How Lehman Brothers went bankrupt: Game Over!
The beginning of the end of the world happened September 15th, 2008 when the unthinkable happened. One of the worlds largest institutional investors not only just went bankrupt but totally collapsed and brought down with it almost all of the companies it had acquired. At the time Lehman Brothers had $639 billion in assets and $619 billion in debt, making it the largest bankruptcy filing in the history of Investment Banking & Private Equity. Lehman Brothers had assets that far surpassed other giants that had also gone under in years past like Enron and Worldcom. At the time Lehman was the fourth largest United States investment bank with over 24,000 employees worldwide. All of them now jobless. The ripple effect was felt throughout the entire planet.
Some say that Lehman was a victim of its own business practices. Being a huge benefactor of the subprime mortgage boom , Lehman made billions of dollars in cash and assets before the sub-prime mortgage financial crisis. Once it was eminent that they wouldn't survive the crisis it became one of many catalysts that contributed to over $10 trillion in market capitalization erosion. Their shady practices although technically legal were equivalent to shooting themselves in the foot. Someone had to be a scapegoat as the government was not going to bailout everybody and Lehman was the sacrificial lamb that was going to have to pay for their mistakes while everybody else could find a way to get off. I wonder who in top management pissed of the FEDS?
The History of Lehman Brothers
Founded by German Immigrant Henry Lehman in Montgomery Alabama in 1844, the Lehmans started from very humble beginnings which was typical of a lot of future magnates of the time. They started with a small general store that sold everyday items such as clothing, perishables, and cotton. In 1850 Henry started Lehman brothers with his siblings Emanuel and Mayer. As the decades passed they began to propsper as the U.S. economy grew into a global powerhouse. Even during the numerous boom and busts of the 1800s and 1900s, the Lehmans survived them all. They made it through the railroad bankruptcies of the 1800s and the great depression in 1930, a couple work wars, and even more recently the capital shortages on the early 1990s. However their luck would run out soon after. The housing crisis was one monster that Lehman brothers as a firm could not fathom and it ate them up alive. What they thought would be a profitable strategy of investing in subprime mortgages eventually became the poison that out them out of their misery.
In 2003 and 2004 the hosing boom was in full force. No Doc loans were the norm and income verification was a joke. still Lehman acquired five mortgage lenders that almost exclusively dealt with such loans, namely BNC Mortgage and Aurora Loan Services who specialized in Alt-A loans (loans made to borrowers without any kind of income verification). At first it seemed like astute aquisitions and revenues on paper were strong which resulted in the capital markets surging 56% between 2004-2006. They securitized $146 billion in mortgages in 2006, a 10% jump from 2005. Record profits were reported and everything seemed lovely. Net income in 2007 was reported at $4.2 billion of $19.3 billion in revenue. Here is where they made the mistake.
In February 2007, Lehman stock reached a record $86.18/share, giving them close to a $60 billion market cap. However the effects of the US housing market crash were starting to be felt as homeowners began defaulting on these subprime loans. On March 14, 2007, a day after the stock had its biggest one-day drop in five years on concerns that rising defaults would affect Lehman's profitability, the firm reported record revenues and profit for its fiscal first quarter. In the post-earnings conference call, Lehman's chief financial officer (CFO) said that the risks posed by rising home delinquencies were well contained and would have little impact on the firm's earnings. He also said that he did not foresee problems in the subprime market spreading to the rest of the housing market or hurting the U.S. economy. That was a lie! Whether he knew it or not, Lehman would soon pay for their miscalculations with their own blood.
In august 2007, two of Bear Sterns Hedgefund failed and this directly affected Lehman stock. In the same month they fired 2,500 employees in its mortgage department and shut down the BNC division. In addition, it also closed offices of Alt-A lender Aurora in three states. In 2007, Lehman underwrote more mortgage-backed securities than any other firm, accumulating an $85 billion portfolio, or four times its shareholders' equity. In the fourth quarter of 2007, Lehman's stock rebounded, as global equity markets reached new highs and prices for fixed-income assets staged a temporary rebound. However, the firm did not take the opportunity to trim its massive mortgage portfolio, which in retrospect, would turn out to be its last chance. Lehman's collapse roiled global financial markets for weeks, given the size of the company and its status as a major player in the U.S. and internationally. Many questioned the U.S. government's decision to let Lehman fail, as compared to its tacit support for Bear Stearns, which was acquired by JPMorgan Chase & Co. In March 2008 Lehman's bankruptcy led to more than $46 billion of its market value being wiped out. Its collapse also served as the catalyst for the purchase of Merrill Lynch by Bank of America in an emergency deal that was also announced on September 15. It was officially game over!
*Citations: Wall Street Journal, Time Magazine, New York Times, Investopedia.com*