Effects of the Financial Crisis on Lehman brothers

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Effects of the Financial Crisis on Lehman brothers
Introduction
In 2008, the entire world witnessed a major financial catastrophe brought by the sub-prime mortgage crisis affected the U.S at the time. The measure taken by the U.S right after the September 11-terror attacks aimed at stimulating the economy, were cited as the major culprits affecting this crisis. According Taylor (2009) the financial crisis happened when the economy underwent a period of over prosperity due to a sudden economic boom. (p. 1)
History of Lehman brother’s
Lehman brothers surely come a long way from its origins in 1844 when two brothers, Emanuel and Hendry Lehman created the company as a general store. Lehman brother started to grow through the capitalization of high cotton prices, which saw its growth explode tremendously. Through strategic partnership, the business survived and was able to endure the turmoil that rocked America during the 18 century. Lehman was also able to join the financial advisory business. Later in the year 1883, Lehman become a member of the coffee exchange. Finally, 1887 Lehman headed to the New York stock exchange where he began the work of underwriting; Lehman’s first client was the “international steam pump company” and from then on, grew to bigger clients such as Woolworth s and sears roebuck and company. It also had partnership with Goldman Sach’s at the time.
Lehman brothers in the 20th century
Lehman brothers had offices in the world trade center in America. On the September 11, 2001, the building got a direct hit from a terror ploy that destroyed it substantially leaving Lehman brother without a head office and one employee dead. Lehman brothers endeavored to quickly recover from the loss and set up an improvised trading floor in a hotel in New Jersey in record time of under fifty hours after the terror attack. In addition, after a week when market opened, it was business as usual for Lehman brothers operations. A month later, they acquired a brand new 32-story building for a whopping 700 million dollars. Criticisms surmounted as to why Lehman brothers never returned to their former building in lower Manhattan.
Lehman’s collapse
In 2008, Lehman brother got a sire of reprieve when the Federal Reserve scheduled a meeting to discuss the liquidation of Lehman’s assets. Top of the agenda was the possible sale of Lehman’s to either Barclay's bank or bank of America. According to reports, an outright sale of Lehman brothers was the purchase price Lehman was looking for. With these conditions, the two banks refused and talks stalled. On September 14, 2008, the ISDA allowed an impromptu market session to permit firms exposed to Lehman’s derivatives to counterbalance their positions, since Lehman brothers was scheduled to file for bankruptcy later that day.
Lehman brother once the fourth largest investment bank in the U.S, files for chapter 11(bankruptcy) on the 15th of September 2008 at approximately 1 am. This was the largest shock of an investment bank of this magnitude to have collapsed with a colossal amount of outstanding debt amounting to six hundred and nineteen billion dollars, together with asset totaling six hundred and thirty-nine billion dollars, not even Enron’s collapse could come close. The collapse affected employees worldwide who numbered close to twenty five thousand. With the collapse of Lehman brothers, Wall Street firms approved capital assistance to support the bank with its systematic liquidation with included the exchange of its inferior asses for loans and other required assistance. After the collapse, Lehman brother’s staff had the whole day to finalize their departure. The priority of the say was the removal the company logo together with all their possession from their investment banks headquarters.
Another blow to Lehman brother happened, when its subsidiary in Australia stopped trading at the ASX and a result of Lehman brother’s bankruptcy, also affected was the Dow Jones, which closed under 500 points that day. Lehman brother’s subsidiary across the globe faced major crisis, each subsidiary, or branch facing its own specific kind of crisis, in japan for instance the bank filed for civil reorganization.
Why Lehman brothers collapsed
(a) Management
According to the court appointed auditors, Lehman brother undertook manipulative and misleading accounting practices especially when it come to the valuation of its assets, to delude the bank as a going concern. They manipulate stakeholder by hiding securities in their books of accounts using purchase agreements. In their financial statements of 2007 and 2008, they indicated in the notes to the accounts, the fact that they disposed of their securities while in reality it that had not happened, amounted to a material misstatement.
After bear Stearn's hostile takeover, in 2008, Lehman brother took precautionary measure amid fears they would be the next bank to collapse. In 2008, with the new CFO in the helms of Lehman’s financial sector, the bank was able record profits of four hundred and eighty-nine million dollars in the first quarter of the year. After the news was disseminated Lehman’s stock-price rose to forty-six per cent. The next year saw Lehman brother’s performance in the second quarter of the year reduced to a loss of two point eight billion dollars. The reason for is dismal performance, was due to enhanced market volatility towards its hedges, rendering them useless. As a result, the bank had to raise an additional capital of six billion dollars to increase liquidity. To stabilize the bank and avoid further losses, the head of investment banking convened a meeting with the intention of removing Fuld who was the current CEO and his assistant from office. As a result, the president of Lehman brothers Joe Gregory accepted to step down and Bart McDade took over because of pressures that emanated from senior managers. As the shake-ups started to take effect, Erick Callans become the next casualty, and later received a demotion. He had only managed to hold his position for six month. With McDade as the new president, Gelband and Kirk previously force to resign got reinstated back to their former positions.
In August 2008, Korea development banks went into talks with Lehman brothers with the intention of buying the bank. This new development created positive effects for Lehman brothers stock, with closed at sixteen percent at the end of the week. In September, that year, talk finally broke down between Korea development bank and Lehman brothers due to unresolved issues, this brought about a fall in Lehman’s share price, of forty-five percent. This was a difficult time for Swiss Re that had exposure to the bank, at fifty two point five billion dollars. With Lehman brother dismal performance, investors’ confidence started to dwindle forcing the market price of its shares to reduce by half, it also affected by overall market capitalization by eroding three hundred points from the Dow Jones. At this time, the American government did nothing to cushion investors from any financial crisis emerging caused by Lehman brothers, and as a result, the investment bank announced losses of three point nine billion dollars with intention of disposing off its majority shareholding of Neuberger Berman. Lehman’s stock fell by seven percent that day because of its bad quarterly earnings. Lehman later back down from Neuberger Berman sale, since the news of its intended sale had affected Lehman’s stocks to a further deflation of forty percent.
Before Lehman’s collapse, Neuberger Berman Lehman’s subsidiary under-took frantic efforts to appeal to Lehman executive to forgoer, their large sums of bonuses given to the executives of the company to portray as a sign that the executive were now taking responsibility for Lehman’s poor results. However, the pleas received were disregard by the management of Lehman brothers who downplayed the appeals as preposterous. The management went ahead and apologized to its members terming the notion to reduce their bonuses as ridicules.
(b) Sub-prime mortgage crisis
2003-2004 was a period of rising property prices. Lehman brothers saw this as opportunity to cash in. The acquisition of five firms included the Aurora Loan Services: a mortgage provider, specialized in giving NINA loans with the disguise of ‘A’ loans to ease faster borrowings and BNC Mortgages, was a strategic plan for Lehman brothers to gain access into the booming property market. Later this proved to be one of the best investment decision taken by Lehman brothers that resulted in enormous profits that went up by fifty-six per-cents from the two years preceding 2006, a surely remarkable percentage of growth surpassing any other revenue sector in the economy at the time.
During the years of the housing, boom, Lehman brother’s profits skyrocketed to the highest level ever recorded. Its two acquisitions the Aurora and BNG were able to securitize mortgages and sell them to the secondary market resulting in profits of up to a hundred and forty-six billion dollars, which signified a marked increase from the 2005. Lehman ended up making a profit of four point two billion dollars, and its shares ended up trading at 86.18 per dollar with a market capitalization of sixty-two billion dollars.
By the mid 2006-2007, cracks in the housing market started appearing with massive mortgage defaults resulting from sub-prime mortgage borrowers defaulting almost instantaneously. The bank apparently recorded a high profit in its first quarter of 2007 immediately after the start of the crisis. Later its stock plummeted to its lowest level on March 14, 2007. With the threats of massive defaults, the company shaved off concerns about its business, saying the crisis would not be able to affect them. The bank also foresaw a lack of threat imposed by delinquent loans as confined and unable to affect the country at large.
In 2008, as a result of its continual process of securitization and holding large amounts of sub-prime mortgages together with low end derivatives. Lehman faced massive loses because of a lack of market to sell its low-end tranches. Some also believe it may have been a speculative strategy to sell them short. That year Lehman reported losses of two point eight billion and as a result had to dispose of assets totaling six billion dollars. With the continued shrinking of the credit market, the banks stock lost close to seventy-three percent of its total market value and as a result had to undertake corrective measures that lead to a reduction of its.
(c) Lehman Financial Policy
Lehman brothers had a very high debt to equity ratio and took to a reliance of short-term repo debt as compared to other commercial banks that had equity to debt ratio of 1.5:1. At the start of the crisis Lehman brother had a debt to equity ratio of 30:1, which in financial terms signifies a going concern problem, since a sudden drop in the asset value amounting to three per-cents, was likely to render the company insolvent due to its inability to function. Lehman also suffered from a poor working capital policy. They used short-term funds to finance half its assets instead of using long-term debt. This increased the chances of running into bank runs. Since short-term borrowing can have interest rates fluctuate according to market volatility, any hints of a company’s inability to pay, immediately dries up all the sources of revenue instantly. When the crisis began, Lehman brother had taken a step toward to rectify the use of short-term borrowing policies by eliminating the use short-term debt, which later did not materialized (Zingales 2008, p. 16).
(d) Lawsuit
In 2003, Lehman brother was involved in settlement proceeding against the SEC because of its unfair and manipulative practice to receive under writing opportunities. The total amounts paid out by Lehman’s totaled eighty million dollars and in addition it was required to have a total restructuring of its investment banking division to avoid instances where analyst could be bribed.
On March 2010, vital information in relation to Lehman brothers’ finances was reveled in court proceedings. Noted; was Lehman brothers’ use of shady accounting practices to manipulate its financial status by temporarily changing its assets into cash using repo 105 before publishing its account. Ernst & Young, who were Lehman brother’s auditors at the time, played a part in hiding this material fact from its stakeholders. They could face charges of financial malpractice is found guilty together with Lehman’s CEO who could go to jail. However, finding credible evidence that Lehman brothers actually contravened U.S laws may not be possible in the court of law.
On October 2011, Lehman brother paid one hundred and forty eight million pounds into their pension funds after they lost an appeal to stop the case.
(e) Short selling
Despite numerous allegation of naked short selling by Lehman’s brothers, no evidence to date suggests this actually took place. According to Richard Fuld the former CEO of Lehman brothers, sighted during the bankruptcy filing hearing that naked short selling, lack of investor confidence and deceitful rumors were the major factor in Lehman’s demise. According to numerous documents received from Lehman brothers, the House Committee Chairman during the hearing preceding suggested the lack of evidence to support any one factor leading to Lehman’s demise. However, article in the news seem to suggest naked short selling was a contributor leading to Lehman’s failure. A certain university of business that undertook advanced studies into the dealing of Lehman brothers concluded that there was no substantial evidence linking naked short selling to Lehman brothers decline in stock. This is an area we shall never really know the truth.
Liquidation of Lehman brothers
 Barclay's bank
On the 20th of September 2008, the U.S bankruptcy court approved Barclay’s public limited companies Intention to acquire a portion of Lehman brothers for one point seventy-five billion dollar. Of particular interest to Barclay's bank was Lehman’s, North American operations. Later Barclay's revised the deal downwards to one point three-five billion dollars, with further intention of acquiring Lehman’s head office. The Manhattan court approved Barclay's bid, justifying the ruling as the only alternative Lehman brothers had, according to the circumstances. This was the first time the court had undertaken such a ruling of this magnitude. Judge Perk, who presided over the court proceeding deemed the ruling as a first and not be a precedent for other cases later on, if such a case would ever emerge again,. A according to a partner of Hadley and McCloy the purchase price of Lehman was not particularly agreed upon by the credit committee, but was seen as the only feasible option given the time frame needed to make a ruling. According to the purchase agreement, Barclay's would assume a sizable amount of Lehman brothers trading securities as well as liabilities, which had potential of reaching billions in settlement cases, potentially the payment of severance to Lehman’s former employees if Barclay's chooses not to employ them. The purchase prize included Lehman’s headquarters in New York and two data centers in New Jersey. Barclay's however was entitled to Lehman’s eagle energy unit but got its branches in Uruguay, Canada and its prestigious investment management business for its high-flying clients. In the end, Lehman brothers retained only twenty billion dollars in securities.
 Nomura
Lehman’s brothers Asian division was purchases at two hundred and twenty-two million dollars, by Nomura holdings. The purchase prices for Lehman brother’s Asian division was only for its work force and not its assets as this would have meant assuming all the assets as well as the liabilities which Nomura holding did not particularly care for, hence the low purchase price. Lehman’s overseas division accounted for more than half the banks income.
 Bain Capital Partners and Hellman & Friedman
Lehman brothers agreed on September 2008 to dispose of its investment management business (Neuberger Berman) for two point one-five billion dollars to Hellman & Friedman and Brain Capital Partners pending approval from the bankruptcy court. The bid never materialized since the management of Neuberger Berman made a counter-offer on December 2008, which accepted by the U.S bankruptcy court. Neuberger Berman had its name changed to Berman Group LLC with Creditors of Lehman Brothers Holdings Inc. getting minority shareholding. Another subsidiary reclaimed by its employees is the Quantitative Asset Management Business, which has now changed its name to TOBAM.
How Lehman brothers may have evaded its downfall
Some historical facts point to the problem to have emanated when the glass-steagall act made into law. What this landmark ruling did was to separate the two division of banking sector; its commercial banking and investment banking sector from being competitor with each other. In order for each sector to run on their own without interference from the other, separate books of accounts were used and each was left to do what it does best in its sector. This meant volatile liquid asset portfolios, went to the investment-banking sector while the commercial sector had corporate investors. This acts also provided a cushion in instances where a banking sector would collapse. The cushion provided for a provision that excluded unaffected banking sector from falling with the affected sector. Later when the former president of the United States, bill Clinton come into power, he was able to sign a bill that allowed the two division of the banking sector to compete head to head with later led disastrous results for the financial sector at large.
With the reversal of the Glass-Steagall, Lehman brother took advantage of the property boom and as a results; its profits were enormous at that period. Other reasons pertaining to Lehman brother’s demise happened in relation so to its senior executive’s deceits, the lies told by the CEO, camouflage of its financial standing permitted by the CFO and finally negligence of behalf of its auditing company.
With cracks in the housing market in 2007, the CEO was fixated in a highly aggressive and leveraged business model at a time when other players who had foreseen impending doom in the mortgage market due to defaults originating from sub-prime mortgage borrowers backed away such mortgage backed securities. With Lehman brother’s wrong financial strategy, their assets portfolio increased greatly with MBS leaving them greatly exposed to high risk. When the time came for the CEO to own up to his mistakes, he evaded and downplayed the situation to investors and hence investor failed to know the true nature of Lehman brothers. Some believe if the manager had come clean with the true state of affair facing the institution, corrective solutions would have been in hand to help the bank and to a high extend would have prevented Lehman’s demise. If at the time, they had approached bank of America of Barclay's for acquisition talks, some believed it would have presented a more opportune time for two banks to design strategies to revive Lehman brothers as compared to when they approached this two banks when Lehman brothers was fast approaching collapse. Again, if the CEO had been open with the affairs of the bank without fear of repercussion from its stakeholders due to its dismal financial policies, the bank would definitely have survived to this time. Some also believed investors who had invested heavily had known about the financial position of the investment bank, immediately after the shock of discovering the true nature of events, would have sought for corrective actions and deterred the demise of the bank. If the federal government had known of the true state of Lehman brothers at the time and the public at large, the bank would have survived due to government intervention both in capital injection and with management support. Unfortunately, this did not happen due to Fuld the former CEO’s foolishness that led to the great Lehman brothers to collapse; this was really a case of bad leadership, bad management, and greed on the part of the CEO.
The next failure of Lehman brother lay with its CEO, Callan who facilitated the transfer of assets from Lehman brother’s balance sheet to a ghost subsidiary (Hudson castle) maliciously created for this purpose of hiding the company’s risky asset portfolios. The using of repo 105 for two crucial financial quarters was a blatant and manipulative strategy imposed to hide a bigger financial problem from its stakeholders.
Freddie mac was responsible in issuing short-term loan to Lehman brothers during the beginning of 2008. The loans issued to Lehman brothers were long unsecured overnight loans with limits of hundreds of millions. Every time Lehman failed to honor its debt. Freddie mac rolled over the loan to the next month with additional interest terms. In 2008, the loans had gotten so big that it now totaled eight hundred million dollars. With every loan paid, the amounts become available to Lehman brothers again to take up as a loan, which Lehman gladly took. In addition, from January to February, the loan amount reached a staggering one billion dollars and a further two hundred million added to the loan in months preceding April.
According to evidence, and testimonies presented to the courts, the use of repos by Lehman brothers portrayed the bank as being stable and secure. The company did not employ tax avoidance mechanism by the use of repos. Thought this technique of employing repos 105 was unwarranted for, had they been able to use it in conjunction with corrective measures. They would have eliminating some of the highly exposed asset portfolios while still being in the phantom account. Hence, their strategy would have worked well. In addition, in no time they would have been to submit proper true and fair financial statement. Nevertheless, with these possibilities, the bank kept on hooding large amounts of credit hence leading to a high debt ratio, which become unmanageable and the only alternative was to deceive its shareholders. Its strategies proved to be a shortsighted type lacking long-term focus. In this scenario if the CEO would have come clean concerning the true state of the company finances, they would have received all the needed help to revive back the bank.
The last was not come from Lehman brothers but from their auditing company, Ernst & young that had a duty of analyzing accounting data, detecting fraud, reporting to management about how assets are used and recommendation to name a few, failed to reveal the true nature of the bank. As a result, the accounting firm could face charges of gross negligence and legal action could be taken.
Why such a reputable firm could allow Lehman brother to continue with its misconducts is a question that needs answers. The possibility of losing such a large paycheck may have forced them to ignore Lehman’s misconducts hence discrediting them to the entire world. When Ernst & young gave a seal of approval to Lehman accounts, nobody could actually refute their financial statement. The fact that such a big and reputable accounting firm with such a high moral standing such Ernst & young had given an unqualified report showing the financial statement that represented a true and fair view of the company’s financial standings all stakeholders thought the financial statement was the portrayed the real state of the company. Because of Lehman brother’s demise, they too had a big hand in the collapse of Lehman brothers and as a result should be accountable for its fate. The story learned from this unfortunate event, is that, lack of ethical behavior can bring down even the biggest of institutions. In addition, accountability and transparency should always be the first factor instilled in every corporation’s policy. Lehman brother would have survived if ethical behavior were a mandatory behavior from its executive right through to its juniors.
Lessons learned from Lehman brothers
Before the collapse of Lehman brothers, some powerful people in the Federal Reserve, as well as the U.S treasury saw the financial crisis aiding in cleaning up all the mess that had happened to the stock market and property markets by eradication all the decay, exterminating it from the system finally. Some of these sentiments come from the house of representative as well as the business news Medias. After the collapse of Lehman brothers, the policy makers sought for ways to countering the crisis at any cost because the repercussions of Lehman’s demise was greater than anticipated by the financial regulators in the United States. There easy way out turned out to be a harsh punishment to the American economy and the financial world globally.
The effects of Lehman’s demise lead to the financial markets lack of confidence for hedge funds and international banks worldwide. Investor stopped investing and bank tightened the squeeze in lending amides fears of credit defaults. This forced government to take steps to control of the situation to avoid a total collapse of the market. In America, a relief program me totaling seven hundred billion dollars passed as a rescue program.
Conclusion
Lehman brothers collapse had major implication, not only to the American government but also to the global financial sector at large. Whether Lehman brothers left to its own demise is a question only the American government can tell us. The fact that the American government could actually let the bank to fall is still under attack and major criticism have been forwarded to it, since the collapse lead to major losses of investors’ money, depleting 46 billion from them. The choice for the bank of America to buy of Merrill lynch instead of Lehman brothers is still a subject that has left some wondering until today. According to Tibman (2009), “I do not consider the firms murder calculated or premeditated. Rather I believe it was an act of involuntary manslaughter, of criminal negligence” (p. 6). Some of the steps taken by Lehman brother seemed to culminate from lack of proper financial research, business knowledge, ignorance/poor management, and showing elements of gambling (short selling). Whether the U.S government sought to make the same conclusion, we may never know. With more government intervention especially how financial institutions run their affairs. This kind of crisis will never happen again. Greed fueled the crisis together with cooperate corruption on a massive scale in a first world country lacking proper financial regulations. The FDA and all the financial regulators we caught sleeping and had no answers to the massive malpractices being done especially by banks such as Lehman brothers, such as doctoring there accounting making them more favorable to investors. With the financial crisis-ending lesson learned have made countries are educated in regards to how a lack of proper financial system in a country can be unable to Copt with current crisis. In addition, the crisis showed how a government’s incapability of handling a financial crisis from escalating into near disaster, almost to the size of the great depression in the 1930 has contributed to one of the worst financial crisis. Getting the right balance for any government to effectively deal with the financial sector has to be right to avoid interfering if this kind of disaster is never to happen again in the future. Moreover, with this major crisis, governments now have to take a proactive role in the financial sector. In America, they have proposed the introduction of the consumer financial protection agency. Which such an agency never again will institution like Lehman brother, allowed to run as they did without systematic risk regulators keeping a watch.































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