THE WEEKEND THAT CHANGED

WALLSTREET

AMEENA FATIMA SHAH

AYESHA KHALID
SHAYAN USMAN

SECTION D
 INTRODUCTION

 Lehman Brothers founded in 1850 (158 year old investment bank)

 Was the fourth-largest investment bank in the United States (25,000 employees)

 CEO Dick Fuld(2008)

 Served the needs of corporations, government and municipalities, institutional clients and high
net-worth individuals
 OPERATIONS & SERVICES

 Services include:  Operated in three main segments

 Investment banking  Investment banking
 Equity and fixed income sales  Capital markets
 Trading and research  Investment management
 Asset management
 Private investment management
 Private equity

o Generated client-flow revenue by giving advice on structuring transactions

o Acting as an underwriter to clients
o Investment management and advisory services
 THE PROBLEM
 Lehman Brother’s CEO was facing a crisis – bank faced bad mortgage related investments in
(billions of dollars)

 Struggling to find a buyer for the bank

 Made several calls to Bank of America CEO Ken Lewis
 Barclay’s would agree to buy only if they did not have to take on the struggling real-estate
portfolio

 Barclay’s needed a shareholder vote which was impossible to get on a Sunday

 Announced intention to seek bankruptcy protection on 15th September 2008, Monday morning
BACKGROUND: COMMERCIAL PAPER/CREDIT DEFAULT
SWAP MARKETS
 Commercial papers are short-term, unsecured fixed income instruments used by firms to finance
short-term debt obligations

 Since they are not backed by any collateral, only firms with investment grade ratings can issue
them – exempt from SEC regulations

 Deemed as one of the most safe and liquid investments in the market
 CONTD.

 Three party interaction in the commercial paper market

 Issuers of the commercial paper marketed commercial paper through one of two avenues.
 Direct Method – Saved issuer from paying a dealer fee of five basis points.
 Alternative Method

 Direct issuance was usually only done by large financial firms that had large short-term
borrowing needs.
EXHIBIT 1
EXHIBIT 2
 CONTD.

 CDS transfers the credit risk associated with debt by protecting the buyer against default and
credit ratings downgrades

 In return for a series of payments, seller is obligated to pay the buyer a lump sum whenever a
negative credit event regarding the respective debt instrument occurs

 Lehman Brother’s was a major player in both of these markets

 CONTD.
 One of the largest dealers in the commercial-papers markets

 Influence on the $55 trillion CDS market was threefold

 Top 10 counterparty in the CDS market – contracts amounting to roughly $800 billion
 Contracts on the firm’s own debt
 Synthetic Collateralized Debt Obligations (CDOs)
 THE DOWNFALL & ITS EFFECTS
 Lehman Brother’s bankruptcy had a far reaching impact on investors – disastrous shock to
financial markets around the world

 Fed’s decision to not back the struggling bank resulted in investors losing their trust in the
American financial system model – flocked to relative safety treasury bonds

 By allowing such an important financial institution to go down, Fed shattered belief that such
firms were too big to fail
 CONTD.

 The Federal bank of America also gave investors a false sense of security through its dealings with Bear
Stearns (Ex 3)

 This led to the biggest meltdown in the history of the commercial paper market

 The Reserve Primary Fund, a large money market fund that had invested largely in commercial papers by
Lehman Brothers, “broke the buck”
EXHIBIT 3
 WHY THE FED DID NOT BACK LEHMAN
BROTHERS’
 In 2006, Lehman Brother’s embarked on an aggressive growth strategy – took on significantly greater risk

 Was slow to recognize sub-prime mortgage business crisis – significantly and repeatedly increased its
internal risk

 Lehman Brother’s painted a misleading picture of its financial condition - told the markets that it had
liquidity of $41 billion however, the pool of assets it could readily monetize was just $2 billion

 Company did not have the legal authority to make a direct capital investment, and its assets were
insufficient to support a loan large enough to avoid its collapse

https://www.irishtimes.com/business/economy/why-lehman-brothers-was-allowed-to-fail-1.1523885
 Ripple effect – commercial paper market dried up as investors switched to ‘safer’ government
securities. (Ex 4&5)

 As Lehman Brother’s was so interconnected with the CDS market, CDS spreads spiked. (Ex 6)
EXHIBIT 4
EXHIBIT 5
EXHIBIT 6
 CDS MARKET EVOLUTION & LEHMAN
BROTHERS’ DEMISE

 CDSs were originally created to lower financial institution's risk; market grew and evolved

 Switched from a risk mitigating instrument to a speculative one that allowed investors to bet on a company’
default. (Ex 7)

 George Soros, chairman of Soros Management Fund, described the misuse of these instruments as toxic.
EXHIBIT 7
 CONTD.

 CDSs became largely speculative

 Investors associated rising prices with deteriorating conditions of the company

 This speculation played a large part in Lehman Brother’s bankruptcy

 Bear-market raid
 Unable to raise capital
 CONCLUSION

 Bankruptcy of Lehman Brothers injected large systemic risk in the market

 Created enormous loss of investor confidence in the world’s financial institutions

IS THE 2018 ECONOMY STILL IMPACTED BY THE
CRASH?

 It seems to most financial analysts that banks still haven’t learned their lesson

 But, the move away from high-risk activities could be a sign that banks are becoming better at
managing risk.

 Investors seem to have learned that they need to diversify more.

HTTPS://WWW.THESTREET.COM/MARKETS/BANKRUPTCY/LEHMAN-BROTHERS-COLLAPSE-14703
 CONTD.

"The Lehman Brothers collapse made financial

institutions realize that the most precious thing they
are entrusted with is trust - and that winning that
back was going to take both structural and cultural
change that would have been unimaginable just a
few years before.”

- Michael Cole-Fontayn, EMEA Chairman at BNY

 CONTD.
 For many others, the economy is steadily chugging along toward another financial crisis.

 The global economy currently has a $237 trillion total debt.

 According to The New York Times, the current market may be overvalued.

 Investors are still not researching their stocks enough.

 Still, the stock market has seen some record highs recently, but speculations over a coming bear market
leave the market at a seeming turning point.

HTTPS://WWW.THESTREET.COM/MARKETS/BANKRUPTCY/LEHMAN-BROTHERS-COLLAPSE-1470
 HAS WALL STREET LEARNED ITS LESSON?

"Some continue to hold Lehman lessons dear, but it's my view the majority have moved on without
revisiting that time every quarter - as they should. It's sad and it will come back to bite investors -
again - within the next five years.”
- Brian Sozzi, 2018.
THANK YOU.