Q&A: The collapse of

Lehman Brothers

1. Why has Lehman Brothers collapsed?

In short, other banks refused to trade with it. Without the

ability to trade, and without investors prepared to bet on its
long-term viability, Lehman effectively had no business.

2. Why would the other banks not trade?

It is a repeat of the Northern Rock debacle. Lehman, while

it was a large and complex business trading in a web of
assets, also supported 100% mortgage loans offered by
specialist lenders to people with few visible means of
support. When interest rates jumped, borrowers could no
longer afford their monthly payments.

Like Northern Rock, it mattered less that 80% of its assets

were rock solid if 20% were considered toxic. We don't
know the exact proportions at Lehman and neither do the
bank's trading partners, which is why they refused in
growing numbers to do business or buy it once the bank
was up for sale.

3. Could the US government have stepped in?

The US treasury has reached the limit of taxpayer funds it

is willing to gamble on propping up investment banks.
Henry Paulson, the treasury secretary, committed £3 trillion
last week to saving Fannie Mae and Freddie Mac. If they
had failed, the mortgage market in the US would have
collapsed and hundreds of banks around the world that
invested in US property would suffer huge losses.
 Paulson bailed out Bear Stearns earlier this year, but he
appears to believe a trading house like Lehman, which has
little direct connection with retail markets and ordinary
homeowners, could be allowed to go bust without causing
the kind of systemic risk posed by Fannie and Freddie.

4. Why was Barclays interested?

Barclays joined the talks at the weekend to buy Lehman

because it was interested in picking up the bank on the
cheap. It is a re-run of the proposed deal for Northern Rock
by Lloyds TSB at the time of its collapse last summer.

Lloyds TSB offered to buy Northern Rock and accept its

liabilities if the government was prepared to set aside
£30bn in discounted loans to support the takeover.
Barclays asked Paulson for the same kind of guarantee. He
refused. The main City regulator, the Financial Services
Authority, was also believed to have expressed concerns
to Barclays boss John Varley that it was unwise to buy a
US investment bank at this time.

5. Will everyone at Lehman's get the sack?

The administrators, PricewaterhouseCoopers, said the

bank was centrally run from New York and therefore all its
main businesses across Europe are wrecked. That puts
5,000 people who are employed at the bank, largely in
Canary Wharf, out of work.

6. Will the whole bank be liquidated?

Not yet. Chapter 11 administration in the US allows PwC to

take its time while it tries to find buyers for the least
affected businesses. The year-long protection offered by
Chapter 11 shields a company from creditors while it is
reshaped or sold as a whole or in parts.

PWC said a number of group companies remain solvent

and will continue to trade. "These companies include
 Lehman Brothers Asset Management (Europe) and a series
of special-purpose vehicles designed to manage portfolios
of residential and commercial real estate assets and non-
performing loans."

7. What are the risks for other banks?

Share prices have tumbled and are likely to fall further as
investors take flight from a sector that appears to be run by
a group of bankers who are in denial about the extent of
their mistakes and the problems their firms now face.

A flight of investors will make their situation worse

because they are to a great extent dependent on their
shareholders for capital. The capital provided by
shareholders is the bedrock for their lending and without it
they cannot continue trading.

8. What is the position with Bank of America and Merrill

Lynch?

In many ways the sale of Merrill Lynch to Bank of America

is a more startling development in the year-long credit
crunch than the collapse of Lehman. It is understood that
once it was obvious Lehman's was going under, Merrill
realised it was vulnerable. The "thundering herd", as
Merrill is affectionately known, was approached by Bank of
America earlier this year, but rebuffed takeover talks. Now
it was Merrill that went cap in hand to the US's largest retail
bank for a rescue deal. Sceptics say the deal does little to
resolve the problems faced by both firms, which are
heavily mired in the US sub-prime home debacle.

9. What's going on at AIG?

American International Group (AIG), which sponsors

Manchester United FC, was hit hard by deterioration in the
credit markets last week and yesterday issued a statement
that said it was reviewing its operations. Its stock dropped
45% since the start of the week amid concerns about the
security of its assets, many of which are linked to the
 financial turmoil on Wall Street. Over the weekend it crafted
a $40bn loan facility from the federal reserve, which had
obviously taken the view that AIG posed more of a
systemic risk than Lehman.

10.Who's next?

Washington Mutual is named by several analysts as the

next to find itself in serious trouble. It was the subject of a
rescue led by private equity firm Texas Pacific group in the
spring. But the billions poured into its coffers no longer
look sufficient to satisfy investors and they are taking
flight. It is possible shareholders will flee Bank of America,
if they consider Merrill Lynch a bad buy.

Another victim could be the US mono line insurers, so

called because they only insure the bonds of large
companies, including mortgage lending institutions. Like
AIG, the insurance cover they provide could be invoked by
customers and, like a tsunami, overwhelm their finances.

In the UK, mortgage banks such as Halifax owner HBOS,

Alliance & Leicester and Bradford & Bingley, could suffer
further if investors switch to safer havens.

11.Will it make a recession worse?

Yes. The CBI predicts a "shallow recession" next year, but

this now appears optimistic. If the last five years of our
decade-long economic boom were characterised by
reckless lending, then living standards, along with property
prices, have a long way to fall.

We are all spending money we simply don't have and when

we stop it will spell the end for many jobs in retail,
hospitality and may other industries. A fall in the value of
the pound will help exporters and that will offset the worst
of the economy's problems. But without banks willing or
able to lend money to millions of people, except at sky-
high interest rates, a long and deep recession seems
inevitable.