Part 1

Triggered by a complex interplay of valuation and liquidity

problems in the U.S banking system.
The bursting of the U.S. housing bubble caused the values
of securities tied to U.S. real estate pricing to plummet.
Resulted in the collapse of large financial institutions,
the bailout of banks by national governments and downturns in
stock markets around the world.
Over 65 U.S. banks have become insolvent and have been taken
over by the FDIC. These banks held over $55 billion in deposits,
and the takeovers cost the federal government an estimated $17
billion
1. THE FINANCIAL CRISIS OF 2008
2.OVERVIEW OF LEHMAN
BROTHERS
2. OVERVIEW OF LEHMAN BROTHERS
The victim of the U.S subprime
financial crisis
Filed for bankruptcy on
15/9/2008
$639 billion in assets and
$619 billion in debt
The largest bankruptcy ever

*Business Overview
Ranked 47
th
among the
Americas largest corporations,
4
th
largest investment bank in US
in 2007
Had long been considered one of
the highest return, highest risk
small investment banking firm in
Wall Street
Since the IPO in 1994 Lehman
had steadily increased revenues.
In 2007, Lehman net revenue
was 19.2 billion dollars, total
assets reached the level of USD
691 billion
*Business Overview
Doing business in investment banking, capital
market and investment management
During the 2000s, roughly 40% of Lehman's net
revenues had come from fixed income sales
and trading (including derivatives and swaps;
mortgage-backed securities (MBS) and futures,
leading to the heavy reliance of LB on capital
markets


Net revenue by division of Lehman Brothers 2007
16%
64%
20%
Capital Markets
Investment Banking
Investment Management
*Business Overview
In 2003 and 2004, the U.S. housing boom was well under way
Lehman acquired five mortgage lenders, including subprime lender
BNC Mortgage and Aurora Loan Services
Due to the acquisitions, record revenues from Lehman's real estate
businesses enabled revenues in the capital markets unit to surge 56%
from 2004 to 2006
The firm securitized $146 billion of mortgages in 2006, a 10%
increase from 2005
LEHMAN FAILURE
&
RESPONSES OF FED
PART 2
Cause 1:
Internal Reasons
*The victim of its own risky
business decisions
*Lehman used securitization => risky bond package relating real
estate
*Involved the sub- prime debt crisis in America 2007-2008.
*Lehman also invested directly or indirectly in commercial real
estate. When the real estate market went down, property values
also declined.
*Its CEO, Dick Fulds decisions became riskier activities and
decisions
*In 2005, Michael Gelband had to resign because of opposing
views on these risky strategies.
In June 2008, he was reinvited to the director in charge of
global capital market to save it.
this was too late action.



* The risky strategy of Lehman Brothers in the sub- prime mortgage is the internal reason for its closing
day. The board of directors do not also have the same voice in management that led to the inconsistent
development and risk management strategy.
* Lawrence G.McDonald regarded the closing of Lehman Brothers as a colosal failure of common
sense. This empire collapsed because Lehman Brothers had the "frivolous" and "dull" kings.
* Three Ls that killed Lehman:
1.Leverage
2.Liquidity
3.Losses
Sub-prime debt crisis in America 2007-2008 =lax management in sub-prime credit lending +the
greed of the market.
Securitization is a smart financial tool but it was taken advantage for the bad intention =>it created
the unpredictable consequences.
I nvestors need to understand the risks before buying the complex financial products in order to avoid
heavy losses.
These are big lessons to challenge for any country in the process of integration and development.



Cause2.
Short
sellers
Legal
Sell securities that are not your
possesses but borrow them from
other party
net negative position
Borrowing to sell at one price,
but repurchasing to give back at
lower price
Making profits by the declining
stock price
Often speculators are short sellers

Critics : accused Lehman for being dishonest about their true
losses
-->Lehman lost investors cause they believed in statement of
critics
Short sellers : spreading rumors to drive down the stock price
to make benefits
June 9, 2008: loss of $2.8 billion announced + lack of trust
from investors
Can not raise capital franchising price = 0
45% plunging in stock price
66% spike in credit-default swaps
hedge fund clients began pulling out
while its short-term creditors cut credit lines
Sep 9, 2008:
Stock lost 50% its value
S&P 500 down 3.4%
eroded investor confidence

The Dow Jones lost nearly 300 points the same day on
investors concerns about the security of the bank
Cause 3. responses of FED
March 2008: established Term Securities
Lending Facility (TSLF)
Later in March: established Primary Dealer
Credit Facility (PDCF)
Invoked Section 13 (3) of the Federal Reserve
Act
Lehman Brothers have base to believe that Fed would help it
Bailed out Bear Sterns : provide $29bl to cover loss
for Maiden Lane acquire Bear
July 2008 : authorize loans to Fannie Mae and
Freddie Mac, putting them into government
receivership.
Failed because
potential bank
borrower can not
face their own
loss and acquire
losses of Lehman
August 2008 : refusal
of Fed to guarantee
$65 billion in
potential bad loans
of Lehman Bank
of America and
Barclays refused to
buy parts of Lehman.
Bank is split into
good bank and bad
bank.
Responses of Fed considered as direct and
most significant cause of Lehman bankruptcy.
2 .ANALISING THE
FED RESPONSE

are two government-sponsored
enterprises (GSE)
The corporations' purpose:
- expanding the secondary mortgage
market by securitizing
mortgages in the form of
mortgage-backed securities (MBS)
- allowing lenders to reinvest their
assets into more lending and in
effect increasing the number of
lenders in the mortgage market by
reducing the reliance on thrifts
*
*
Before the subprime mortgage crisis:
- owned or guaranteed $1.4 trillion, or 40%, of
all U.S. mortgages.
- only held $168 billion in subprime mortgages -
but it was enough to capsize the two
If they were to collapse, mortgages would be
harder to obtain and much more expensive.
If they went bankrupt, all the investments
would go to 0, and there would be mass
upheaval on a global scale
*
is an American multinational insurance
corporation
In the United States, AIG is the largest
underwriter of commercial and industrial
insurance
AIG suffered from a liquidity crisis when its
credit ratings were downgraded below "AA"
levels in September 2008
*
Main reasons why AIG was saved
- AIG is too big (with assets of over $1 trillion), it
also covers too much and has an intimate
relationship
- AIGs insurance policies have accessed to many
Americans (and customers around the world)
- the insurance business of AIG makes a lot of
money
-> the collapse of AIG would have greater global
impact than Lehman Brothers
*
Grown significantly since the early 2000s
Top ten firms in terms of the number of MBS, ABS and commercial mortgage
backed securities originated each year
November 30, 2007: revenues of $16.1 billion
$13.40 trillion in derivative financial instruments
$28 billion in level 3 assets on its books
net equity position of only $11.1 billion
leverage ratio of 35.5 to 1
December 2007, Bear Stearns announced
a loss of $854 million

2007 metrics
Goldman
Sachs
Group
(GS)
Morgan
Stanley
Merrill
Lynch
Lehman
Brothers
Bear
Stearns
Gross earnings ($B) 45.6 23.1 -6.1 19.3 2.2
Pre-tax income ($M) 17,604 3,441 -12,831 6,013 193
1-yr revenue growth (%) 23 -9.7 N/A 9.5 -52
Equity origination revenue
($B)
1,382 1,570 1,629 1,015 N/A
M&A advisory revenue ($B) 4,222 2,541 1,740 1,337 828
Debt underwriting revenue
($B)
1,951 1,427 1,550 1,551 N/A
Fixed Income Sales
and Trading
Revenues as % of
Total Revenues
(1998-2005)
Trading as % of Net
Assets
Avg. Trading
Efficiency
Lehman
Brothers
40% 2.75% 60
Bear Stearns 35% 1.75% 50
Goldman
Sachs
27% 2.00% 55
Morgan
Stanley
20% 1.25% 35
Merrill Lynch 15% 1.9% 25
*Time!
March: the system was not ready for Bear or
too big to fail institutions to fail -> lead to a
confidence crisis
September: better prepare to deal with the
consequences of a failure
*
*Lehman missed its own opportunities to save
Lehman, FED needs to break the law
unpredictable consequences for the US legal
and financial system.
*Moreover, Lehman cannot prove adequately
guaranteed assets to receive support as other
groups (eg. AIG)
*
Moral hazard:
If Government bailed out create moral
hazard (company will take not less risky
investments)
- create an extremely bad precedent.
- may cause a Domino effect in financial
system.
*Political pressure:
- Presidental election Debate: Is it possible to
use tax paid by people to save a for-profit
firm?
- A sacrifice is essential for the market
+ Cannot be AIG, Freddy Mac of Fannie Mae
(why?)
+The best option is Lehman
*Government was limited by Budget constraint,
relationship between tax and bond.
*If budget was spent rescuing Lehman
ineffective action lose peoples confidence
in US Government.
*In our review, there may be a reasonable
implication:
- FED stopped at rescuing Bear Stearns
- Afterwards, giving out a program to refinance
for financial system, framework of punishment
for collapsed firms.
*
a lesson for the others


BUT
*
27 thousand people were unemployed
during the financial market crisis,
contributing to the extremely high rate
of unemployment of this period.


not simply just a financial crisis anymore but an economic
recession that affects all other sectors in the economy.
The lost of rescuing money insiders gave to Lehman made a
caution and afraid of being empty-handed in investors so they
never want or ready to help the other banks on the edge of
bankruptcy again.

So who will? FED again?
the weight on FED shoulder
might be even heavier.
PART 3
*Understand and monitor counterparty, market, and credit
risks
*Measure, monitor and manage liquidity risk
*Increase the operational effectiveness of collateral
management and accurately capture contractual terms
*Know their investments
*Hedge funds and other users of prime brokerage are
seeking alternative custody models to separate the
custodian and trade finance functions
*Stress the importance of transparency of internal controls


STAY HUMBLE

STAY REALISTIC

STAY CAUSTIOUS

*Warran Buffet theory:
Never bought derivative
investment products
That he did not understand
=> If you cant understand the prospectus, the offering documents
or an investment guide, its time to get nervous.

* Within days of Lehmans collapse:
* net asset value < traditional $1 share price for
a money-market fund
*the fund had $785 million of Lehman debt went
to zero
=> The fund was not quite the same as everyone
else.
* The Reserve Primary breaking the buck=> money rushed out
of prime money market funds=> investors who panicked
lost a whole lot more.
=> investors found themselves swamped and in the middle of
the crisis=> needed to stay calm in order to make the right
move.


*At the worst of the 2008 panic, a lot of investors desperately
trying to win their money back => made a bad situation
worse.
sticking with your original strategy
is wiser than trying something more
risky as a quick fix

* investors bailed out on the rumors. consumers find
themselves in financial trouble for counting on troubled
employers to keep paying them => Lehman Brothers failed

= > The financial crisis validated strategies that involve paying
off debt and amassing a big emergency fund rarely seems to
work in all market conditions.


* yield-hungry investors will go further up the
risk scale without recognizing anything
promising a higher yield coming with interest-
rate risk and credit risk.
=> end up badly if you are letting greed drive
your strategy during good times.