What is Lehman Brothers? Exploring the collapse of a financial giant

Lehman Brothers, a name once renowned on Wall Street, was once one of the largest investment banks in the world. However, the collapse of Lehman Brothers sent shockwaves globally and became one of the most memorable financial events of the 21st century.

So, who were Lehman Brothers and what led to the disastrous collapse of such a financial empire? Let’s explore this in detail in this article from AZCoin.

What is Lehman Brothers?

Lehman Brothers was a global investment bank providing financial services such as investment banking, securities trading, asset management and investment management. Before its collapse, Lehman Brothers was one of the world’s leading financial institutions, known for its role in developing complex financial products like mortgage-backed securities.

History of Lehman Brothers

Here are some key milestones in the history of Lehman Brothers:

• 1850: Lehman Brothers was founded by the Lehman brothers, starting with a business in textiles and commodities.
• 1887: Lehman Brothers acquired other brokerage firms and expanded its operations to become a major brokerage firm.
• 1929: During the Great Depression, Lehman Brothers became one of the leading brokerage firms in the U.S., maintaining strong growth during the 1920s due to the stock market boom.
• 1980: The company acquired Shearson Loeb Rhoades, one of the leading investment firms in the U.S. at that time.
• 1993: Lehman Brothers acquired E.F. Hutton Mortgage Corporation, a top real estate finance company, began focusing heavily on real estate.
• 2000: Lehman Brothers achieved significant success in bond trading and provided financial risk management services to institutions.
• 2007: Lehman Brothers heavily invested in real estate, particularly focusing on subprime mortgages, a strategy that led to rapid growth but also to subsequent collapse.
• September 2008: Lehman Brothers faced difficulties raising capital and reducing asset values due to the global credit crisis.
• September 15, 2008: Lehman Brothers filed for bankruptcy, triggering the largest financial crisis since World War II, ending a golden era for an American financial empire.

Products and business scale of Lehman Brothers

Key products of Lehman Brothers

Here are the primary products and services that Lehman Brothers offered before its collapse in 2008:

• Financial Investments: Including investments in stocks, bonds, mutual funds and complex financial instruments based on mortgage debt.
• Asset Management: Services included portfolio management, financial analysis and investment recommendations for stocks, bonds, mutual funds, as well as other complex financial products.
• Asset Valuation: Services included valuation of real estate, businesses and hard-to-value assets like mortgage debt.
• Asset Financing: Provided financing to individual and institutional clients, including mortgage loans, commercial loans and other loans.
• Risk Management: Offered insurance products and financial risk management services to help clients achieve investment goals safely and efficiently.

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Business Scale of Lehman Brothers

Before its bankruptcy, Lehman Brothers was considered one of the world’s top investment banks, on par with Blackrock. Here are some specific details about the company’s scale:

• Lehman Brothers’ total assets at the time of bankruptcy amounted to approximately $639 billion.
• The company had a workforce of over 26,200 employees worldwide.
• Lehman Brothers operated in over 40 countries.
• In fiscal year 2007, the company reported revenues of over $60 billion and a net profit of nearly $4 billion.
• In 2008, Lehman Brothers was ranked fourth on the Fortune 500 list, which lists the largest companies in the U.S.

The Collapse of Lehman Brothers

Context Leading to the Crisis

From 2003-2004, loose monetary policies made borrowing easier, leading to a housing market boom with record-high home prices. Lehman Brothers acquired 5 mortgage lending companies (including BNC Mortgage and Aurora Loan Services), engaged in trading mortgage-backed securities (MBS) and collateralized debt obligations (CDO). They packaged debts into bonds and sold them to investors.

As the U.S. The real estate market peaked, these financial products attracted significant attention and generated huge profits for the bank. In 2007, Lehman Brothers reported a profit of $4.2 billion on total revenue of $19.3 billion.

Mortgage-Backed Securities (MBS) and Collateralized Debt Obligations (CDO)

MBS are securities issued based on mortgage loans, creating bonds with varying risk levels. The high-risk portions typically offer higher interest rates.

Investors bought MBS for higher returns compared to many other financial products. However, if the mortgages in the MBS were not paid on time, the value of the MBS could decrease, leading to losses for investors.

Similarly, CDOs operate like MBS but may include various types of assets such as commercial debt, real estate debt and credit debt. Both MBS and CDOs have high-risk characteristics but remain attractive to investors due to their high returns.

However, they often contained improperly assessed debt, allowing borrowers without repayment capacity to take loans and investors continued to invest in these risky assets.

Housing Market Decline

Ignoring the risks had severe consequences for Lehman Brothers. The company heavily invested in mortgage debt and securitized debt (MBS), making its assets highly dependent on real estate market values. Lehman also misjudged the risks of CDOs, leading to overvaluation and approximately $20 billion in losses as debts struggled.

When the Fed increased interest rates, the real estate market was severely impacted. Higher borrowing costs reduced the number of new speculators and led to a sharp decline in property prices, causing significant financial harm to Lehman Brothers.

Official Collapse of Lehman Brothers

Here are key milestones in the collapse of Lehman Brothers:

• March 2008: Lehman Brothers announced its first net loss since its founding.
• June 2008: The Q2 financial report showed Lehman Brothers’ total debt reached a record $613 billion.
• August 2008: The company announced a plan to cut 6% of its total workforce.
• September 9, 2008: Lehman Brothers announced that the Q3 financial report would be released on September 15 and warned of a decline in the real estate market.
• September 10, 2008: Investors and partners began withdrawing funds from Lehman Brothers, leading to a 45% drop in the company’s stock price in one day.
• September 12, 2008: Lehman Brothers held an emergency meeting with Federal Reserve and U.S. Treasury officials, seeking financial support to handle the crisis.
• September 13, 2008: The acquisition of Lehman Brothers by Barclays failed due to an inability to reach an agreement with investors.
• September 14, 2008: Lehman Brothers officially declared bankruptcy and sought Chapter 11 protection to restructure the company.
• September 15, 2008: Lehman Brothers was removed from the Dow Jones index.

Why Didn’t the U.S. Government Rescue Lehman Brothers?

During the 2008 financial crisis, the U.S. government supported major banks such as JPMorgan Chase, Bank of America, Citigroup, Wells Fargo and Goldman Sachs with loans and funding to prevent collapse and mitigate systemic risk.

However, Lehman Brothers did not receive a bailout because it could not find a sufficiently large investor or partner to rescue it. The U.S. government decided not to intervene, fearing that a bailout would upset the balance and undermine market confidence and it was also not supported by the public as it involved taxpayer money.

Causes of Lehman Brothers’ Collapse

The collapse of Lehman Brothers resulted from various causes, with key factors including:

• Poor Asset Risk Management: Lehman Brothers invested heavily in mortgage debt (MBS and CDO), creating a high-risk investment portfolio heavily reliant on real estate. The company misjudged the risk levels associated with these assets.
• Decline in the U.S. Real Estate Market: The downturn in the real estate market reduced the value of Lehman Brothers’ assets, making it difficult for the bank to meet its real estate-related debt obligations.
• Difficulty Raising Capital and Repaying Debt: Lehman Brothers faced challenges in raising funds and repaying debts, leading to a lack of willingness from the government and other banks to provide support due to the bank’s massive debt relative to its capacity and scale.
• Excessive Financial Leverage: The company used excessive financial leverage to invest in complex financial products, especially short-term loans between banks, increasing financial risk.
• Lack of Cash Reserves: A shortage of cash prevented Lehman Brothers from meeting debt repayment demands from investors, leading to panic and a rush to withdraw funds, ultimately resulting in the company’s collapse.

Consequences of Lehman Brothers’ Collapse

The collapse of Lehman Brothers had significant effects on the global economy, impacting financial markets and the economy. Major consequences include:

• Increased Unemployment: Unemployment rates rose from 5% to 10%, affecting over 26,200 Lehman Brothers employees, along with layoffs at other financial firms.
• Financial Market Decline: Indices such as the Dow Jones and S&P 500 fell by more than 50%, accompanied by a 31% average decrease in property prices.
• GDP Decline: GDP fell by 4.3% from 2007-2009 due to U.S. government expenditures on support for affected companies.
• Global Crisis: Countries faced economic difficulties due to Lehman Brothers being a multinational company, affecting many clients and investment firms.

Policy Changes After Lehman Brothers’ Collapse

Following Lehman Brothers’ collapse, several new policies and laws were implemented to enhance financial system stability, including:

• Dodd-Frank Wall Street Reform and Consumer Protection Act (2010): This law required banks to report detailed operations, enhanced oversight and established new financial regulatory agencies to ensure transparency and stability.
• Stress Tests: Banks must undergo stress tests to ensure they can withstand negative market impacts.
• Volcker Rule (2014): Limited banks’ short-term investment activities to reduce risk and enhance financial stability.
• Basel III (2013): Set minimum capital requirements for banks to protect the financial system.

Additionally, financial regulatory agencies increased oversight, privacy policy, risk management and provided comprehensive information to investors to protect client interests.

Conclusion

The collapse of Lehman Brothers is a valuable lesson about the potential risks in the global financial system. AZcoin hopes this article has helped you understand the causes behind the collapse of a financial empire and the importance of risk management in financial markets.