&e 'hen it 'as spun off by 2merican *7press in
1$$3, and the Lon& 8erm )apital 1ana&ement collapse and 9ussian debt default of 1$$8.
0o'e(er, despite its ability to sur(i(e past disasters, the collapse of the ,.S. housin& market
ultimately brou&ht Lehman Brothers to its knees, as its headlon& rush into the subprime
mort&a&e market pro(ed to be a disastrous step.
The Prime Culprit
4n 200# and 2003, 'ith the ,.S. housin& boom+ or better to say bubble+ 'ell under 'ay,
Lehman ac.uired fi(e mort&a&e lenders, includin& subprime lender B:) 1ort&a&e and
2urora Loan Ser(ices, 'hich speciali-ed in 2lt+2 loans ;made to borro'ers 'ithout full
documentation<. Lehman%s ac.uisitions at first seemed prescient= record re(enues from
Lehman%s real estate businesses enabled re(enues in the capital markets unit to sur&e 5">
from 2003 to 200", a faster rate of &ro'th than other businesses in in(estment bankin& or
asset mana&ement. 8he firm securiti-ed !13" billion of mort&a&es in 200", a 10> increase
from 2005. Lehman reported record profits e(ery year from 2005 to 200?. 4n 200?, the firm
reported net income of a record !3.2 billion on re(enue of !1$.# billion.
Lehman's Colossal Miscalculation
4n @ebruary 200?, the stock reached a record !8".18, &i(in& Lehman a market capitali-ation
of close to !"0 billion. 0o'e(er, by the first .uarter of 200?, cracks in the ,.S. housin&
market 'ere already becomin& apparent as defaults on subprime mort&a&es rose to a se(en+
year hi&h. On 1arch 13, 200?, a day after the stock had its bi&&est one+day drop in fi(e years
on concerns that risin& defaults 'ould affect Lehman%s profitability= the firm reported record
re(enues and profit for its fiscal first .uarter. 4n the post+earnin&s conference call, Lehman%s
)@O said that the risks posed by risin& home delin.uencies 'ere 'ell contained and 'ould
ha(e little impact on the firm%s earnin&s. 0e also said that he did not foresee problems in the
subprime market spreadin& to the rest of the housin& market or hurtin& the ,.S. economy.
The Beginning of the End
2s the credit crisis erupted in 2u&ust 200? 'ith the failure of t'o Bear Stearns hed&e funds,
Lehman%s stock fell sharply. 6urin& that month, the company eliminated 2,500 mort&a&e+
related Aobs and shut do'n its B:) unit. 4n addition, it also closed offices of 2lt+2 lender
2urora in three states. *(en as the correction in the ,.S. housin& market &ained momentum,
Lehman continued to be a maAor player in the mort&a&e market. 4n 200?, Lehman under'rote
more mort&a&e+backed securities than any other firm, accumulatin& an !85+billion portfolio,
or four times its shareholders% e.uity. 4n the fourth .uarter of 200?, Lehman%s stock
rebounded, as &lobal e.uity markets reached ne' hi&hs and prices for fi7ed+income assets
sta&ed a temporary rebound. 0o'e(er, the firm did not take the opportunity to trim its
massi(e mort&a&e portfolio, 'hich in retrospect, 'ould turn out to be its last chance.
Hurtling Toward Failure
Lehman%s hi&h de&ree of le(era&e + the ratio of total assets to shareholders e.uity + 'as #1 in
200?, and its hu&e portfolio of mort&a&e securities made it increasin&ly (ulnerable to
deterioratin& market conditions. On 1arch 1?, 2008, follo'in& the near+collapse of Bear
Stearns + the second+lar&est under'riter of mort&a&e+backed securities + Lehman shares fell as
much as 38> on concern it 'ould be the ne7t all Street firm to fail. )onfidence in the
company returned to some e7tent in 2pril, after it raised !3 billion throu&h an issue
of preferred stock that 'as con(ertible into Lehman shares at a #2> premium to its price at
the time. 0o'e(er, the stock resumed its decline as hed&e fund mana&ers be&an .uestionin&
the (aluation of Lehman%s mort&a&e portfolio.
On Bune $, Lehman announced a second+.uarter loss of !2.8 billion, its first loss since bein&
spun off by 2merican *7press, and reported that it had raised another !" billion from
in(estors. 8he firm also said that it had boosted its li.uidity pool to an estimated !35 billion,
decreased &ross assets by !13? billion, reduced its e7posure to residential and commercial
mort&a&es by 20>, and cut do'n le(era&e from a factor of #2 to about 25.
Too Little Too Late
0o'e(er, these measures 'ere percei(ed as bein& too little, too late. O(er the summer,
Lehman%s mana&ement made unsuccessful o(ertures to a number of potential partners. 8he
stock plun&ed ??> in the first 'eek of September 2008, amid plummetin& e.uity markets
'orld'ide, as in(estors .uestioned )*O 9ichard @uld%s plan to keep the firm independent by
sellin& part of its asset mana&ement unit and spinnin& off commercial real estate assets. 0opes
that the Corea 6e(elopment Bank 'ould take a stake in Lehman 'ere dashed on September
$, as the state+o'ned South Corean bank put talks on hold.
8he ne's 'as a deathblo' to Lehman, leadin& to a 35> plun&e in the stock and a ""> spike
in credit+default s'aps on the company%s debt. 8he company%s hed&e fund clients be&an
pullin& out, 'hile its short+term creditors cut credit lines. On September 10, Lehman pre+
announced dismal fiscal third+.uarter results that underscored the fra&ility of its financial
position. 8he firm reported a loss of !#.$ billion, includin& a 'rite+do'n of !5." billion, and
also announced a s'eepin& strate&ic restructurin& of its businesses. 8he same day, 1oody%s
4n(estor Ser(ice announced that it 'as re(ie'in& Lehman%s credit ratin&s, and also said that
Lehman 'ould ha(e to sell a maAority stake to a strate&ic partner in order to a(oid a ratin&
do'n&rade. 8hese de(elopments led to a 32> plun&e in the stock on September 11.
ith only !1 billion left in cash by the end of that 'eek, Lehman 'as .uickly runnin& out of
time. Last+ditch efforts o(er the 'eekend of September 1# bet'een Lehman, Barclays DL)
and Bank of 2merica, aimed at facilitatin& a takeo(er of Lehman, 'ere unsuccessful. On
1onday September 15, Lehman declared bankruptcy, resultin& in the stock plun&in& $#>
from its pre(ious close on September 12.
Conclusion
Lehman%s collapse roiled &lobal financial markets for 'eeks, &i(en the si-e of the company
and its status as a maAor player in the ,.S. and internationally. 1any .uestioned the ,.S.
&o(ernment%s decision to let Lehman fail, as compared to its tacit support for Bear Stearns
;'hich 'as ac.uired by BD1or&an )hase< in 1arch 2008. Lehman%s bankruptcy led to more
than !3" billion of its market (alue bein& 'iped out. 4ts collapse also ser(ed as the catalyst for
the purchase of 1errill Lynch by Bank of 2merica in an emer&ency deal.
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!nvolved Parties
,S &o(ernment
Lehman Brothers board of directors and mana&ersE )*O 9ichard @uld
Ordinary bankersFmort&a&e mana&ers
Ethical dilemmas
1./i(e mort&a&es to build houses to people 'ho canGt pay them back
2.6eri(ati(es 5 structure of financial instrument and handlin& amon& banks
Bankers sold them 'ithout understandin& product
#.Lie to stockholdersE is not bad that housin& bubble 'ill e7plode, no bad effects on
companies ;home delin.uencies 'ere 'ell contained and 'ould ha(e little impact on the
firm%s earnin&s<
3. Other banks and ,S &o(ernment let Lehman Brothers fail
But if &o(ernment 'ould ha(e rescued, 'ould it be ethical to let ta7 payers pay for itH
"iolated ethical principles
*thics of care 5I (iolation of ethics of care principle
Lesson learnt
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