LEHMAN BROTHERS BANKRUPTCY

Jason Zhang and William Xie

 BEFORE 2008

• Founded in 1847: 158 years of operations

• The 4th largest investment bank in the US
• Operations in North America, Asia, Europe, and Middle East
• Multiple Divisions: investment banking, S&T, research, asset
management, PE, and private banking
• Survived numerous past disasters
• Railroad bankruptcies of the 1800s
• Great Depression of the 1930s
• 2 world wars
• Long Term Capital Management collapse
• Russian debt default of 1998
 L EHMAN’S BET ON
MORTG AG ES

• Increased exposure to mortgage-backed securities

(MBS) and other collateral debt obligations (CDOs) in
2003 and 2004
• Required short-term loans to cover
• Moved to loan origination, acquired 5 mortgage lenders,
including subprime lender BNC Mortgage and Aurora
Loanfive Services, which specialized in Alt-A loans made
to borrowers without full documentation.
• Capital markets revenue surged 56% from 2004 to 2006
• Securitized $146 billion of mortgages in 2006, a 10%
increase from 2005
• Aggressive strategy lead to increase in leverage ratio
from 24x to 30x
• Excessive leverage let to rating agencies demanding
deleveraging (increasing equity or selling assets), but
they could not sell assets at acceptable price

“relied heavily on the unregulated short-term

wholesale funding of commercial paper loans
and repos carried by investment banks, hedge
funds and other institutional investors—the
“shadow banking system”
 THE CRASH

• Mortgage price plunged as defaults on subprime

mortgages rose to seven-year-high
• In 2007, Lehman underwrote more mortgage
securities than any other firm, accumulating an $85
billion portfolio, or four times its shareholders’
equity
• The stock plunged 77% in the first week of Sept.
2008
• Korean Development Bank stopped the process to
bail out Lehman Brothers
• Barclay and Bank of America unsuccessfully tried to
takeover Lehman
• Lehman filed for Chapter 11 on Sept. 15th, 2008
 NO B AILOUT

• Secretary of the Treasury Henry Paulson: “the firms rescued by the Fed had
enough collateral for the loans they needed, and Lehman Brothers did not.”
• Fed team could not accurately evaluate Lehman’s illiquid assets — primarily a
real estate portfolio that Lehman claim to be valued at $50 billion
• Lehman claimed that the firm had a surplus of assets over liabilities of $28.4
billion.
• Fed team determined Lehman was solvent and decided NOT to bail out the
firm
• Fed already faced widespread criticism for bailing out Bear Sterns
 • Lehman Brothers filed for bankruptcy on Sept. 15, 2008
• $639 billion in assets, $619 billion in debt
• $1 trillion worth of creditor claims
• 4 bodies of applicable U.S. laws

T H E LA R GE ST • insolvency proceedings that involved more than 80

international legal jurisdictions
B A NKRUPTCY
• Advisors & Attorneys
I N U. S.
• Restructuring Adviser: Alvarez & Marsal, $77.3 million
H I STORY fees
• Bankruptcy Law Firm: Weil Gotshal & Manges, $45.6
million fees
• Creditor Advisors: Milbank Tweed Hadley &
McCloy, $10.4 million fees
 LEHMAN
ORGANIZATION
CHART
 MAIN S TEPS

• Pre-bankruptcy planning, including searching for potential buyers

and preparing for filing of a bankruptcy petition
• Motions to obtain funding to operate businesses during
bankruptcy and permission to use cash collateral on which
secured creditors had claims
• Closing and netting out qualified financial contracts (QFCs)
• Section 363 asset sales
• Establishing the total amount owed to creditors through the
claims process, by providing reports on the debtor’s financial
condition and reviewing creditor claims
• Filing a plan of reorganization after negotiations with significant
creditors, along with a disclosure statement to inform creditors
about the plan
• Confirming the plan to settle creditor claims through voting by
creditors and a confirmation hearing
• Making payments to creditors under the plan

BARCLAYS
• Acquired Lehman’s NA business
for $1.35B
• $960M headquarter
• 9000 former employees
• Barclays absorbed $47.4B in
securities and assume $45.5B in
trading liabilities
• Sold at a discount
• Lehman retained $2.5B securities
asset
ACQUISITIONS
NOMURA
• Japan's top brokerage firm
acquired Lehman’s Asian
division for $225M and
European division $2
• Only acquired employees
without any assets
• These divisions accounted for
over 50% of Lehman’s global
revenue
ASSET MANAGEMENT
• Sold a subsidiary Neuberger
Berman to 2 PE firms for $2.15B
• Bain Capital
• Hellman & Friedman
• Creditors hold 49% equity
interest in NB
• Quantitative Asset Management
acquired by employees and
renamed to TOBAM
 LEHMAN’S
FUNDING IN
THE FIRST
WEEK OF
CHAPTER 11
FILING
CHAPTER
11
PROCESS
 DERIVATIVE
SETTLEMENT
PROCEDURE
SETTLEMENT
OF OTC
DERIVATIVES
CONTRACTS
RECOVERY
OF
CREDITOR
CLAIMS
 VULTURE HEDGE FUND BEHAVIOR

• As usual, hedge funds bought up claims post-bankruptcy from those who did
not want to hold on to their claims
• Bonds from Lehman’s parent company estimated 26.9 cents on dollar, up from
initial 21.1 expected
• Creditors of Lehman derivatives arm (Goldman Sachs, Silver Point) expected
recovery up to 30.9 cents on dollar
• Elliot, Paulson, Halcyon, King Street, Baupost, all profited on Lehman claims
 R E C OV ERY R AT E S

“prices of assets held by Lehman increased as

the economy recovered during bankruptcy
proceedings, especially for loans, real estate,
and private equity investments. Also, some
large-value disputed claims (for example, by
certain derivatives counterparties and
JPMorgan Chase) were decided by the court in
Lehman’s favor, reducing the amount of
allowed claims. “
 KEY TAKEAWAY

• The payout ratio to third-party creditors is over 21 percent on estimated allowable

claims of $362 billion
• Recovery rates for Lehman’s senior unsecured creditors remain below historical
averages even after accounting for possible mitigating factors
• The experience of resolving Lehman in the bankruptcy courts has led to an active
debate about the effectiveness of U.S. Chapter 11 proceedings for complex financial
institutions
• Lehman’s poor pre-bankruptcy planning may have substantially reduced the value of
Lehman’s estate and contributed to many ensuing disputes with creditors
• For the complex OTC derivatives transactions, creditors’ recovery rate was below
historical averages for failed firms comparable to Lehman
• Some of the losses borne by Lehman investors stemmed from the manner in which
Lehman failed and could have been avoided in a more orderly process
• In the future, Dodd-Frank Act will allow regulators to resolve large, complex financial
firms under the Orderly Liquidation Authority, through the expanded reach of the FDIC
APPENDIX
 USEFUL ARTICLES

• https://ypfs.som.yale.edu/sites/default/files/Fleming%2C%20Michael%20J%20%26%2
0Asani%20Sarkar%20Failure%20Resolution%20of%20LBH%2012-14_0.pdf
• http://blogs.harvard.edu/bankruptcyroundtable/2019/02/05/how-much-value-was-destroyed-by-
the-lehman-bankruptcy/
• https://digitalcommons.law.yale.edu/cgi/viewcontent.cgi?referer=https://www.google.com/&http
sredir=1&article=1414&context=yjreg
• https://www.institutionalinvestor.com/article/b14zbd2n2dvmt7/lehman-brothers-restructuring-
proves-that-the-system-
works?fbclid=IwAR1P9DGOu9Go6OQwLPZpv5iBlL5qpnWfRcELRI4mYLaxxwlm-
vAkYfshzgA#:~:text=%E2%80%9CLehman's%20bankruptcy%20precipitated%20a%20crisis,even
%20though%20more%20work%20remains.&text=SIPC%20customer%20assets%20with%20Leh
man%20totaled%20more%20than%20%24100%20billion
• https://en.wikipedia.org/wiki/Bankruptcy_of_Lehman_Brothers#Breakup_process