LEHMAN BROTHERS’

BANKRUPTCY

Financial Management 2
By: Aribas, Christian
Lamaton, Philip
Luniza, John Rod
The History

The Bankruptcy

The Impact
 LEHMAN BROTHERS
Founded :
Montgomery, Alabama, USA (1850)
Founder(s) :
Hendry Lehman
Emanuel Lehman
Mayer Lehman
Headquarters :
New York, USA
• CEO :
Richard S. Fuld Jr.
 The History

1844 Henry Lehman opened a dry-goods

store named “H. Lehman” in Montgomery,
Alabama

1847 with his brother Emanuel Lehman “H.

Lehman” changed into “H. Lehman and
Bro.”

1850 with the arrival of their youngest

brother, Mayer Lehman, the firm changed
again its name to “Lehman Brothers”
 The History (cont’d)

1858 opened its first branch office in New York

City's Manhattan

1870 moved the headquarters New York City,

and helped found the New York Cotton
Exchange

1887 became a member of New York Stock

Exchange

I899 underwrote its first public offering, the

preferred and common stock of the
International Steam Pump Company
 The History (cont’d)

1977 , merged with Kuhn, Loeb & Co to form

Lehman Brothers, Kuhn, Loeb Inc.

1984 was sold to Shearson and became

Shearson Lehman/American Express

1988 with E.F. Hutton & Co. merged as

Shearson Lehman Hutton Inc.

1994 it spun off Lehman Brothers Kuhn Loeb

in an initial public offering, as Lehman
Brothers Holdings, Inc
 The History (cont’d)

2001 acquired the private-client services, or

"PCS", business of Cowen & Co.

2003 acquired the Crossroads Group, the fixed-

income division of Lincoln Capital
Management and Neuberger Berman

2008 declared bankruptcy

Lehman Brothers
Modern investment banks like Lehman
are complex institutions with advanced
and opaque structures, with daily
transactions of several billion of dollars.
The main business areas of Lehman
before the collapse was typical investment
banking as well as equities, fixed income,
capital markets and investment
management.
Lehman Brothers
Their investment banking business
provided financial services such as
mergers and acquisitions, underwritings
and issuing securities.
In the other business lines, the equity part
of Lehman invested in equity around the
world while the fixed income, capital
markets and investment management
parts concerned various services and
wealth management.
Risks in Investment Banking
Before the bankruptcy, Lehman Brothers’
risk management department had
identified five specific risks inherent in
their business.

Liquidity
Market
Credit risk
risk
risk is the
represents
representsrisk
thethat
the ofLehman
possibility
potential brothers
unfavorable
that arechange
a counterparty

 Reputational
Operational risk
risk concerns
is the risk the risk resulting
loss of losing confidence
from
unable
in
or the
from to customers,
obligor
the
inadequate meet
valuewill
of their
or afailed
be payment
portfolio
unable or
public obligations,
ofand
unwilling
internalfinancial borrow
instruments
to people
honor
the government
processes, its
due
andfunds
due
to to
in the market
changes
contractual
unfortunate
systems, at a good
inormarket
obligations
decisions
from price
rates, onand
toprices
Lehman
about
external a regular
client
events. basis,
Brothers. andto
volatilities.
selection thefund
actual
conduct or of
proposed commitments or to liquidate assets..
their business.
Dick Fuld
He
 As made
Forthe significant
newly
example,elected
in 1994changes
CEO, in ofFuld,
only Dick
4% shares
employees’
who
werehad compensation
survived
owned through packages
by employees the and
butLehman’s
by 2006
shares allocations
internal warfare
employees (Oliver
owned 30% and Goodwin,
of the company
2010)
sharesdecided to steer the firm from a
small bond trading firm known for its
internal competitive but dysfunctional
culture towards a new culture that
embraced teamwork and ownership.
Dick Fuld

 Under
capital
In Fuld’s
market
addition, leadership,
Lehman’s Lehman
segmentfinancial
contributed to
services
experienced
64% of total
expanded significant
revenue
to cover financial
while
three growth.
theareas
main investment
of
For instance
banking
business and Lehmani.e.
management
operations reported net
segments
capital positive
market,
earnings forbanking
contributed
investment toa period
20% and of 16%
and 13 years between
respectively
investment
1994 till 2007. Lehman also experience an
management.
increase in market capitalization of USD
45billion in 2007 compared to USD 2
billion in 1994
Capital market segment
consisted of fixed income and equities
and involved trading of financial
instruments and research coverage.
Investment banking segment
consisted of global finance and advisory
services
involved a range of activities which
included and not limited to underwriting
services, private placement, leverage
finance, merger and acquisitions,
restructuring and other corporate activities
Investment management segment
consisted of asset management and
private investment management mainly
for high net worth clients, mutual funds
and institutional investors.
What did they do wrong?
Irresponsible lending practices, viewed as
a risk cutback mechanism.
 Excessive dependence on credit ratings
by investors.
 An extensive view of markets, assuming
they could auto correct themselves and an
inadequate appreciation of the risks of
deregulation, led to weaker principles and
regulatory breach.
What did they do wrong?
 The explosion of complex financial products,
together with derivatives, with lack of liquidity
and other risk characteristics that were not
transparent or understood.
•Vicious incentives and asymmetric return
arrangements encouraged unwarranted risk-
taking.
 Deficient management of risk and oversight of
companies involved in marketing and
purchasing complex financial products.
What did they do wrong?
 Lack of monitoring in financial
regulatory framework and lessening the
risks across has synchronized entities and
markets.
 The lack of an adequate legitimate
framework for the lapse of large
investment bank holding companies on a
consolidated basis
In the beginning of 2008 Chief Financial Officer, Erin Callan, was
asked at a regular investor update conference call why Lehman
Brothers was not in need of a capital restoration program. Ms. Callan
responded with a number of points:

 Lehman did not need more money

 the company had not yet posted a loss during the credit crisis
 the firm had industry veterans in the executive suite who have perfected
the science of risk management
 the bank's real estate investments were top notch
 we know when we need capital and we do not, and right now there is no
way
The three Ls that killed Lehman:
Leverage
Liquidity
Losses
4 Reasons Why Lehman Failed
There Was No Buyer
Its Balance Sheet Was a Disaster
There Was No Political Palatability for
Bailouts
Its Failure Wouldn't Directly Affect
Average Americans
The Strategical Failures
 Lehman started to focus more on long-term investments
instead of brokerage, it consumed significantly more
capital than before. Considering Lehman Brother’s
small equity base this meant a drastically increase in
liquidity risk
 Lehman Brothers continued to pursuit their aggressive
growth strategy despite the financial crisis. They
believed that the subprime crisis would not spread onto
other market and to global economy.
Why did Lehman Brothers go
bankrupt?

Subprime Mortgage Crisis

Malfeasance
1. Subprime Mortgage Crisis
They held on to large positions in
subprime and other lower-rated mortgage
tranches when securitizing the underlying
mortgages
2. Malfeasance
This practice was a type of repurchase
agreement that temporarily removed
securities from the company's balance
sheet.
They hid over $50 billion in loans
disguised as sales
Repo 105 scheme where they sold "toxic
assets" to Cayaman Island banks under
repurchase agreement
 The Bankruptcy (cont’d)

The Bankruptcy Filing

On September 13, 2008, Timothy F.

Geithner, the president of the Federal
reserve bank of New York called a meeting
on the future of Lehman

On September 14, 2008, The New York

Times reported, that Barclays had ended its
bid to purchase all or part of Lehman and a
deal to rescue the bank from liquidation
collapsed.
 The Bankruptcy (cont’d)

Finally on September 15, 2008 Lehman

Brothers filed for bankruptcy protection
after failing to find a buyer.
The significance of Lehman Brothers’ bankruptcy
The significance of Lehman Brothers’ bankruptcy
 The Impact
In the USA
• The Dow Jones closed down just over 500
points on September 15, 2008
• Several money funds and institutional cash
funds, The Bank of New York Mellon and
the Primary Reserve Fund, both falling below
$1 per share
• About 100 hedge funds are being forced to
de-lever and sit on large cash balances
inhibiting chances at further growth.
 The Impact (cont’d)
• Constellation Energy was reported to
have exposure to Lehman, its stock went
down 56% in the first day of trading
having started at $67.87
• The Federal Agricultural Mortgage
Corporation or Farmer Mac said it would
have to write off $48 million in Lehman
debt it owned as a result of the
bankruptcy
 The Impact (cont’d)
In Japan
Banks and insurers announced a combined
249 billion yen ($2.4 billion) in potential
losses tied to the collapse of Lehman
In Hongkong
More than 43,700 individuals in the city
have invested in HK$15.7 billion of
"guaranteed mini-bonds“ from Lehman.
The significance of Lehman Brothers’ bankruptcy
The significance of Lehman Brothers’ bankruptcy

Firms that have weathered the financial crisis

thus far are beginning to identify and implement
risk measurement and mitigation techniques,
while also addressing the complexities of a
changing regulatory landscape.
Investors and counterparties are requiring added
assurance that their assets and trade obligations
are adequately safeguarded, moving business
and assets away from arrangements and
institutions perceived as less secure, or seeking
to modify existing contractual arrangements.
What happened to the people
involved in Lehman Brother's
bankruptcy?
 Richard "Dick" S. Fuld Jr.,
◦ - Lehman Brothers’ pugnacious
chief executive was pilloried as the
face of America’s financial failures
following the collapse of the bank
he led for 14 years.
◦ Mr Fuld was reportedly punched
in the face in the Lehman gym
shortly after the bankruptcy
announcement and soon
afterwards disappeared from view,
barring the occasional appearance
in front of the US committees set
up to explore the causes of the
crash.
◦ He has refused to shoulder the
blame for the crisis, although he
said earlier this year that he still
thinks about the bank - and the
“perfect storm” that led to its
demise - every day.
◦ He still works at Matrix Advisors,
a boutique firm that he launched in
2009 to carry out consultancy
work for mergers and acquisitions.
 Three Lessons of the Lehman
Brothers Collapse
First, our complex financial system is awfully
fragile.
Second, government action is capable of keeping a
financial panic from snowballing into a complete
economic disaster along the lines of the Great
Depression.
Third, the government has — in large part because
of its success in averting disaster — found it difficult
to take any actions that would make the financial
system less fragile in the future.
The significance of Lehman Brothers’ bankruptcy

Key Issues

 Weak supervision can lead to a bank taking undue risk

and failing to maintain sufficient capital against the
constellation of risks it faces
 Identifying when an institution is too big to fail when no
depositors interests are at stake
 Oversight of a financial holding company where there
is no legal authority
 Whether it is better to have a public policy on when the
government should intervene or is constructive
ambiguity still relevant
Comment and Question

THANK YOU