Factors That Contributed to The Financial Failure of the Firm

Investment Risk Management
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Institutional Affiliation

Investment Risk Management
Lehman Brothers Holding was the fourth largest investment bank in the U.S, with a total of 25000 employees across the globe. On mid-September 2008, the bank filed for bankruptcy, with its assets valued at $ 639 billion and its debts amounting to $613 billion (Astapova, 2014). The bankruptcy filing surpassed the previous bankruptcy ever filled in history, such as that of Enron and WorldCom, making it the largest bankruptcy proceed. The collapse of the firm had a large impact on the global economic and financial performance, and resulted in a global slump in 2008. Under the management of the company’s chief executive officer; Richard Fuld, the company was using a high-leverage financing method, which was a highly risky model that required the company to raise billions of dollars on a daily basis to finance its operations. The company employed many risk professionals and accountants to monitor its balance sheet, risks, and key ratios. The company was engaged in questionable and desperate actions to stay in business. However, the company finally collapsed as a result of the inability to finance its operations. The bankruptcy of the company is mainly attributed to inappropriate risk management practices employed by the firm and its advisors.
1. Factors That Contributed to The Financial Failure of the Firm
One of the major causes of the Lehman Brothers Holding collapsing was the exposure to the U.S. real estate markets and subprime mortgage markets. In the year 2006, Lehman Brothers Holding adopted a new business strategy with the aim of increasing the revenues from asset investments, and this exposed the company to more capital risks. When the subprime mortgage markets began to experience a slowdown, they contracted their rate of short term loans provision as a risk management strategy against the unknown exposure on the short-term markets. At the time, Lehman relied on this financing method to raise billions of dollars required to finance its daily operations. The inability of the company to secure the funds led to its downfall (Astapova, 2014). Other factors that contributed to the fall of the company is the high-leveraged and risk-taking financing strategies and limited equity, complicated corporate structures, and products that spread risk across all the department; an excessive risk-taking culture. In addition, regulatory gaps that did not take into account the systemic risks faced by large global firms also contributed to the downfall of the company.
The management contributed to the collapse of the company due to its inability to control the business risks. In the case of high leverage and low equity levels, the management failed to put in place measures that would reduce the rate at which the company depended on short-term loan finances to fund its operations. The management also failed to realize the risk associated with the involvement in the real estate activities, and work towards mitigating the risks. The complicated business practices and structures exposed the firm to financial risks (Aikman, 2010). The management also failed to put in control the excessive risk-taking culture exhibited by the firm, and this ultimately led to its downfall.
Firms should put in place measures aimed at managing the extent of risk exposure. Such measures include hiring professionals who are involved in risk mitigation planning. The risk mitigation process involves identifying potential risks, analyzing the causes of the risk and then coming up with mitigation tools, methods, and strategies that can be enforced. The risk mitigation practices aid in identifying business risks and solving them before they caused more damage to the firm. Risks can be managed through methods such as risk avoidance, risk transfer, risk hedging and risk control. Risk avoidance involves elimination of business activities that are likely to result in the identified risks. Risk transfer involves putting in place measures that transfer the risk to a third party, for example by insuring the risk so that the company will receive compensation in the event that the risk occurs. Hedging involves the establishment of some buffer or reserve that absorbs the effects of the risks. The final risk management method is risk control, which involves putting in place measures aimed at reducing the likelihood or impact of risk occurring (Das, 2006). It is necessary for any firm to put in place risk management practices to safeguard its operations.
2. Sufficiency of Risk Management Techniques Used by Financial Institutions Today
All investments have a given level of risk and uncertainty associated with them. However, high-risk investments such as investment in mortgage-backed securities carry a considerably high level of risk, and therefore require proper risk management practices to be put in place. When undertaking these high-risk investments, it is important for companies to analyze what the investments entails before decided to include the investments in the investment portfolio. Professional advice is necessary when analyzing the investments. In case an investment proves to be unsuitable for the company, the company should avoid it, so as to evade the losses that may result from t...