In 2008 Lehman Brothers made headlines by filing for the
largest bankruptcy in history. At the time of this historic collapse Lehman
brothers were the fourth largest US investment bank and had $639 billion in
assets and $619 billion in debt. So how did it all go wrong? What caused these
giants in the investment industry to collapse in such dramatic fashion? Earlier
in the week I watched a very enlightening drama on the demise of Lehman
Brothers and showed exactly where they went wrong!
Ever since the financial crisis hit in 2007 the share price
of Lehman Brothers continued to fall at a consistent rate, however Lehman Brothers
still reported that they had a net income of $4.2 billion from a $19.3 billion.
So how can a company operating so successfully one year become the mess that
Lehman Brothers did? Well to put it in “Lehman’s” terms, they made a lot of
short term investments that increased the cash flow of the company temporarily,
fooling the shareholders and investors. This contributed to their own
detriment, as when shareholders caught wind of this they started selling shares
at a very quick rate, resulting in the share price dropping radically.
Lehman Brothers also shot themselves in the foot, as they
continued to buy mortgage securities when the housing market was a swiftly
failing one. In 2007 they back more mortgage based securities than any other
firm and their portfolio built up to a massive $85 billion! Due to market
conditions continuing to deteriorate, Lehman Brothers were put in a very exposed
position, as they had all of these mortgage securities and people were not
paying their mortgages. This should have been a massive alert for Lehman
Brothers and with the failing market they should have cut their losses and
reduced the size of their massive, risky portfolio of securities. In
retrospect, if they had done this rather than attempt to wait out the economic
crisis and wait for a bailout at a later date then perhaps the collapse of
Lehman Brothers could have been avoided.
In March 2008 Bear
Stearns very nearly collapsed and as a result of this Lehman Brothers share
price fell by 48%, with investors worrying that this would be the next firm in
Wall Street to Collapse. This was just a further demonstration of how untrusted
Lehman Brothers were by their shareholders and the general public!
The drama on Lehman Brothers showed the days leading up to
the inevitable collapse and how agonisingly close they were to being saved! The
initial thought was that The Bank of America or Barclays would have to be the
only organisations that could say Lehman Brothers, as the US government claimed
to have no tax payer’s money to pay for a bailout. As The Bank of America
pulled out of any arrangement, all faith for Lehman Brothers survival fell to
Barclays. Lehman Brothers had valued their toxic assets at a value of $40
billion and after Barclays had been to look through the assets, they came up
with the value of $25 billion. Obviously Lehman Brothers were not in a position
where they could negotiate so accepted the offer of $25 billion. However,
Lehman Brothers were unaware that this takeover from Barclays had to be passed by
a shareholder vote and this was not going to be completed until the following
Tuesday at the earliest.
Because Barclays could not complete the takeover in time
Lehman Brothers ended up filing for bankruptcy. As a result of this the US government
ended up paying out $700 billion for federal aid (Probably not the outcome that
anyone was hoping for).
In my opinion the major reason for Lehman Brothers demise
was due to the other confidence and arrogance of the company and the CEO (Dick
Fuld) in thinking that they were too big an organisation to fail and that if
things went wrong they could simply rely on the US government to bail them out.
In fairness to Lehman Brothers they had good reason to think that the US government
would bail them out, as in all previous cases similar to Lehman Brothers the
company had been bailed out. In my opinion though it was inexcusable that they
had the opportunity earlier to trim some of their massive portfolio of mortgage
securities and they refused to do so!
Would love to hear some thoughts from my fellow bloggers on
this matter, so feel free to comment if you have an opinion to add.
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