A CASE STUDY ENTITLED:

THE COLLAPSE OF LEHMAN BROTHERS

In Partial Fulfillment for the Final Activity

of Treasury Management

Submitted to:
Mrs. Leila M. Valero

Prepared by:
Abe, Ryuji
Atencio, Jamhil
Gapan, Viviene Venus
Francisco, Aaron
Hina, Lynea Ryziel
Ibe, Roby Emmanuel
Malig, Rein Justin
Medina, Irish Joyce
Paraiso, Jonalyn
Robles, Isaac
Surio, Justine Catherine

April 2023
IDENTIFY THE PROBLEM:

1. High Leverage.

❖ Lehman Brothers was highly leverage, they went into borrowing billions of dollars to

fund its business.

❖ They used debt to raise capital to buy high risk investment in expect of higher returns.

2. Poor Risk and Investment Management.

❖ Lehman Brothers suffered enormous losses as a result of the value of its investment

declining as default rates increased.

❖ They have invested and relied so much in subprime mortgage industry which is extremely

susceptible to default rates.

❖ Default Rate is the rate of all loans issued that is left unpaid by the borrower and declared

to be in default.

3. Subprime Meltdown (Financial Crisis)

❖ Consumers incapacity to repay their debt.

❖ The Company's main consumers are the low-income family with low credit scores.

❖ The Lehman Brother failed to pay its debt due to failure to raise cash quickly. Although

technically they have the assets more than enough to cover their debt, however, these assets

were illiquid making it difficult for them to raise cash. Consecutively, failure to raise funds

in a short span of time, resulted in bankruptcy of the company.

ANALYZE THE CASE:

o No capacity to repay short term debt.

o Lehman's heavy reliance on the real estate and subprime mortgage markets in the United

States contributed to its bankruptcy.

o Was too motivated/ greedy to the point that they turned a blind eye on how risky those

investments were.

LIQUIDITY RISK

When financial leverage is advantageous, the business is making a profit on its borrowings

that surpasses its expenses of doing so. Shareholders are interested in the ratio of debt to

shareholders' equity in a company's capital structure since a higher debt level entails greater risk

for them. To avoid taking on too much risk, organizations must properly manage the ratio of debt

to equity. But that was not the case for the Lehman Brothers. Their excessive borrowing behavior

to finance its assets resulted in a position with immense leverage. In 2007, Lehman's high degree

of leverage was 31, while its large mortgage securities portfolio made it highly susceptible to the

deteriorating market conditions. Lehman pursued a high-leverage business strategy similar to that

of its rival investment banks, involving the use of billions of dollars in debt to fund its balance

sheet. Despite having an asset that is larger than liabilities, there’s a tendency that companies may

fail due to the lack of liquidity. In business terms, liquidity is called the lifeblood of the financial

aspect.

Lehman's incapacity to fulfill short-term obligations was crucial to their failure. Lehman

Brothers had a large asset base, yet it occasionally ran into liquidity issues. As seen in their balance
sheet, Lehman Brothers has a total of $639B in assets while they have $613B in liabilities, but

only $7B of it was available in cash. Meaning, their assets are worth more than their debt, so

theoretically, if they sold everything they owned, they would be able to pay back their obligations,

but the problem is, so much of these assets were tied into these investments that no one wanted to

touch. If the company takes actions in the first place, they can prevent the failure in fulfilling their

obligations. In addition, company lack of approach to cash flow management and liquidity

management that leads to company to these consequences.

RISK MANAGEMENT AND INVESTMENT MANAGEMENT

Lehman Brothers was supposedly "too big to fail," but if history has taught us anything,

it's that there is no such thing as "too big to fail." One of the key causes of the global financial

crisis in 2007–2008 was the subprime mortgage crisis. Lehman had a significant presence in the

subprime mortgage sector, which by definition involves lending money to people with bad credit

records and low incomes. Even as the correction in the U.S. housing market gained momentum,

Lehman continued to be a major player in the mortgage market. But by the first quarter of 2007,

cracks in the U.S. housing market were already becoming apparent. Defaults on subprime

mortgages began to rise to a seven-year high. Lehman brothers’ did foresee that this may cause

financial trouble to their company. It is a process that is fueling unchecked economic expansion.

But because they were given to people with bad credit records and low incomes, these loans were

by definition the riskiest kind. The effectiveness of an organization's operating structures, policies,

and controls depends on how well they are implemented. Following its bankruptcy, Lehman was

found to have ignored risk management procedures, violated other internal rules, employed
accounting "gimmicks," and hid some facts from its board. These practices may have all had a role

in its collapse.

Their failure to assess risks was one of the many reasons that contributed to the

bankruptcy of the firm. Back in the days, real estate was the place to make money. Given the status

of the stock market back in the days, investing in real estate can be a better alternative. Real estate

was seen as an amazing investment but then the interest rate went up and the demand for it went

down. As a result, real estate lost value. This was bad news for Lehman Brothers since they were

significantly involved in real estate. As I’ve said, real estate was a lucrative industry for a while,

and Lehman Brothers became motivated to ignore the risks involved and gradually increase its

involvement because of the high returns.

Lehman's brother foresees the possible risk that might occur to their investments, but they

are too greedy and turn to disregard how risky those investments are. The company failed to assess

the risk that led them into failure. Meaning, if the company assesses those risks early, it helps the

company to minimize the possible damage. Risk management involves identifying events that

could have financial consequences and taking action to prevent the damage caused by those events.

On the contrary, the company failed to assess the risk.

DEVELOP ALTERNATIVES

#1: REGULAR FINANCIAL ANALYSIS. The company disclosed that its equity, which is the

difference between assets and liabilities, was $28 billion. Lehman overvalued its assets by $15 to

$32 billion, according to estimates from other financial institutions that looked at Lehman's
balance sheet. According to these calculations, Lehman's actual equity, calculated using mark-to-

market valuation, was between -$4 billion and +$13 billion.

The collapse of Lehman Brothers in 2008 was primarily due to a lack of effective cash flow

and balance sheet management. Lehman's brother can use financial analysis to monitor cash flow,

identify trends, and evaluate the financial health of their business.

ADVANTAGES:

It provides decision-makers with the information they need to make informed decisions

about investments, acquisitions, and other business activities.

It reduced exposure to dangerous mortgage-backed securities if they had greater knowledge

to guide their investment decisions.

DISADVANTAGES:

Financial analysis may not always take into consideration monetary issues and instead

focuses on the financial performance of certain businesses or assets.

The Lehman Brothers may need to invest in more sophisticated financial analysis tools, or

may need to hire a dedicated financial analyst or team of analysts, which can be more

expensive.

#2: CAUTIOUSLY ASSESS RISKS & ENSURE INVESTMENTS ARE WELL-PLANNED

AND THOUGHT OUT. The bank had assumed too much risk since it was unable to quickly

acquire money. Lehman put a significant amount of money into dangerous loans and commercial

real estate, but instead of selling them right once, it kept them on its books. Lehman places
excessive emphasis on the relevance of subprime mortgages, which raises the possibility of danger.

The timing of the management's decision to purchase these assets, when real estate values were

declining, was terrible since it anticipated it would increase its financial gain.

Assessing risk and ensuring effective investment management are critical for achieving

financial success and securing long-term wealth. Effective investment management helps The

Lehman Brothers mitigate potential losses by diversifying their investments and minimizing

exposure to high-risk investments.

ADVANTAGES:

Mitigating Losses: Effective investment management assists investors by allowing them

to diversify their holdings and minimize potential losses.

Maximizing return: Assessing risk can also help you identify investments with high

potential returns. By understanding the risks involved, you can make informed decisions

to pursue investments that offer the best return on investment.

DISADVANTAGE:

Assessing risk and ensuring investment requires time, resources, and expertise. It can be

costly and time-consuming to conduct a thorough risk assessment and ensure that

investments are secure.

RECOMMEND A COURSE OF ACTION

Risk Management and Investment Management: Intensification of Scrutiny of Financial

Intermediaries and Development of more Robust Risk Management Systems.

The bankruptcy of Lehman Brothers had such a significant impact that it prompted the

intensification of scrutiny of financial intermediaries and the development of more robust risk

management systems. Following the company's bankruptcy, based on the analysis of the events

that led to its demise revealed flaws in the firm's risk management implementation strategies. It

similarly revealed the weaknesses in the regulating of managerial bodies as monetary financial

investors could not anticipate this adversity coming.

Administrative bodies showed an absence of proficient capacity in scrutinizing the

financial summaries of Lehman Brothers. It is recommended that administrative bodies have

enough resources to guarantee viable and proficient checking and supervision. In order to

recognize and comprehend the intricacies of all financial institution products and services under

their jurisdiction, such bodies' staff should receive appropriate training. Figuring out the basics of

bookkeeping, planning, and examination of fiscal reports and evaluating would empower

controllers to identify unethical works or behavior with respect to monetary organizations. Last

but not least, if Lehman Brothers' financial collapse is to be avoided, robust corporate governance

structures are required.

LIQUIDITY RISK: STRENGTHENING PRINCIPLES OF LIQUIDITY MANAGEMENT

Lehman Brothers case proved that effective liquidity management is a must for an

organization striving for long term success. On the contrary, based on the analysis conducted, it is

highlighted that Lehman Brother's assets are large compared to their liabilities. However, the
majority of its cash on hand was too little to at least pay off their short-term obligations. Therefore,

the ultimate contributor to the downfall of Lehman Brothers were illiquid assets. It is

recommended to strengthen principles of liquidity management. By doing so, a firm can minimize

liquidity risk, capture financial health, predict future cash positions, increase business agility, and

attract additional financing. The idea is that they should keep a lot of cash on hand in the Holdings

Chain so that they can deal with a very bad liquidity event. Additionally, they need to put up

trustworthy secured finance levels per counterpart and asset category. Finally, they need to

segregate the holdings chain and each regulated entity's cash capital model. Consider every extra

money a restricted entity.

One of the most difficult business management challenges in history was the administration

of Lehman Brothers, and maintaining the integrity of the global financial system depended on how

successfully this crisis was manages. There’s no doubt that the scenario was highly technical. Of

course, subject-matter expertise knowledge of the law, accounting, the operation of the financial

markets etc. was essential to properly addressing this crisis.

REFLECT ON YOUR LEARNING

The collapse of Lehman Brothers in 2008 was a major event that caused a global financial

crisis. It was a result of the company's risky investments in the subprime mortgage market and

poor management practices. The bankruptcy of Lehman Brothers led to a domino effect that caused

other banks and financial institutions to also suffer losses, leading to a deep recession.

The collapse of Lehman Brothers serves as a reminder of the importance of responsible

leadership and risk management in the financial industry. It highlighted the need for effective

regulation and oversight to prevent future financial crises. The impact of the Lehman Brothers
collapse was felt around the world, and it demonstrated the interconnectedness and fragility of the

global financial system. It is a lesson that we should continue to learn from and apply in our efforts

to ensure financial stability and security. Also, it helps us to understand and realize that taking risks

are normal and important aspect for every business to achieve success, however, concrete plans

and strategies are needed for every possible bad scenario that might happen.

The most crucial lesson is about making decisions; it is important that we study and look

for potential loop holes in every decision we make. As well as, we learned that while it's excellent

to take bigger risks in order to gain bigger payoffs, we should nonetheless set limitations or take

measures in case things go on the other way.