Lehman Brothers filed for Chapter 11 bankruptcy protection on September 15, 2008 and the bank’s collapse still remains the greatest bankruptcy in US history with a loss of more than $600 billion in assets.
The collapse occurred because the bank had allowed itself to become so deeply involved in the sub-prime mortgage market that it was extremely vulnerable to a downturn in real estate prices.
Lehman’s implosion greatly exacerbated the 2008 global financial crisis and contributed to the loss of almost $10 trillion in market value from global equity markets in October 2008 alone, which was the largest monthly decline ever recorded.
The origins of the disaster
As the early noughties U.S. housing boom got underway, Lehman Brothers acquired five mortgage lending companies which included the subprime lenders BNC Mortgage and Aurora Loan Services. The acquisitions initially appeared to be sound as record revenues were achieved between 2004 and 2006. Lehman reported record profits every year from 2005 to 2007, and in 2007 the company reported a record $4.2 billion profit against revenues of $19.3 billion.
By February of 2007, Lehman’s stock had reached record levels but the cracks in the U.S. housing market were already beginning to show as defaults on subprime mortgages rose to a seven-year high. Lehman had borrowed significant amounts of cash to fund its investments over the years and a significant proportion of this investment was tied up in housing-related assets which made the bank vulnerable to a downturn in that sector. Whilst the bank was generating tremendous profits during the boom, its vulnerable position meant that a mere 3–4% decline in the value of its assets would wipe out the value of its equity.
On March 14, 2007, one day after Lehman shares had suffered their biggest single-day drop in five years over concerns that the rising number of defaults would affect the bank’s profitability, the firm still reported record revenues and profit. Lehman’s chief financial officer said that the rising mortgage defaults would have very little impact on the firm’s earnings and that he did not foresee the problems in the subprime market spreading to other parts of the housing market or U.S. economy.
As the credit crisis deepened in August 2007 Lehman’s stock fell sharply again. The company laid off 2,500 staff with mortgage-related jobs and closed its BNC mortgage unit. The company also shut down the offices of Aurora in three US states. Despite this, Lehman continued to be a major player in the mortgage market and still underwrote more mortgage-backed securities than any other firm in 2007.
As Lehman’s stock rebounded in late 2007 as the global equity markets enjoyed a temporary resurgence, the company didn’t take the opportunity to reduce its massive mortgage portfolio. Whether Lehman did this because it was unable to sell its lower-rated assets, or took a conscious decision to hold onto them is unclear, but huge losses mounted in mortgage-backed securities with lower ratings throughout 2008. In the first half of the year alone, Lehman’s stock lost 73% of its value as the credit crunch continued to take hold and by August 2008, Lehman anounced that it intended to release 6% of its work force – roughly 1,500 people.
A lifeline was briefly extended to Lehman Brothers as the state controlled Korea Development Bank considered making a bid for the failing financial giant, but this hope was swiftly put paid to as news emerged that Korea Development Bank was “facing difficulties pleasing regulators and attracting partners for the deal.”
Investor confidence continued to slide as Lehman’s stock lost roughly half its value and on September 14th 2008, an emergency meeting was held by leaders of the major Wall Street banks to work out a plan to save Lehman Brothers and place reigns on the ensuing global financial crisis – all to no avail.
Lehman Brothers filed for Chapter 11 bankruptcy protection on September 15, 2008 and the bank’s collapse remains the largest bankruptcy filing in U.S. history.
In our opinion, the bean counters at Lehman brothers shouldn’t be too surprised at what happened when the sub-prime mortgage bubble burst. Our publisher Darcus White once lent money to an ex-girlfriend who needed a deposit for her new flat but didn’t get a penny of it back. What she didn’t tell him at the time was that the new flat was in another country and she would be moving into it with her new boyfriend – hence the reason why she is now an ex!