Lehman Brother Collapse: Happy Birthday

15th September,2008 The day Finance Industry will never forget. The day when World’s fourth largest investment Bank (in 2008) filed for Chapter 11. The bankruptcy which was never imagined before was before the eyes of the world. The worst crisis since the Second World War had rocked the whole world. A little brief details about the Lehman Brother’s incident to remind you:

a. Lehman Brothers was founded in 1850 by Henry Lehman for trading purposes.

b. Lehman brothers was fourth largest investment bank doing business in investment banking, equity and fixed income sales and trading (especially U.S. Treasury Securities), research, investment management, private equity, and private banking.

c. The Bank had exposure globally and had offices worldwide. Almost 15000 employees went out of Job due to Lehman Brothers debacle.

d. At the time of bankruptcy, it had assets worth of $630 Billion and $619 Billion in debt.

It is the brief insights about the bank which was once called to be “Too big to fail”. Now the question is:

What really made this debacle to occur?

a. The Prime Culprit: With the US’s housing market is on full swing during the period 2000-2007, Lehman Brothers acquired five mortgage lenders, including sub-prime lender BNC Mortgage and Aurora Loan Services, which specialized in Alt-A loans( made to borrowers without full documentation). The acquisition was not big deal as it was a bush in the jungle; record revenues from Lehman’s Real Estate businesses enabled revenues in the capital markets unit to surge 56% from 2004 to 2006, faster growth than other investment banking operations. The firm secuterized $146 Billion of mortgages in 2006. Lehman reported record profits between 2005-2007 till the date of it’s debacle.

b. Lehman’s Colossal Miscalculation: The stock of Lehman Brother’s was all time high during February 2007 giving it the market capitalization of over $60 Billion. Since, the Housing Boom(Real Estate Bubble) began to crack out and the defaults starting to happen, the CFO of the company turned down the “risks as being under control and will not have any large impact on the company’s risk”.

c. The Beginning of the End: As the crisis began to erupt in August 2007, after the falling of Bear Stearns( an investment bank which had major exposures in sub prime mortgages), the company’s share took a plunge in that month and seeing the risk it closed offices of Alt-A lender Aurora in three states and shut down it’s BNC unit. Even as the correction in the US Housing Markets were going on and began some momentum, Lehman Brothers was underwriting the mortgage backed securities like any other firm in US, accumulating an $85 billion portfolio or four times the equity of the company. In the fourth quarter of 2007 the stock rebounded(of the company) as global markets touched new highs.

d. Hurtling towards Failure: The Leverage Ratio of 31 was highest in the industry in case of the company. As the Bear Stearn’s collapsed in March 2008, the prices of Lehman Brothers share plunged record 48% due to fears that it would be next to collapse. On June 9 2008, Lehman Brothers reported quarterly loss of $2.8 billion. But as the fears of other banks to be collapse grew further, investor confidence shattered in the company and heavy selling took off. In June, Lehman Brothers tried to cut down it’s exposure from the real estate market but that was not enough as company was sitting on high debts. The stocks started to plunge heavily after shareholders questions management’s attitude towards the situation. And finally running out of Cash, the company filed for bankruptcy at 1:45AM on 15 September 2008.

The World after 5 Years of Lehman Brothers Crisis

Since 5 years have been completed of the Lehman Brother Crisis. The general expectations from the Wall Street pundits and from SEC to regulate the Shadow Banking for the betterment of investors. But, as the reality checks out the world has not learned from its past. The question now comes to whether such kind of crisis can also occur again in the near future? And the simple answer is no one really knows about it. Here are the four peculiar features of the post Lehman world which might raise doubts about the soundness of the financial system:

a. The big banks are bigger-not smaller: Since the post Lehman crisis, the big banks which during 2008 were “too big to fail” have expanded  largely since then and became more sophisticated than ever. The banking world was becoming more cases. The crisis made markets more concentrated than ever in the past.

b. The Rise of the Shadow Banking: Lehman Brothers failure was the feature of the one of the most dangerous problem ,i.e., Shadow Banking. Since the regulators do kept eyes on Shadow Banking industry which grew from $59 trillion to $67 trillion till 2013, according to Financial Stability Board.

c. The system depends more than ever on investor’s faith in central bank. The investors confidence that the Central Bank will clear all the mess. Logic suggests that blind faith on the central banks led to the failure of Lehman Brothers but investors still have faith in the Central Banks.

d. The income inequality has risen as most benefits of loose monetary policy(quantitative easing) by US and developed economies had mostly benefitted to top 5% of the population as it made asset prices to swell which made their wealth grow.

Conclusion:

Thus, there is no assurance that the debacle to this scale can never happen before. History might repeat in the much larger extent and destabilizing the financial markets in much bigger manner had shadow banking not been regulated properly.