The Reason Behind the Collapse of the Lehman Brothers and Recommendation for the Firm

Lehman Brothers
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Abstract
The paper addresses the collapse of the Lehman Brothers. It illustrates the reason for the firm’s failure, why it was allowed to fall, the consequences, and what could have been done to save the situation. The main focus of the study is to analyze the causes of Lehman Brothers’ collapse and why it wasn’t easy to help the firm continue its operations. Multiple factors such as poor management practices, the firm’s financial well-being when it filed for bankruptcy, political intervention, lack of private enterprises to help in the rescues operations, and policymakers’ decision are discussed in the context. Also, the study provides recommendations for robust organization governance techniques, risk management methods, and continuous and correct monitoring and supervision of financial bodies.
Keywords: Lehman Brothers, Management, Finance, Bankruptcy.
Introduction
Lehman Brothers Holdings Inc. was a worldwide financial service organization formed in 1847. The firm was the fourth-largest investment bank in the United States before filing for bankruptcy in 2008. It had approximately 28,000 employees across the globe, and its operations included investment banking, private equity, research, treasury security trading, to mention a few. On 15th September 2008, after the Lehman Brothers filed for bankruptcy, many employees vacated the premises, holding boxes in their hands. The firm asset value was $639 billion and $613 for liabilities (AMADEO & RASURE, 2020). The 2007-2008 financial crises and the subprime meltdown that affected financial markets resulting in an estimated loss of $10 trillion worth of economic output, played a significant role in the bank’s downfall. The stock price for the Lehman Brothers was $86.18 per share in February 2007, placing its market capitalization at approximately $60 billion (Lioudis, 2021). The organization reported its revenue and profits for the first fiscal quarter on 14th March 2007. After the earnings report, Lehman deduced that the risks present due to the rising home delinquencies would not affect the firm’s income.
During the credit crisis in 2007, Lehman’s stock was reduced at an alarming rate. Similarly, the firm eradicated 1,200 mortgage-related positions and closed its BNC branch. The firm underwrote additional mortgage-backed securities than any other organization in 2007, accumulating a portfolio of $85 billion (Lioudis, 2021). The firm failed to take the opportunity to trim its colossal mortgage portfolio, which in reconsideration would be its last chance. On 17th March 2008, Lehman’s share dropped approximately 48% due to concerns that the firm would fall after Bear Stearns’ near-collapse. However, confidence in the firm returned in April 2008 after the preferred stock issue that was convertible into Lehman shares but later declined after hedge fund managers started questioning the valuation of the firm’s mortgage portfolio. The firm announced a second-quarter loss of $2.8 billion on 7th June 2008 (Lioudis, 2021). It was its first loss since the American express spun off. This paper illustrates why the Lehman Brothers were allowed to fall despite being an enormous investments bank in the United States.
Why Lehman Brothers was allowed to Fall
Lehman Brothers was Weak
The Federal Reserve failed to rescue the Lehman Brothers since the firm was weaker than Bearn Stearns, which was salvaged in March the same year. Investors began to lose confidence in Lehman after weakening the real estate trade. There were significant concerns about the type of assets after a reduced liquidity rate in the market. In 2008, Lehman’s management engaged in unsuccessful advances with multiple partners. Its stock dropped by 75% in the first week of September 2008. Investors were concerned with the CEO’s decision to keep the organization independent by selling a portion of its assets management unit and broadening its commercial real estate products (Hancock, 2013). On 9th September, the South-Korean bank held talks to stake Lehman. As a result, the firm’s stock dropped 45%, and its debt increased by 66% in credit-default swaps. Multiple credit companies began to ignore the firm, breaking its financial position. Lehman announced a comprehensive strategic restructuring after encountering a $3.9 billion loss that included a write-down worth $5.6 billion (Lioudis, 2021). After reviewing the firm’s credit ratings, Moody’s Investor Service deduced that Lehman could avoid a downgrade rating by selling a majority stake to a strategic partner. The development resulted in an additional drop in stock value by 42% by 11th September. The continuous decline of stock made it challenging for the Federal Reserve to save the firm since it lost a significant market share.
Additionally, Lehman Brothers Inc. was broke with little probability of recovering. Unlike Bear Stearns, Lehman’s brother was broke. The Federal Reserve rescued Bear Stearns since the value of their assets was higher than their debts. However, they lacked liquid and ready cash since most of their resources were held in long-term commitments such as mortgages and loans. Lehman didn’t have long-term investments, and their debts were more than their assets were worth. Bear Stearns operated many banks; they borrowed money from other banks to finance their operations. The lending banks started raising concerns about the ability of bear Stearns to pay back immediately. The banks knew they would be paid back eventually but not instantly hence terminating the daily money lending. Later, the Federal Reserve Bank intervened by helping JP Morgan purchase Bear Stearns, reducing the risks. Also, the Fed promised to pay up if Bear’s multiple assets were unreachable, which made JP Morgan contented (DAVIDSON, 2008). On the flip side, the Fed was required to undertake extra measures to save Lehman Brothers since the firm’s debt was huge and lacked assets. The Fed would have handed out money to anyone thinking of purchasing Lehman Brothers. They would have paid a private corporation to save another company. The procedure made it difficult for the Federal Reserve to intervene and save Lehman Brothers.
Lastly, Lehman was unable to meet its short-term obligations. The firm was facing intermittent liquidity problems despite having a high asset base. The scenario led to a loss of market confidence, and enterprises segregated themselves from the organization. The firm reduced its attraction to customers, and stakeholders started withdrawing their services. Lehman decreased its asset base to $147 billion to enhance its liquidity position. Also, the firm engaged in multiple risky and inappropriate investments to increase the mini structure and take their chances in the real estate market. Between 2006 and 2007, approximately half of the firm’s CDOs worth $431 billion had faced defaults by November 2008 (Vlukas, 2010). Financial analysts suggested that the drastic decline in CDOs value played a crucial role in Lehman Brothers’ collapse. Also, the firm had a high tendency for borrowing, which ruined its reputation.
The Firm had A Poor Management
Lehman’s management failed to act quickly and wisely before filing for bankruptcy in 2008. Experts argue that the firm had adequate collateral to request short-term funding from the Fed and avoid the immediate collapse. In March 2018, the Federal Reserve set up the Primary Dealer Credit Facility (PDCF), allowing primary dealers to lend money against collateral. PDCF was formed after the Bear Stearns disaster to protect investment banks from running on the repo market. Through PDCF, dealers could lend money with a wide range of collateral and were protected from challenges while borrowing in repos. On 24th September 2008, PDCF began accepting any collateral committed on tri-party repo trade (Cloud Y., 2018). By so doing, it assured people who felt the repo market was closing on them. Lehman Brothers had adequate collateral to acquire funds through PDCF and extend their survival for some time. Although the money could not sustain long-term operations for the firm, it could have provided adequate time for the firm to cease operations orderly.
Lehman Brothers’ management used doubtful mechanisms and inappropriate accounting techniques without considering the proper business governance operations. Studies have indicated that the organization always avoided showing its financial records. Lehman Brothers applied an accounting procedure to window dress its financial records and altered the statements to portray a positive view to the public with the help of their dishonest auditors (Dutta et al., 2020). Also, the firm used a repurchase agreement to alter the financial records in its favor. For instance, the firm manipulated its balance in 2008 to hide funds, which is unacceptable. Banks and financial institutions can legally participate in repo transactions. However, the procedure should consider the corporation and st...