Monday, 26 October 2015

Lehman Brothers, Where Did It All Go So Wrong?

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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