Lehman Brothers

a) ISSUE
The bankruptcy of Lehman Brothers is the largest bankruptcy filing in U.S. history with Lehman holding over $600 billion in assets. 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". 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. In the first half of 2008 alone, Lehman stock lost 73% of its value as the credit market continued to tighten. 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. 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. 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." 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. 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. The U.S. government did not announce any plans to assist with any possible financial crisis that emerged at Lehman. 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. The stock slid 7% that day. 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. Lehman reported that it had been in talks with Bank of America and Barclays for the company's possible sale. 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. It emerged subsequently that a deal had been vetoed by the Bank of England and the UK's Financial Services Authority. Leaders of major Wall Street banks continued to meet late that day to prevent the bank's rapid failure. Bank of America's rumored involvement also appeared to end as federal regulators resisted its request for government involvement in Lehman's sale. Lehman had reached the end of the line.

b)

BACKGROUND

Lehman Brothers was founded in 1850 by two cotton brokers in Montgomery, Ala. Lehman Brothers Holdings, Inc., through its subsidiaries, provides various financial services to corporations, governments and municipalities, institutions, and high-net-worth individuals worldwide. The company operates in three segments: Capital Markets, Investment Banking, and Investment Management. The Capital Markets segment represents institutional customer flow activities, including secondary trading, financing, mortgage origination and securitization, prime brokerage, and research activities in fixed income and equity products. It also offers equity and fixed income products, including U.S., European, and Asian equities; government and agency securities; money market products; corporate high grade securities; high yield and emerging market securities; mortgage- and asset-backed securities; preferred stock; municipal securities; bank loans; foreign exchange; and financing and derivative products. The Investment Banking segment provides advice to corporate, institutional, and government clients on mergers, acquisitions, and other financial matters. It also raises capital for clients by underwriting public and private offerings of debt and equity instruments. The Investment Management segment consists of private investment management, which provides investment, wealth advisory, and capital markets execution services to high net worth and middle market institutional clients; and asset management that provide customized investment management services for high net worth clients, mutual funds, and other small and middle market institutional investors. Its primary subsidiaries included Lehman Brothers Inc., Neuberger Berman Inc., Aurora Loan Services, Inc., SIB Mortgage Corporation, Lehman Brothers Bank, FSB, Eagle Energy Partners, and the Crossroads Group. The firm's worldwide headquarters were in New York City, with regional headquarters in London and Tokyo, as well as offices located throughout the world. The source balance statement listed the company's assets as $314 billion in cash, $42 billion in net receivables, $4.3 billion in fixed assets, and $279 billion in non-current assets.

c)

PROBLEM

Those days there was mortgage crisis in United States due to decline in prices of real-estates. As a result, housing loans made by the bank to people with little support made these loans very risky, and when interest rates were raised by these banks, these borrowers could no more repay Lehman. This led to huge losses for Lehman. It caused $60 billion loss in bad real estate loans for Lehman Bros. One of the main reasons for its downfall was its poor relations with top banks of United States. They refused to do business with Lehman due to over-confidence of its CEO over the Lehman financial assets. And after big debt of $639 billion, when Lehman asked Barclays and Bank of America for acquisition, they simply rejected the offer.

d)

FINDINGS

Lehman Brothers became bankrupt, as a large part of their loan portfolio comprised of loans for buying real estate. With the meltdown in the property market in US the values of properties became lesser than the value of loan outstanding. Due to this most of the loans became irrecoverable leading to bankruptcy of Lehman Brothers. In short, I can summarize the reasons of bankruptcy as follows: They faced huge losses in the mortgage market and a loss of investors confidence. They were unable to find a buyer. They had assets worth billions of dollars but were unable to maintain positive Balance Sheet during the last many quarters. Also the future looked bleak and the stock value was declining very rapidly. They were unable to meet their cash commitments. And finally, the loans they gave were unable to recover.

e)

RECOMMENDATIONS

There are some basic reasons for bankruptcy, both personal and business: Bad Luck, Acts of God, Circumstances beyond Your Control:

The biggest reason for personal bankruptcy is long-term illness/poor health. Businesses often go bankrupt because they can't recover from natural disasters like flooding, or other events like a fire. If the business doesn't have enough insurance, including business interruption coverage, it might have to give up.
Lack of Planning; Forgetting to Save For Emergencies:

Many businesses fail because they have not planned for emergencies. They live close to the edge with their cash flow, and then when a large bill comes due, they are in trouble. So they borrow from themselves (or their customers), or they delay paying bills, until the snowball of debt is too big to recover from. Although it's difficult to do, having some money saved to pay unexpected bills is necessary for business survival. Poor Financial Decisions: Everyone makes mistakes, but in business you can't afford errors very often, particularly when it comes to finances. Big companies often think they are immune to the basic laws of finance (like the principle of cash flow (more cash must be flowing in than is flowing out), and the rule that your assets must exceed your liabilities. Small businesses don't have time to recover from these errors; they are like planes flying close to the ground; no margin of error. Get good financial advice, from your board of directors or others, before you make critical business decisions.