Bankruptcy of Lehman Brothers

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Lehman Brothers headquarters in New York City

See also: Lehman Brothers

Lehman Brothers filed for Chapter 11 bankruptcy protection on September 15, 2008. The
bankruptcy of Lehman Brothers is the largest bankruptcy filing in U.S. history with
Lehman holding over $600 billion in assets.[1]

Contents
[hide]

• 1 Background
o 1.1 Exposure to the mortgage market
o 1.2 Lehman's final months
• 2 Bankruptcy filing
o 2.1 Breakup process
• 3 Impact of bankruptcy filing
• 4 Neuberger Berman
• 5 Controversies
o 5.1 Controversy of executive pay during crisis
o 5.2 Accounting manipulation
• 6 See also
• 7 References

• 8 External links

[edit] Background
Main article: Subprime mortgage crisis

[edit] Exposure to the mortgage market

Lehman borrowed significant amounts to fund its investing in the years leading to its
bankruptcy in 2008, a process known as leveraging or gearing. A significant portion of
this investing was in housing-related assets, making it vulnerable to a downturn in that
market. One measure of this risk-taking was its leverage ratio, a measure of the ratio of
assets to owners equity, which increased from approximately 24:1 in 2003 to 31:1 by
2007.[2] While generating tremendous profits during the boom, this vulnerable position
meant that just a 3-4% decline in the value of its assets would entirely eliminate its book
value or equity.[3] Investment banks such as Lehman were not subject to the same
regulations applied to depository banks to restrict their risk-taking.[4]

In August 2007, Lehman closed its subprime lender, BNC Mortgage, eliminating 1,200
positions in 23 locations, and took a $25-million after-tax charge and a $27-million
reduction in goodwill. The firm said that poor market conditions in the mortgage space
"necessitated a substantial reduction in its resources and capacity in the subprime space".
[5]

[edit] Lehman's final months

In 2008, Lehman faced an unprecedented loss due to the continuing subprime mortgage
crisis. Lehman's loss was apparently a result of having held on to large positions in
subprime and other lower-rated mortgage tranches when securitizing the underlying
mortgages. Whether Lehman did this because it was simply unable to sell the lower-rated
bonds, or made a conscious decision to hold them, is unclear. In any event, huge losses
accrued in lower-rated mortgage-backed securities throughout 2008. In the second fiscal
quarter, Lehman reported losses of $2.8 billion and was forced to sell off $6 billion in
assets.[6] In the first half of 2008 alone, Lehman stock lost 73% of its value as the credit
market continued to tighten.[6] In August 2008, Lehman reported that it intended to
release 6% of its work force, 1,500 people, just ahead of its third-quarter-reporting
deadline in September.[6]

On August 22, 2008, shares in Lehman closed up 5% (16% for the week) on reports that
the state-controlled Korea Development Bank was considering buying Lehman.[7] Most of
those gains were quickly eroded as news emerged that Korea Development Bank was
"facing difficulties pleasing regulators and attracting partners for the deal."[8] It
culminated on September 9, 2008, when Lehman's shares plunged 45% to $7.79, after it
was reported that the state-run South Korean firm had put talks on hold.[9]

Investor confidence continued to erode as Lehman's stock lost roughly half its value and
pushed the S&P 500 down 3.4% on September 9, 2008. The Dow Jones lost nearly 300
points the same day on investors' concerns about the security of the bank.[10] The U.S.
government did not announce any plans to assist with any possible financial crisis that
emerged at Lehman.[11]
On September 10, 2008, Lehman announced a loss of $3.9 billion and their intent to sell
off a majority stake in their investment-management business, which includes Neuberger
Berman.[12][13] The stock slid 7% that day.[13][14]

On September 13, 2008, Timothy F. Geithner, then president of the Federal Reserve
Bank of New York called a meeting on the future of Lehman, which included the
possibility of an emergency liquidation of its assets.[15] Lehman reported that it had been
in talks with Bank of America and Barclays for the company's possible sale.[15] The New
York Times reported on September 14, 2008, that Barclays had ended its bid to purchase
all or part of Lehman and a deal to rescue the bank from liquidation collapsed.[16] It
emerged subsequently that a deal had been vetoed by the Bank of England and the UK's
Financial Services Authority.[17] Leaders of major Wall Street banks continued to meet
late that day to prevent the bank's rapid failure.[16] Bank of America's rumored
involvement also appeared to end as federal regulators resisted its request for government
involvement in Lehman's sale.[16]

[edit] Bankruptcy filing

Lehman Brothers headquarters in New York City

Lehman Brothers filed for Chapter 11 bankruptcy protection on September 15, 2008.
According to Bloomberg, reports filed with the U.S. Bankruptcy Court, Southern District
of New York (Manhattan) on September 16 indicated that J.P. Morgan provided Lehman
Brothers with a total of $138 billion in "Federal Reserve-backed advances." The cash-
advances by JPMorgan Chase were repaid by the Federal Reserve Bank of New York for
$87 billion on September 15 and $51 billion on September 16.[18]

[edit] Breakup process

On September 22, 2008, a revised proposal to sell the brokerage part of Lehman Brothers
holdings of the deal, was put before the bankruptcy court, with a $1.3666 billion (£700
million) plan for Barclays to acquire the core business of Lehman Brothers (mainly
Lehman's $960 million Midtown Manhattan office skyscraper), was approved. Manhattan
court bankruptcy Judge James Peck, after a 7 hour hearing, ruled: "I have to approve this
transaction because it is the only available transaction. Lehman Brothers became a
victim, in effect the only true icon to fall in a tsunami that has befallen the credit markets.
This is the most momentous bankruptcy hearing I've ever sat through. It can never be
deemed precedent for future cases. It's hard for me to imagine a similar emergency."[19]

Barclays acquired the investment banking business of Lehman Brothers in September

2008

Luc Despins, the creditors committee counsel, said: "The reason we're not objecting is
really based on the lack of a viable alternative. We did not support the transaction
because there had not been enough time to properly review it."[citation needed] In the amended
agreement, Barclays would absorb $ 47.4 billion in securities and assume $ 45.5 billion
in trading liabilities. Lehman's attorney Harvey R. Miller of Weil, Gotshal & Manges,
said "the purchase price for the real estate components of the deal would be $ 1.29
billion, including $960 million for Lehman's New York headquarters and $ 330 million
for two New Jersey data centers. Lehman's original estimate valued its headquarters at $
1.02 billion but an appraisal from CB Richard Ellis this week valued it at $900
million."[citation needed] Further, Barclays will not acquire Lehman's Eagle Energy unit, but
will have entities known as Lehman Brothers Canada Inc, Lehman Brothers Sudamerica,
Lehman Brothers Uruguay and its Private Investment Management business for high net-
worth individuals. Finally, Lehman will retain $20 billion of securities assets in Lehman
Brothers Inc that are not being transferred to Barclays.[20] Barclays had a potential
liability of $ 2.5 billion to be paid as severance, if it chooses not to retain some Lehman
employees beyond the guaranteed 90 days.[21][22]

On September 22, 2008, Nomura Holdings, Inc. announced it agreed to acquire Lehman
Brothers' franchise in the Asia Pacific region including Japan, Hong Kong and Australia.
[23]
The following day, Nomura announced its intentions to acquire Lehman Brothers'
investment banking and equities businesses in Europe and the Middle East. A few weeks
later it was announced that conditions to the deal had been met, and the deal became
legally effective on Monday, 13 October.[24] In 2007, non-US subsidiaries of Lehman
Brothers were responsible for over 50% of global revenue produced.[25]

[edit] Impact of bankruptcy filing

The Dow Jones closed down just over 500 points (−4.4%) on September 15, 2008, at the
time the largest drop by points in a single day since the days following the attacks on
September 11, 2001.[26] (This drop was subsequently exceeded by an even larger −7.0%
plunge on September 29, 2008.)

Lehman's bankruptcy is expected to cause some depreciation in the price of commercial

real estate. The prospect for Lehman's $4.3 billion in mortgage securities getting
liquidated sparked a selloff in the commercial mortgage-backed securities (CMBS)
market. Additional pressure to sell securities in commercial real estate is feared as
Lehman gets closer to liquidating its assets. Apartment-building investors are also
expected to feel pressure to sell as Lehman unloads its debt and equity pieces of the $22
billion purchase of Archstone, the third-largest United States Real Estate Investment
Trust (REIT). Archstone's core business is the ownership and management of residential
apartment buildings in major metropolitan areas of the United States. Jeffrey Spector, a
real-estate analyst at UBS said that in markets with apartment buildings that compete
with Archstone, "there is no question that if you need to sell assets, you will try to get
ahead" of the Lehman selloff, adding "Every day that goes by there will be more pressure
on pricing."[27]

Several money funds and institutional cash funds had significant exposure to Lehman
with the institutional cash fund run by The Bank of New York Mellon and the Primary
Reserve Fund, a money-market fund, both falling below $1 per share, called "breaking
the buck", following losses on their holdings of Lehman assets. In a statement The Bank
of New York Mellon said its fund had isolated the Lehman assets in a separate structure.
It said the assets accounted for 1.13% of its fund. The drop in the Primary Reserve Fund
was the first time since 1994 that a money-market fund had dropped below the $1-per-
share level.

Putnam Investments, a unit of Canada's Great-West Lifeco, shut a $12.3 billion money-
market fund as it faced "significant redemption pressure" on September 17, 2008.
Evergreen Investments said its parent Wachovia Corporation would "support" three
Evergreen money-market funds to prevent their shares from falling.[28] This move to
cover $494 million of Lehman assets in the funds also raised fears about Wachovia's
ability to raise capital.[29]

Close to 100 hedge funds used Lehman as their prime broker and relied largely on the
firm for financing. In an attempt to meet their own credit needs, Lehman Brothers
International routinely re-hypothecated[30] the assets of their hedge funds clients that
utilized their prime brokerage services. Lehman Brothers International held close to 40
billion dollars of clients assets when it filed for Chapter 11 Bankruptcy. Of this, 22
billion had been re-hypothecated.[31] As administrators took charge of the London
business and the U.S. holding company filed for bankruptcy, positions held by those
hedge funds at Lehman were frozen. As a result the hedge funds are being forced to de-
lever and sit on large cash balances inhibiting chances at further growth.[32] This in turn
created further market dislocation and over all systemic risk, resulting in a 737 billion
dollar decline in collateral outstanding in the securities lending market.[33]

In Japan, banks and insurers announced a combined 249 billion yen ($2.4 billion) in
potential losses tied to the collapse of Lehman. Mizuho Trust & Banking Co. cut its profit
forecast by more than half, citing 11.8 billion yen in losses on bonds and loans linked to
Lehman. The Bank of Japan Governor Masaaki Shirakawa said "Most lending to Lehman
Brothers was made by major Japanese banks, and their possible losses seem to be within
the levels that can be covered by their profits," adding "There is no concern that the latest
events will threaten the stability of Japan's financial system."[34] During bankruptcy
proceedings a lawyer from The Royal Bank of Scotland Group said the company is
facing between $1.5 billion and $1.8 billion in claims against Lehman partially based on
an unsecured guarantee from Lehman and connected to trading losses with Lehman
subsidiaries, Martin Bienenstock.[35]

Lehman was a counterparty to mortgage financier Freddie Mac in unsecured lending

transactions that matured on September 15, 2008. Freddie said it had not received
principal payments of $1.2 billion plus accrued interest. Freddie said it had further
potential exposure to Lehman of about $400 million related to the servicing of single-
family home loans, including repurchasing obligations. Freddie also said it "does not
know whether and to what extent it will sustain a loss relating to the transactions" and
warned that "actual losses could materially exceed current estimates." Freddie was still in
the process of evaluating its exposure to Lehman and its affiliates under other business
relationships.[36]

After Constellation Energy was reported to have exposure to Lehman, its stock went
down 56% in the first day of trading having started at $67.87. The massive drop in stocks
led to the New York Stock Exchange halting trade of Constellation. The next day, as the
stock plummeted as low as $13 per share, Constellation announced it was hiring Morgan
Stanley and UBS to advise it on "strategic alternatives" suggesting a buyout. While
rumors suggested French power company Électricité de France would buy the company
or increase its stake, Constellation ultimately agreed to a buyout by MidAmerican
Energy, part of Berkshire Hathaway (headed by billionaire Warren Buffett).[37][38][39]

The Federal Agricultural Mortgage Corporation or Farmer Mac said it would have to
write off $48 million in Lehman debt it owned as a result of the bankruptcy. Farmer Mac
said it may not be in compliance with its minimum capital requirements at the end of
September.[40]
In Hong Kong more than 43,700 individuals in the city have invested in HK$15.7 billion
of "guaranteed mini-bonds" (迷你債券) from Lehman.[41][42][43] Many claim that banks and
brokers mis-sold them as low-risk. Conversely, bankers note that minibonds are indeed
low-risk instruments since they were backed by Lehman Brothers, which until just
months before its collapse was a venerable member of Wall Street with high credit and
investment ratings. The default of Lehman Brothers was a low probability event, which
was totally unexpected. Indeed, many banks accepted minibonds as collateral for loans
and credit facilities. Another HK$3 billion has been invested in similar like derivatives.
The Hong Kong government proposed a plan to buy back the investments at their current
estimated value, which will allow investors to partially recover some of their loss by the
end of the year.[44] HK chief executive Donald Tsang insisted the local banks respond
swiftly to the government buy-back proposal as the Monetary Authority received more
than 16,000 complaints.[41][43][44] On October 17 He Guangbe, chairman of the Hong Kong
Association of Banks, agreed to buy back the bonds, which will be priced using an agreed
upon methodology based on its estimated current value.[45] This episode has deep
repercussions on the banking industry, where misguided investor sentiments have
become hostile to both wealth management products as well as the banking industry as a
whole. Under intense pressure from the public, all political parties have come out in
support of the investors, further fanning distrust towards the banking industry.

Politically the bankruptcy proved of influence on the 2008 United States Presidential
Election, for the day after Barack Obama moved ahead of John McCain in the
presidential gallup poll, never again to fall behind.[dubious – discuss]

[edit] Neuberger Berman

Neuberger Berman Inc., through its subsidiaries, primarily Neuberger Berman, LLC,
is an investment-advisory firm founded in 1939 by Roy R. Neuberger and Robert
Berman, to manage money for high-net-worth individuals. In the decades that followed,
the firm's growth mirrored that of the asset-management industry as a whole. In 1950, it
introduced one of the first no-load mutual funds in the United States, the Guardian Fund,
and also began to manage the assets of pension plans and other institutions. Historically
known for its value-investing style, in the 1990s the firm began to diversify its
competencies to include additional value and growth investing, across the entire
capitalization spectrum, as well as new investment categories, such as international, real-
estate investment trusts and high-yield investments. In addition, with the creation of a
nationally and several state-chartered trust companies, the firm became able to offer trust
and fiduciary services. Today the firm has approximately $130 billion in assets under
management.
Neuberger Berman's New York City headquarters on Third Avenue.

In October 1999, the firm conducted an initial public offering of its shares and
commenced trading on the New York Stock Exchange, under the ticker symbol "NEU".
In July 2003, shortly after the retired Mr. Neuberger's 100th birthday, the company
announced that it was in merger discussions with Lehman Brothers Holdings Inc. These
discussions ultimately resulted in the firm's acquisition by Lehman on October 31, 2003,
for approximately $2.63 billion in cash and securities.

On November 20, 2006, Lehman announced its Neuberger Berman subsidiary would
acquire H. A. Schupf & Co., a money-management firm targeted at wealthy individuals.
Its $2.5 billion of assets would join Neuberger's $50 billion in high-net-worth client
assets under management.[46]

An article in The Wall Street Journal on September 15, 2008, announcing that Lehman
Brothers Holdings filed for Chapter 11 bankruptcy protection, quoted Lehman officials
regarding Neuberger Berman: "Neuberger Berman LLC and Lehman Brothers Asset
Management will continue to conduct business as usual and will not be subject to the
bankruptcy case of the parent company, and its portfolio management, research and
operating functions remain intact. In addition, fully paid securities of customers of
Neuberger Berman are segregated from the assets of Lehman Brothers and aren't subject
to the claims of Lehman Brothers Holdings' creditors, Lehman said."[47]

Just before the collapse of Lehman Brothers, executives at Neuberger Berman sent e-mail
memos suggesting, among other things, that the Lehman Brothers' top people forgo
multi-million dollar bonuses to "send a strong message to both employees and investors
that management is not shirking accountability for recent performance."

Lehman Brothers Investment Management Director George Herbert Walker IV dismissed

the proposal, going so far as to actually apologize to other members of the Lehman
Brothers executive committee for the idea of bonus reduction having been suggested. He
wrote, "Sorry team. I am not sure what's in the water at Neuberger Berman. I'm
embarrassed and I apologize."[48]

[edit] Controversies
[edit] Controversy of executive pay during crisis

Richard Fuld, head of Lehman Brothers, faced questioning from the U.S. House of
Representatives' Committee on Oversight and Government Reform. Rep. Henry Waxman
(D-CA) asked: "Your company is now bankrupt, our economy is in crisis, but you get to
keep $480 million (£276 million). I have a very basic question for you, is this fair?"[49]
Fuld said that he had in fact taken about $300 million (£173 million) in pay and bonuses
over the past eight years.[49] Despite Fuld's defense on his high pay, Lehman Brothers
executive pay was reported to have increased significantly before filing for bankruptcy.[50]
On October 17, 2008, CNBC reported that several Lehman executives, including Richard
Fuld, have been subpoenaed in a case relating to securities fraud.[citation needed]

[edit] Accounting manipulation

In March 2010, the report of Anton R. Valukas, the Bankruptcy Examiner, drew attention
to the use of Repo 105 transactions to boost the bank's apparent financial position around
the date of the year-end balance sheet. The attorney general later Andrew Cuomo filed
charges against the bank's auditors Ernst & Young in December 2010, alleging that the
firm "substantially assisted... a massive accounting fraud" by approving the accounting
treatment.[51]

On April 12, 2010, a New York Times story revealed that Lehman had used a small
company, Hudson Castle, to move a number of transactions and assets off Lehman's
books as a means of manipulating accounting numbers of Lehman's finances and risks.
One Lehman executive described Hudson Castle as an "alter ego" of Lehman. According
to the story, Lehman owned one quarter of Hudson; Hudson's board was controlled by
Lehman, most Hudson staff members were former Lehman employees.[52]

[edit] See also

Wikinews has related news: Lehman Brothers files for bankruptcy

• Valukas Report
• Bear Stearns
• List of entities involved in 2007-2008 financial crises
• Subprime crisis impact timeline
• United States housing market correction
• Federal takeover of Fannie Mae and Freddie Mac
• A Colossal Failure of Common Sense
• Aurora Bank
• Hudson Castle Group, Inc.

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[edit] External links

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