Lehman BrothersLehman Brothers
Industry Fate Founded
Investment services Chapter 11 bankruptcy 1850, Montgomery,
Alabama, U.S.[1] Henry Lehman Emanuel Lehman Mayer Lehman 2008, New
York City, New York, U.S.
Founder(s)
Defunct
Headquarters New York City, New York, United States Area served
Worldwide Richard S. Fuld, Jr. Key peopleFormer (Chairman) &
(CEO)[2]
Bart McDadeFormer President and COO
Products
Financial Services Investment Banking Investment management
26,200 (2008) Lehman Brothers Inc., Neuberger Berman Inc., Aurora
Loan Services, Inc., SIB Mortgage Corporation, Lehman Brothers
Bank, FSB, Eagle Energy Partners, and the Crossroads Group
Employees
Subsidiaries
Lehman Brothers Holdings Inc. (former NYSE ticker symbol LEH)
(pronounced / li m n/) was a global financial services firm. Before
declaring bankruptcy in 2008, Lehman was the fourth largest
investment bank in the USA (behind Goldman Sachs, Morgan Stanley,
and Merrill Lynch), doing business in investment banking, equity
and fixed-income sales and trading (especially U.S. Treasury
securities), market research, investment management, private
equity, and private banking. On September 15, 2008, the firm filed
for Chapter 11 bankruptcy protection following the massive exodus
of most of its clients, drastic losses in its stock, and
devaluation of its assets by credit rating agencies. The filing
marked the largest bankruptcy in U.S. history,[3] and is thought to
have played a major role in the unfolding of the late-2000s global
financial crisis. The following day, Barclays announced its
agreement to purchase, subject to regulatory approval, Lehman's
North American investment-banking and trading divisions along with
its New York headquarters building.[4][5] On September 20, 2008, a
revised version of that agreement was approved by US Bankruptcy
Court Judge James M. Peck.[6] The next week, Nomura Holdings
announced that it would acquire Lehman Brothers' franchise in the
Asia-Pacific region, including Japan, Hong Kong and Australia,[7]
as well as Lehman Brothers' investment banking and equities
businesses in Europe and the Middle East. The deal became effective
on 13 October 2008.[8]
Contents[hide]y
y
y y y y y y y y y
1 History o 1.1 Under the Lehman family (1850 1969) o 1.2 An
evolving partnership (1969 1984) o 1.3 Merger with American Express
(1984 1994) o 1.4 Divestment and independence (1994 2008) o 1.5
Response to September 11 terrorist attacks o 1.6 2003 SEC
litigation 2 Collapse o 2.1 Causes 2.1.1 Malfeasance 2.1.2 Subprime
mortgage crisis 2.1.3 Short-selling allegations o 2.2 Bankruptcy o
2.3 Liquidation 2.3.1 Barclays acquisition 2.3.2 Nomura acquisition
2.3.3 Sale of Neuberger Berman o 2.4 Financial fallout o 2.5
Ongoing litigation 3 Merger and acquisition history 4 Board of
directors 5 Former officers 6 In popular culture 7 Principal
locations (first year of occupancy) 8 See also 9 References 10
Further reading 11 External links
[edit] History[edit] Under the Lehman family (1850 1969)
Emanuel and Mayer Lehman
In 1844, 23-year-old Henry Lehman,[9] the son of a cattle
merchant, emigrated to the United States from Rimpar, Bavaria.[10]
He settled in Montgomery, Alabama,[9] where he opened a drygoods
store, "H. Lehman".[11] In 1847, following the arrival of his
brother Emanuel Lehman, the firm became "H. Lehman and Bro."[12]
With the arrival of their youngest brother, Mayer Lehman, in 1850,
the firm changed its name again and "Lehman Brothers" was
founded.[11][13] During the 1850s, cotton was one of the most
important crops in the United States. Capitalizing on cotton's high
market value, the three brothers began to routinely accept raw
cotton from customers as payment for merchandise, eventually
beginning a second business trading in cotton. Within a few years
this business grew to become the most significant part of their
operation. Following Henry's death from yellow fever in
1855,[11][14] the remaining brothers continued to focus on their
commodities-trading/brokerage operations. By 1858, the center of
cotton trading had shifted from the South to New York City, where
factors and commission houses were based. Lehman opened its first
branch office in New York City's Manhattan borough at 119 Liberty
Street,[14] and 32-year-old Emanuel relocated there to run the
office.[11] In 1862, facing difficulties as a result of the Civil
War, the firm teamed up with a cotton merchant named John Durr to
form Lehman, Durr & Co.[15][16] Following the war the company
helped finance Alabama's reconstruction. The firm's headquarters
were eventually moved to New York City, where it helped found the
New York Cotton Exchange in 1870;[14][17] Emanuel sat on the Board
of Governors until 1884. The firm also dealt in the emerging market
for railroad bonds and entered the financial-advisory business.
Herbert H. Lehman Official U.S. Senate Photo
Lehman became a member of the Coffee Exchange as early as 1883
and finally the New York Stock Exchange in 1887.[14][17] In 1899,
it underwrote its first public offering, the preferred and common
stock of the International Steam Pump Company.
Despite the offering of International Steam, the firm's real
shift from being a commodities house to a house of issue did not
begin until 1906. In that year, under Philip Lehman, the firm
partnered with Goldman, Sachs & Co.,[18][19] to bring the
General Cigar Co. to market,[20] followed closely by Sears, Roebuck
and Company.[20] During the following two decades, almost one
hundred new issues were underwritten by Lehman, many times in
conjunction with Goldman, Sachs. Among these were F.W. Woolworth
Company, [20][21] May Department Stores Company, Gimbel Brothers,
Inc.,[22] R.H. Macy & Company,[22] The Studebaker
Corporation,[21] the B.F. Goodrich Co. and Endicott Johnson
Corporation. Following Philip Lehman's retirement in 1925, his son
Robert "Bobbie" Lehman took over as head of the firm. During
Bobbie's tenure, the company weathered the capital crisis of the
Great Depression by focusing on venture capital while the equities
market recovered. Traditionally, a family-only partnership, in 1924
John M. Hancock became the first non-family member to join the
firm,[18][23] followed by Monroe C. Gutman and Paul Mazur in 1927.
By 1928, the firm moved to its now famous One William Street
location.
Pete Peterson
In the 1950s, Lehman underwrote the IPO of Digital Equipment
Corporation. In the 1930s, Lehman underwrote the initial public
offering of the first television manufacturer, DuMont, and helped
fund the Radio Corporation of America (RCA).[24] It also helped
finance the rapidly growing oil industry, including the companies
Halliburton and Kerr-McGee. Later, it arranged the acquisition of
Digital by Compaq.[edit] An evolving partnership (1969 1984)
Robert Lehman died in 1969 after forty-four years as the
patriarch of the firm, leaving no member of the Lehman family
actively involved with the partnership.[25] Robert's death, coupled
with a lack of a clear successor from within the Lehman family left
a void in the company. At the same time, Lehman was facing strong
headwinds amidst the difficult economic environment of the early
1970s. By 1972, the firm was facing hard times and in 1973, Pete
Peterson, Chairman
and Chief Executive Officer of the Bell & Howell
Corporation, was brought in to save the firm.[25] Under Peterson's
leadership as Chairman and CEO, the firm acquired Abraham & Co.
in 1975, and two years later merged with the venerable, but
struggling, Kuhn, Loeb & Co.,[25] to form Lehman Brothers,
Kuhn, Loeb Inc., the country's fourth-largest investment bank,
behind Salomon Brothers, Goldman Sachs and First Boston.[26]
Peterson led the firm from significant operating losses to five
consecutive years of record profits with a return on equity among
the highest in the investment-banking industry. By the early 1980s,
hostilities between the firm's investment bankers and traders (who
were driving most of the firm's profits) prompted Peterson to
promote Lewis Glucksman, the firm's President, COO and former
trader, to be his co-CEO in May 1983. Glucksman introduced a number
of changes that had the effect of increasing tensions, which when
coupled with Glucksmans management style and a downturn in the
markets, resulted in a power struggle that ousted Peterson and left
Glucksman as the sole CEO.[27] Upset bankers who had soured over
the power struggle, left the company. Steve Schwarzman, chairman of
the firm's M&A committee, recalled in a February 2003 interview
with Private Equity International that "Lehman Brothers had an
extremely competitive internal environment, which ultimately became
dysfunctional." The company suffered under the disintegration, and
Glucksman was pressured into selling the firm.[edit] Merger with
American Express (1984 1994)
Shearson Lehman/American Express Logo Main article: Shearson
Lehman Hutton
Shearson/American Express, an American Express-owned securities
company focused on brokerage rather than investment banking,
acquired Lehman in 1984, for $360 million. On May 11, the combined
firms became Shearson Lehman/American Express.[27] In 1988,
Shearson Lehman/American Express and E.F. Hutton & Co. merged
as Shearson Lehman Hutton Inc.[28]
From 1983 to 1990, Peter A. Cohen was CEO and Chairman of
Shearson Lehman Brothers,[29] where he led the one billion dollar
purchase of E.F. Hutton to form Shearson Lehman Hutton.[30] During
this period, Shearson Lehman was aggressive in building its
leveraged finance business in the model of rival Drexel Burnham
Lambert. In 1989, Shearson backed F. Ross Johnson's management team
in its attempted management buyout of RJR Nabisco but were
ultimately outbid by private equity firm Kohlberg Kravis Roberts,
who was backed by Drexel.[edit] Divestment and independence (1994
2008)
In 1993, under newly appointed CEO, Harvey Golub, American
Express began to divest itself of its banking and brokerage
operations. It sold its retail brokerage and asset management
operations to Primerica[31] and in 1994 it spun off Lehman Brothers
Kuhn Loeb in an initial public offering, as Lehman Brothers
Holdings, Inc.[32] Despite rumors that it would be acquired again,
Lehman performed quite well under Chairman and CEO Richard S. Fuld,
Jr.. By 2008, Fuld had been with the company for 30 years, and
would be the longest-tenured CEO on Wall Street. Fuld had steered
Lehman through the 1997 Asian Financial Crisis, a period where the
firm's share price dropped to $22 USD in 1998, but he was said to
have underestimated the downturn in the US housing market and its
effect on Lehman's mortgage bond underwriting business. Fuld kept
his job as the subprime mortgage crisis took hold, while CEOs of
rivals like Bear Stearns, Merrill Lynch, and Citigroup were forced
to resign.[33] In addition, Lehman's board of directors, which
includes retired CEOs like Vodafone's Christopher Gent and IBM's
John Akers were reluctant to challenge Fuld as the firm's share
price spiraled lower. [33] Fuld had a succession of "number twos"
under him, usually titled as President and Chief Operating Officer.
Chris Pettit was Fuld's second-in-command for two decades until
November 26, 1996, when he resigned as President and board member.
Pettit lost a power struggle with his deputies ( Steve Lessing, and
Joseph M. Gregory) back on March 15 that year that caused him to
relinquish its COO title, likely brought about after Pettit had a
mistress which violated Fuld's unwritten rules on marriage and
social etiquette. Bradley Jack and Joseph M. Gregory were appointed
co-COOs in 2002, however Jack was demoted to the Office of the
Chairman in May 2004 and departed in June 2005 with a severance
package of $80 million, making Gregory the sole COO and President.
Gregory was demoted on June 12, 2008 and replaced by Bart McDade,
who would see Lehman through bankruptcy. [34][35] In 2001, the firm
acquired the private-client services, or "PCS", business of Cowen
& Co.[36] and later, in 2003, aggressively re-entered the
asset-management business, which it had exited in 1989.[37]
Beginning with $2 billion in assets under management, the firm
acquired the Crossroads Group, the fixed-income division of Lincoln
Capital Management[37] and Neuberger Berman.[38] These businesses,
together with the PCS business and Lehman's private-equity
business, comprised the Investment Management Division, which
generated approximately $3.1 billion in net revenue and almost $800
million in pretax income in 2007. Prior to going bankrupt, the firm
had in excess of $275 billion in assets under management.
Altogether, since going public in 1994, the firm had increased net
revenues over 600% from $2.73 billion to $19.2 billion and had
increased employee headcount over 230% from 8,500 to almost
28,600.
At the 2008 ALB China Law Awards,[39] Lehman Brothers was
crowned:y y
Deal of the Year - Debt Market Deal of the Year Deal of the Year
- Equity Market Deal of the Year
[edit] Response to September 11 terrorist attacks
The Former New York City headquarters now owned by Barclays.
On September 11, 2001, Lehman occupied three floors of One World
Trade Center where one of its employees was killed in the attacks
of that day. Its global headquarters in Three World Financial
Center were severely damaged and rendered unusable by falling
debris, displacing over 6,500 employees. The bank recovered quickly
and rebuilt its presence. Trading operations moved across the
Hudson River to its Jersey City, New Jersey, facilities, where an
impromptu trading floor was built in a hotel and brought online
less than forty-eight hours after the attacks. When stock markets
reopened on September 17, 2001, Lehman's sales and trading
capabilities were restored. In the ensuing months, the firm fanned
out its operations across the New York City metropolitan area in
over forty temporary locations. Notably, the investment-banking
division converted the first-floor lounges, restaurants, and all
665 guestrooms of the Sheraton Manhattan Hotel into office space.
The bank also experimented with flextime (to share office space)
and telecommuting via virtual private networking. In October 2001,
Lehman purchased a 32-story, 1,050,000-square-foot (98,000 m2)
office building for a reported sum of $700 million. The building,
located at 745 Seventh Avenue, had recently been built, and not yet
occupied, by rival Morgan Stanley.
With Morgan Stanley's world headquarters located only two blocks
away at 1585 Broadway, in the wake of the attacks the firm was
re-evaluating its office plans which would have put over 10,000
employees in the Times Square area of New York City. Lehman began
moving into the new facility in January and finished in March 2002,
a move that significantly boosted morale throughout the
firm.[citation needed] The firm was criticized for not moving back
to its former headquarters in lower Manhattan. Following the
attacks, only Deutsche Bank, Goldman Sachs, and Merrill Lynch of
the major firms remained in the downtown area. Lehman, however,
points to the facts that it was committed to stay in New York City,
that the new headquarters represented an ideal circumstance where
the firm was desperate to buy and Morgan Stanley was desperate to
sell, that when the new building was purchased, the structural
integrity of Three World Financial Center had not yet been given a
clean bill of health, and that in any case, the company could not
have waited until May 2002 for repairs to Three World Financial
Center to conclude. After the attacks, Lehman's management placed
increased emphasis on business continuity planning. Unlike its
rivals, the company was unusually concentrated for a bulge-bracket
investment bank. For example, Morgan Stanley maintains a
750,000-square-foot (70,000 m2) trading-and-banking facility in
Westchester County, New York. The trading floor of UBS is located
in Stamford, Connecticut. Merrill Lynch's asset-management division
is located in Plainsboro Township, New Jersey. Aside from its
headquarters in Three World Financial Center, Lehman maintained
operations-and-backoffice facilities in Jersey City, space that the
firm considered leaving prior to 9/11. The space was not only
retained, but expanded, including the construction of a
backup-trading facility. In addition, telecommuting technology
first rolled out in the days following the attacks to allow
employees to work from home was expanded and enhanced for general
use throughout the firm.[40][edit] 2003 SEC litigation
In 2003, the company was one of ten firms which simultaneously
entered into a settlement with the U.S. Securities and Exchange
Commission (SEC), the Office of the New York State Attorney General
and various other securities regulators, regarding undue influence
over each firm's research analysts by their investment-banking
divisions. Specifically, regulators alleged that the firms had
improperly associated analyst compensation with the firms'
investment-banking revenues, and promised favorable, market-moving
research coverage, in exchange for underwriting opportunities. The
settlement, known as the global settlement, provided for total
financial penalties of $1.4 billion, including $80 million against
Lehman, and structural reforms, including a complete separation of
investment banking departments from research departments, no
analyst compensation, directly or indirectly, from
investment-banking revenues, and the provision of free,
independent, third-party, research to the firms' clients.
[edit] CollapseMain article: Bankruptcy of Lehman Brothers
[edit] Causes [edit] Malfeasance
A March 2010 report by the court-appointed examiner indicated
that Lehman executives regularly used cosmetic accounting gimmicks
at the end of each quarter to make its finances appear less shaky
than they really were. This practice was a type of repurchase
agreement that temporarily removed securities from the company's
balance sheet. However, unlike typical repurchase agreements, these
deals were described by Lehman as the outright sale of securities
and created "a materially misleading picture of the firms financial
condition in late 2007 and 2008."[41][edit] Subprime mortgage
crisis
In August 2007, the firm closed its subprime lender, BNC
Mortgage, eliminating 1,200 positions in 23 locations, and took an
after-tax charge of $25 million and a $27 million reduction in
goodwill. Lehman said that poor market conditions in the mortgage
space "necessitated a substantial reduction in its resources and
capacity in the subprime space".[42] In 2008, Lehman faced an
unprecedented loss to the continuing subprime mortgage crisis.
Lehman's loss was a result of having held on to large positions in
subprime and other lower-rated mortgage tranches when securing the
underlying mortgages; whether Lehman did this because it was simply
unable to sell the lower-rated bonds, or made a conscious decision
to hold them, is unclear. In any event, huge losses accrued in
lower-rated mortgage-backed securities throughout 2008. In the
second fiscal quarter, Lehman reported losses of $2.8 billion and
was forced to sell off $6 billion in assets.[43] In the first half
of 2008 alone, Lehman stock lost 73% of its value as the credit
market continued to tighten.[43] In August 2008, Lehman reported
that it intended to release 6% of its work force, 1,500 people,
just ahead of its third-quarter-reporting deadline in
September.[43] On August 22, 2008, shares in Lehman closed up 5%
(16% for the week) on reports that the state-controlled Korea
Development Bank was considering buying the bank.[44] Most of those
gains were quickly eroded as news came in that Korea Development
Bank was "facing difficulties pleasing regulators and attracting
partners for the deal."[45] It culminated on September 9, when
Lehman's shares plunged 45% to $7.79, after it was reported that
the staterun South Korean firm had put talks on hold.[46] On
September 17, 2008 Swiss Re estimates its overall net exposure to
Lehman Brothers as approximately CHF 50 million.[47] Investor
confidence continued to erode as Lehman's stock lost roughly half
its value and pushed the S&P 500 down 3.4% on September 9. The
Dow Jones lost 300 points the same day on investors' concerns about
the security of the bank.[48] The U.S. government did not announce
any plans to assist with any possible financial crisis that emerged
at Lehman.[49]
The next day, Lehman announced a loss of $3.9 billion and their
intent to sell off a majority stake in their investment-management
business, which includes Neuberger Berman.[50][51] The stock slid
seven percent that day.[51][52] Lehman, after earlier rejecting
questions on the sale of the company, was reportedly searching for
a buyer as its stock price dropped another 40 percent on September
11, 2008.[52] Just before the collapse of Lehman Brothers,
executives at Neuberger Berman sent e-mail memos suggesting, among
other things, that the Lehman Brothers' top people forgo
multi-million dollar bonuses to "send a strong message to both
employees and investors that management is not shirking
accountability for recent performance."[53] Lehman Brothers
Investment Management Director George Herbert Walker IV dismissed
the proposal, going so far as to actually apologize to other
members of the Lehman Brothers executive committee for the idea of
bonus reduction having been suggested. He wrote, "Sorry team. I am
not sure what's in the water at Neuberger Berman. I'm embarrassed
and I apologize."[53][edit] Short-selling allegations
During hearings on the bankruptcy filing by Lehman Brothers and
bailout of AIG before the House Committee on Oversight and
Government Reform,[54] former Lehman Brothers CEO Richard Fuld said
a host of factors including a crisis of confidence and naked
short-selling attacks followed by false rumors contributed to both
the collapse of Bear Stearns and Lehman Brothers. House committee
Chairman Henry Waxman said the committee received thousands of
pages of internal documents from Lehman and these documents portray
a company in which there was no accountability for
failure".[55][56][57] An article by journalist Matt Taibbi in
Rolling Stone contended that naked short selling contributed to the
demise of both Lehman and Bear Stearns.[58] A study by finance
researchers at the University of Oklahoma Price College of Business
studied trading in financial stocks, including Lehman Brothers and
Bear Stearns, and found "no evidence that stock price declines were
caused by naked short selling".[59][edit] Bankruptcy
On Saturday, September 13, 2008, Timothy F. Geithner, the
president of the Federal Reserve Bank of New York called a meeting
on the future of Lehman, which included the possibility of an
emergency liquidation of its assets.[60] Lehman reported that it
had been in talks with Bank of America and Barclays for the
company's possible sale. However, both Barclays and Bank of America
ultimately declined to purchase the entire company.[60][61] The
next day, Sunday, September 14, the International Swaps and
Derivatives Association (ISDA) offered an exceptional trading
session to allow market participants to offset positions in various
derivatives on the condition of a Lehman bankruptcy later that
day.[62][63] Although the bankruptcy filing missed the deadline,
many dealers honored the trades they made in the special
session.[64]
Lehman Brothers headquarters in New York City on September 15,
2008
Shortly before 1 a.m. Monday morning (New York time), Lehman
Brothers Holdings announced it would file for Chapter 11 bankruptcy
protection[65] citing bank debt of $613 billion, $155 billion in
bond debt, and assets worth $639 billion.[66] It further announced
that its subsidiaries would continue to operate as normal.[67] A
group of Wall Street firms agreed to provide capital and financial
assistance for the bank's orderly liquidation and the Federal
Reserve, in turn, agreed to a swap of lower-quality assets in
exchange for loans and other assistance from the government.[68]
The morning witnessed scenes of Lehman employees removing files,
items with the company logo, and other belongings from the world
headquarters at 745 Seventh Avenue. The spectacle continued
throughout the day and into the following day. Later that day, the
Australian Securities Exchange (ASX) suspended Lehman's Australian
subsidiary as a market participant after clearing-houses terminated
their contracts with the firm.[69] Lehman shares tumbled over 90%
on September 15, 2008.[70][71] The Dow Jones closed down just over
500 points on September 15, 2008, which was at the time the largest
drop in a single day since the days following the attacks on
September 11, 2001.[72] In the United Kingdom, the investment bank
went into administration with PricewaterhouseCoopers appointed as
administrators.[73] In Japan, the Japanese branch, Lehman Brothers
Japan Inc., and its holding company filed for civil reorganization
on September 16, 2008, in Tokyo District Court.[74] On September
17, 2008, the New York Stock Exchange delisted Lehman Brothers.[75]
On March 16, 2011 some three years after filing for bankruptcy and
following a filing in a Manhattan U.S. bankruptcy court, Lehman
Brothers Holdings Inc announced it would seek creditor approval of
its reorganization plan by October 14 followed by a confirmation
hearing to follow on November 17.[76][edit] Liquidation [edit]
Barclays acquisition
On Tuesday, September 16, 2008, Barclays plc announced that they
would acquire a "stripped clean" portion of Lehman for $1.75
billion, including most of Lehman's North America
operations.[4][77] On September 20, this transaction was
approved by U.S. Bankruptcy Judge James Peck.[78][79] On September
20, 2008, a revised version of the deal, a $1.35 billion (700
million) plan for Barclays to acquire the core business of Lehman
(mainly its $960-million headquarters, a 38story office
building[80] in Midtown Manhattan, with responsibility for 9,000
former employees), was approved. Manhattan court bankruptcy Judge
James Peck, after a 7-hour hearing, ruled: "I have to approve this
transaction because it is the only available transaction. Lehman
Brothers became a victim, in effect the only true icon to fall in a
tsunami that has befallen the credit markets. This is the most
momentous bankruptcy hearing I've ever sat through. It can never be
deemed precedent for future cases. It's hard for me to imagine a
similar emergency."[81] Luc Despins, then a partner at Milbank,
Tweed, Hadley & McCloy, the creditors committee counsel, said:
"The reason we're not objecting is really based on the lack of a
viable alternative. We did not support the transaction because
there had not been enough time to properly review it."[citation
needed] In the amended agreement, Barclays would absorb $47.4
billion in securities and assume $45.5 billion in trading
liabilities. Lehman's attorney Harvey R. Miller of Weil, Gotshal
& Manges, said "the purchase price for the real estate
components of the deal would be $1.29 billion, including $960
million for Lehman's New York headquarters and $330 million for two
New Jersey data centers. Lehman's original estimate valued its
headquarters at $1.02 billion but an appraisal from CB Richard
Ellis this week valued it at $900 million."[citation needed]
Further, Barclays will not acquire Lehman's Eagle Energy unit, but
will have entities known as Lehman Brothers Canada Inc, Lehman
Brothers Sudamerica, Lehman Brothers Uruguay and its Private
Investment Management business for high net-worth individuals.
Finally, Lehman will retain $20 billion of securities assets in
Lehman Brothers Inc that are not being transferred to Barclays.[82]
Barclays acquired a potential liability of $2.5 billion to be paid
as severance, if it chooses not to retain some Lehman employees
beyond the guaranteed 90 days.[83][84][edit] Nomura acquisition
Nomura Holdings, Japan's top brokerage firm, agreed to buy the
Asian division of Lehman Brothers for $225 million and parts of the
European division for a nominal fee of $2.[85][86] It would not
take on any trading assets or liabilities in the European units.
Nomura negotiated such a low price because it acquired only
Lehman's employees in the regions, and not its stocks, bonds or
other assets. The last Lehman Brothers Annual Report identified
that these non-US subsidiaries of Lehman Brothers were responsible
for over 50% of global revenue produced.[87][edit] Sale of
Neuberger Berman
On September 29, 2008, Lehman agreed to sell Neuberger Berman,
the bulk of its investment management business, to a pair of
private-equity firms, Bain Capital Partners and Hellman &
Friedman, for $2.15 billion.[88] The transaction was expected to
close in early 2009, subject to approval by the U.S. Bankruptcy
Court,[89] but a competing bid was entered by the firm's
management, who ultimately prevailed in a bankruptcy auction on
December 3, 2008. Creditors of Lehman Brothers Holdings Inc. retain
a 49% common equity interest in the firm, now known as Neuberger
Berman Group LLC.[90] It is the fourth largest private
employee-controlled asset
management firm globally, behind Fidelity Investments, The
Capital Group Companies and Wellington Management Company.[edit]
Financial fallout
Lehman's bankruptcy was the largest failure of an investment
bank since Drexel Burnham Lambert collapsed amid fraud allegations
18 years prior.[68] Immediately following the bankruptcy filing, an
already distressed financial market began a period of extreme
volatility, during which the Dow experienced its largest one day
point loss, largest intra-day range (more than 1,000 points) and
largest daily point gain. What followed was what many have called
the perfect storm of economic distress factors and eventually a
$700bn bailout package (Troubled Asset Relief Program) prepared by
Henry Paulson, Secretary of the Treasury, and approved by Congress.
The Dow eventually closed at a new six-year low of 7,552.29 on
November 20, followed by a further drop to 6626 by March of the
next year. The fall of Lehman also had a strong effect on small
private investors such as bond holders and holders of so-called
Minibonds. In Germany structured products, often based on an index,
were sold mostly to private investors, elderly, retired persons,
students and families. Most of those now worthless derivatives were
sold by the German arm of Citigroup, the German Citibank now owned
by Crdit Mutuel.[edit] Ongoing litigation
On March 11, 2010, Mangal H Pandey, a court-appointed examiner,
published the results of its year-long investigation into the
finances of Lehman Brothers.[91] This report revealed that Lehman
Brothers used an accounting procedure termed repo 105 to
temporarily exchange $50 billion of assets into cash just before
publishing its financial statements.[92] The action could be seen
to implicate both Ernst & Young, the bank's accountancy firm
and Richard S. Fuld, Jr, the former CEO.[93] This could potentially
lead to Ernst & Young being found guilty of financial
malpractice and Fuld facing time in prison.[94] According to the
Wall Street Journal, in March 2011, the SEC announced that they
weren't confident that they could prove that Lehman Brothers
violated US laws in its accounting practices.[95]
[edit] Merger and acquisition historyThe following is an
illustration of the company's major mergers and acquisitions and
historical predecessors (this is not a comprehensive
list):[96]Lehman Brot hers(1994, spun-off by American Express;
2008, bankrupt see Bankruptcy of
Shearson Shearson/Amer Shearson American Express Lehman ican
Express (est. 1850) Lehman Brothers (merged 1981) Shearson Shearson
Hayden Ston Hutton (merged 19 Hayden e, Inc. (merged 19 (formerly
Stone (merged 197 CBWL-Hayden Stone, 3) merged 1970)
Cogan, Berlind , Weill & Levitt(formerl y Carter, Berlind,
Potoma
Lehman Brothers)
88)
84)
Loeb, Rhoa Loeb, des, Rhoades & (acquired 1 Hornblower Co.
981) (merged 19 & Co.(merged 1978) 37)
Loeb Rhoades
Carl M. Loeb & Co.(est. 1931)
Rhoades & Compan y(est. 1905)
Hornblowe r, Weeks, No yes & Trask53-1977)
Hornblo wer & Weeks(est. 1888)
Hemphill , Noyes (merged 19 & Co.(est. 1919, acq. 1963)
Spencer Trask & Co.(est. 1866 as Trask & Brown)
Paul H. Davis & Co.(est. 1920, acq. 1953) Lehman Lehman
Brothers Kuhn Brothers Loeb (merged 1975) (merged 1977)
Abraham & Co.(est. 1938)
Lehman Brothers(est. 1850)
Kuhn, Loeb & Co.(est. 1867)
E. F. Hutton & Co.(est. 1904)
Neuberger Berman(est. 1939, acq. 2003, sold to management
2009)
Crossroads Group(est. 1981, acq. 2003)
[edit] Board of directorsy y y y
Richard S. Fuld, Jr., Chairman and Chief Executive Officer[97]
Michael L. Ainslie[97] John F. Akers[97] Roger S. Berlind[97]
y y y y y y
Thomas Cruikshank[97] Marsha Johnson Evans[97] Sir Christopher
Gent[97] Roland A. Hernandez[97] Dr. Henry Kaufman[97] John D.
Macomber[97]
[edit] Former officersy y y y y y y y y y y
Richard S. Fuld, Jr. Tom Russo Scott J. Freidheim Bart McDade
Joe Gregory Ion Lowitt Jessie Bhattal Jeremy Isaacs (not Sir Jeremy
Issacs the British television producer and executive) Skip McGee
George Walker Michael Gelband
Bankruptcy of Lehman BrothersFrom Wikipedia, the free
encyclopedia Jump to: navigation, search
Lehman Brothers headquarters in New York City
See also: Lehman Brothers
Lehman Brothers filed for Chapter 11 bankruptcy protection on
September 15, 2008. The bankruptcy of Lehman Brothers remains the
largest bankruptcy filing in U.S. history with Lehman holding over
$600 billion in assets.[1]
Contents[hide]y
y y y y
y y y
1 Background o 1.1 Exposure to the mortgage market o 1.2
Lehman's final months 2 Bankruptcy filing o 2.1 Breakup process 3
Impact of bankruptcy filing 4 Neuberger Berman 5 Controversies o
5.1 Controversy of executive pay during crisis o 5.2 Accounting
manipulation o 5.3 Section 363 Sale 6 See also 7 References 8
External links
[edit] BackgroundMain article: Subprime mortgage crisis [edit]
Exposure to the mortgage market
Lehman borrowed significant amounts to fund its investing in the
years leading to its bankruptcy in 2008, a process known as
leveraging or gearing. A significant portion of this investing was
in housing-related assets, making it vulnerable to a downturn in
that market. One measure of this risk-taking was its leverage
ratio, a measure of the ratio of assets to owners equity, which
increased from approximately 24:1 in 2003 to 31:1 by 2007.[2] While
generating tremendous profits during the boom, this vulnerable
position meant that just a 3-4% decline in the value of its assets
would entirely eliminate its book value or equity.[3] Investment
banks such as Lehman were not subject to the same regulations
applied to depository banks to restrict their risktaking.[4] In
August 2007, Lehman closed its subprime lender, BNC Mortgage,
eliminating 1,200 positions in 23 locations, and took a $25-million
after-tax charge and a $27-million reduction in goodwill. The firm
said that poor market conditions in the mortgage space
"necessitated a substantial reduction in its resources and capacity
in the subprime space".[5]
[edit] Lehman's final months
In 2008, Lehman faced an unprecedented loss due to the
continuing subprime mortgage crisis. Lehman's loss was apparently a
result of having held on to large positions in subprime and other
lower-rated mortgage tranches when securitizing the underlying
mortgages. Whether Lehman did this because it was simply unable to
sell the lower-rated bonds, or made a conscious decision to hold
them, is unclear. In any event, huge losses accrued in lower-rated
mortgage-backed securities throughout 2008. In the second fiscal
quarter, Lehman reported losses of $2.8 billion and was forced to
sell off $6 billion in assets.[6] In the first half of 2008 alone,
Lehman stock lost 73% of its value as the credit market continued
to tighten.[6] In August 2008, Lehman reported that it intended to
release 6% of its work force, 1,500 people, just ahead of its
third-quarterreporting deadline in September.[6] On August 22,
2008, shares in Lehman closed up 5% (16% for the week) on reports
that the state-controlled Korea Development Bank was considering
buying Lehman.[7] Most of those gains were quickly eroded as news
emerged that Korea Development Bank was "facing difficulties
pleasing regulators and attracting partners for the deal."[8] It
culminated on September 9, 2008, when Lehman's shares plunged 45%
to $7.79, after it was reported that the state-run South Korean
firm had put talks on hold.[9] Investor confidence continued to
erode as Lehman's stock lost roughly half its value and pushed the
S&P 500 down 3.4% on September 9, 2008. The Dow Jones lost
nearly 300 points the same day on investors' concerns about the
security of the bank.[10] The U.S. government did not announce any
plans to assist with any possible financial crisis that emerged at
Lehman.[11] On September 10, 2008, Lehman announced a loss of $3.9
billion and their intent to sell off a majority stake in their
investment-management business, which includes Neuberger
Berman.[12][13] The stock slid 7% that day.[13][14] On September
13, 2008, Timothy F. Geithner, then president of the Federal
Reserve Bank of New York called a meeting on the future of Lehman,
which included the possibility of an emergency liquidation of its
assets.[15] Lehman reported that it had been in talks with Bank of
America and Barclays for the company's possible sale.[15] The New
York Times reported on September 14, 2008, that Barclays had ended
its bid to purchase all or part of Lehman and a deal to rescue the
bank from liquidation collapsed.[16] It emerged subsequently that a
deal had been vetoed by the Bank of England and the UK's Financial
Services Authority.[17] Leaders of major Wall Street banks
continued to meet late that day to prevent the bank's rapid
failure.[16] Bank of America's rumored involvement also appeared to
end as federal regulators resisted its request for government
involvement in Lehman's sale.[16]
[edit] Bankruptcy filing
Lehman Brothers headquarters in New York City
Lehman Brothers filed for Chapter 11 bankruptcy protection on
September 15, 2008. According to Bloomberg, reports filed with the
U.S. Bankruptcy Court, Southern District of New York (Manhattan) on
September 16 indicated that J.P. Morgan provided Lehman Brothers
with a total of $138 billion in "Federal Reserve-backed advances."
The cash-advances by JPMorgan Chase were repaid by the Federal
Reserve Bank of New York for $87 billion on September 15 and $51
billion on September 16.[18][edit] Breakup process
On September 22, 2008, a revised proposal to sell the brokerage
part of Lehman Brothers holdings of the deal, was put before the
bankruptcy court, with a $1.3666 billion (700 million) plan for
Barclays to acquire the core business of Lehman Brothers (mainly
Lehman's $960 million Midtown Manhattan office skyscraper), was
approved. Manhattan court bankruptcy Judge James Peck, after a 7
hour hearing, ruled: "I have to approve this transaction because it
is the only available transaction. Lehman Brothers became a victim,
in effect the only true icon to fall in a tsunami that has befallen
the credit markets. This is the most momentous bankruptcy hearing
I've ever sat through. It can never be deemed precedent for future
cases. It's hard for me to imagine a similar emergency."[19]
Barclays acquired the investment banking business of Lehman
Brothers in September 2008
Luc Despins, the creditors committee counsel, said: "The reason
we're not objecting is really based on the lack of a viable
alternative. We did not support the transaction because there had
not been enough time to properly review it."[citation needed] In
the amended agreement, Barclays would absorb $ 47.4 billion in
securities and assume $ 45.5 billion in trading liabilities.
Lehman's attorney Harvey R. Miller of Weil, Gotshal & Manges,
said "the purchase price for the real estate components of the deal
would be $ 1.29 billion, including $960 million for Lehman's New
York headquarters and $ 330 million for two New Jersey data
centers. Lehman's original estimate valued its headquarters at $
1.02 billion but an appraisal from CB Richard Ellis this week
valued it at $900 million."[citation needed] Further, Barclays will
not acquire Lehman's Eagle Energy unit, but will have entities
known as Lehman Brothers Canada Inc, Lehman Brothers Sudamerica,
Lehman Brothers Uruguay and its Private Investment Management
business for high net-worth individuals. Finally, Lehman will
retain $20 billion of securities assets in Lehman Brothers Inc that
are not being transferred to Barclays.[20] Barclays had a potential
liability of $ 2.5 billion to be paid as severance, if it chooses
not to retain some Lehman employees beyond the guaranteed 90
days.[21][22] On September 22, 2008, Nomura Holdings, Inc.
announced it agreed to acquire Lehman Brothers' franchise in the
Asia Pacific region including Japan, Hong Kong and Australia.[23]
The following day, Nomura announced its intentions to acquire
Lehman Brothers' investment banking and equities businesses in
Europe and the Middle East. A few weeks later it was announced that
conditions to the deal had been met, and the deal became legally
effective on Monday, 13 October.[24] In 2007, non-US subsidiaries
of Lehman Brothers were responsible for over 50% of global revenue
produced.[25]
[edit] Impact of bankruptcy filingThe Dow Jones closed down just
over 500 points (4.4%) on September 15, 2008, at the time the
largest drop by points in a single day since the days following the
attacks on September 11, 2001.[26] (This drop was subsequently
exceeded by an even larger 7.0% plunge on September 29, 2008.)
Lehman's bankruptcy is expected to cause some depreciation in the
price of commercial real estate. The prospect for Lehman's $4.3
billion in mortgage securities getting liquidated sparked a selloff
in the commercial mortgage-backed securities (CMBS) market.
Additional pressure to sell securities in commercial real estate is
feared as Lehman gets closer to liquidating its assets.
Apartment-building investors are also expected to feel pressure to
sell as Lehman unloads its debt and equity pieces of the $22
billion purchase of Archstone, the third-largest United States Real
Estate Investment Trust (REIT). Archstone's core business is the
ownership and management of residential apartment buildings in
major metropolitan areas of the United States. Jeffrey Spector, a
real-estate analyst at UBS said that in markets with apartment
buildings that compete with Archstone, "there is no question that
if you need to sell assets, you will try to get ahead" of the
Lehman selloff, adding "Every day that goes by there will be more
pressure on pricing."[27] Several money funds and institutional
cash funds had significant exposure to Lehman with the
institutional cash fund run by The Bank of New York Mellon and the
Primary Reserve Fund, a money-market fund, both falling below $1
per share, called "breaking the buck", following losses on their
holdings of Lehman assets. In a statement The Bank of New York
Mellon said its fund had isolated the Lehman assets in a separate
structure. It said the assets accounted for 1.13% of its fund. The
drop in the Primary Reserve Fund was the first time since 1994 that
a money-market fund had dropped below the $1-per-share level.
Putnam Investments, a unit of Canada's Great-West Lifeco, shut a
$12.3 billion money-market fund as it faced "significant redemption
pressure" on September 17, 2008. Evergreen Investments said its
parent Wachovia Corporation would "support" three Evergreen
moneymarket funds to prevent their shares from falling.[28] This
move to cover $494 million of Lehman assets in the funds also
raised fears about Wachovia's ability to raise capital.[29] Close
to 100 hedge funds used Lehman as their prime broker and relied
largely on the firm for financing. In an attempt to meet their own
credit needs, Lehman Brothers International routinely
re-hypothecated[30] the assets of their hedge funds clients that
utilized their prime brokerage services. Lehman Brothers
International held close to 40 billion dollars of clients assets
when it filed for Chapter 11 Bankruptcy. Of this, 22 billion had
been re-hypothecated.[31] As administrators took charge of the
London business and the U.S. holding company filed for bankruptcy,
positions held by those hedge funds at Lehman were frozen. As a
result the hedge funds are being forced to de-lever and sit on
large cash balances inhibiting chances at further growth.[32] This
in turn created further market dislocation and over all systemic
risk, resulting in a 737 billion dollar decline in collateral
outstanding in the securities lending market.[33]
In Japan, banks and insurers announced a combined 249 billion
yen ($2.4 billion) in potential losses tied to the collapse of
Lehman. Mizuho Trust & Banking Co. cut its profit forecast by
more than half, citing 11.8 billion yen in losses on bonds and
loans linked to Lehman. The Bank of Japan Governor Masaaki
Shirakawa said "Most lending to Lehman Brothers was made by major
Japanese banks, and their possible losses seem to be within the
levels that can be covered by their profits," adding "There is no
concern that the latest events will threaten the stability of
Japan's financial system."[34] During bankruptcy proceedings a
lawyer from The Royal Bank of Scotland Group said the company is
facing between $1.5 billion and $1.8 billion in claims against
Lehman partially based on an unsecured guarantee from Lehman and
connected to trading losses with Lehman subsidiaries, Martin
Bienenstock.[35] Lehman was a counterparty to mortgage financier
Freddie Mac in unsecured lending transactions that matured on
September 15, 2008. Freddie said it had not received principal
payments of $1.2 billion plus accrued interest. Freddie said it had
further potential exposure to Lehman of about $400 million related
to the servicing of single-family home loans, including
repurchasing obligations. Freddie also said it "does not know
whether and to what extent it will sustain a loss relating to the
transactions" and warned that "actual losses could materially
exceed current estimates." Freddie was still in the process of
evaluating its exposure to Lehman and its affiliates under other
business relationships.[36] After Constellation Energy was reported
to have exposure to Lehman, its stock went down 56% in the first
day of trading having started at $67.87. The massive drop in stocks
led to the New York Stock Exchange halting trade of Constellation.
The next day, as the stock plummeted as low as $13 per share,
Constellation announced it was hiring Morgan Stanley and UBS to
advise it on "strategic alternatives" suggesting a buyout. While
rumors suggested French power company lectricit de France would buy
the company or increase its stake, Constellation ultimately agreed
to a buyout by MidAmerican Energy, part of Berkshire Hathaway
(headed by billionaire Warren Buffett).[37][38][39] The Federal
Agricultural Mortgage Corporation or Farmer Mac said it would have
to write off $48 million in Lehman debt it owned as a result of the
bankruptcy. Farmer Mac said it may not be in compliance with its
minimum capital requirements at the end of September.[40] In Hong
Kong more than 43,700 individuals in the city have invested in
HK$15.7 billion of "guaranteed mini-bonds" ( ) from
Lehman.[41][42][43] Many claim that banks and brokers mis-sold them
as low-risk. Conversely, bankers note that minibonds are indeed
low-risk instruments since they were backed by Lehman Brothers,
which until just months before its collapse was a venerable member
of Wall Street with high credit and investment ratings. The default
of Lehman Brothers was a low probability event, which was totally
unexpected. Indeed, many banks accepted minibonds as collateral for
loans and credit facilities. Another HK$3 billion has been invested
in similar like derivatives. The Hong Kong government proposed a
plan to buy back the investments at their current estimated value,
which will allow investors to partially recover some of their loss
by the end of the year.[44] HK chief executive Donald Tsang
insisted the local banks respond swiftly to the government buy-back
proposal as the Monetary Authority received more than 16,000
complaints.[41][43][44] On October 17 He Guangbe, chairman of the
Hong Kong Association of Banks, agreed to buy back the bonds, which
will be priced
using an agreed upon methodology based on its estimated current
value.[45] This episode has deep repercussions on the banking
industry, where misguided investor sentiments have become hostile
to both wealth management products as well as the banking industry
as a whole. Under intense pressure from the public, all political
parties have come out in support of the investors, further fanning
distrust towards the banking industry.
[edit] Neuberger BermanNeuberger Berman Inc., through its
subsidiaries, primarily Neuberger Berman, LLC, is an
investment-advisory firm founded in 1939 by Roy R. Neuberger and
Robert Berman, to manage money for high-net-worth individuals. In
the decades that followed, the firm's growth mirrored that of the
asset-management industry as a whole. In 1950, it introduced one of
the first no-load mutual funds in the United States, the Guardian
Fund, and also began to manage the assets of pension plans and
other institutions. Historically known for its value-investing
style, in the 1990s the firm began to diversify its competencies to
include additional value and growth investing, across the entire
capitalization spectrum, as well as new investment categories, such
as international, real-estate investment trusts and high-yield
investments. In addition, with the creation of a nationally and
several state-chartered trust companies, the firm became able to
offer trust and fiduciary services. Today the firm has
approximately $130 billion in assets under management.
Neuberger Berman's New York City headquarters on Third
Avenue.
In October 1999, the firm conducted an initial public offering
of its shares and commenced trading on the New York Stock Exchange,
under the ticker symbol "NEU". In July 2003, shortly after the
retired Mr. Neuberger's 100th birthday, the company announced that
it was in merger discussions with Lehman Brothers Holdings Inc.
These discussions ultimately resulted in the firm's acquisition by
Lehman on October 31, 2003, for approximately $2.63 billion in cash
and securities. On November 20, 2006, Lehman announced its
Neuberger Berman subsidiary would acquire H. A. Schupf & Co., a
money-management firm targeted at wealthy individuals. Its $2.5
billion of assets would join Neuberger's $50 billion in
high-net-worth client assets under management.[46]
An article in The Wall Street Journal on September 15, 2008,
announcing that Lehman Brothers Holdings filed for Chapter 11
bankruptcy protection, quoted Lehman officials regarding Neuberger
Berman: "Neuberger Berman LLC and Lehman Brothers Asset Management
will continue to conduct business as usual and will not be subject
to the bankruptcy case of the parent company, and its portfolio
management, research and operating functions remain intact. In
addition, fully paid securities of customers of Neuberger Berman
are segregated from the assets of Lehman Brothers and aren't
subject to the claims of Lehman Brothers Holdings' creditors,
Lehman said."[47] Just before the collapse of Lehman Brothers,
executives at Neuberger Berman sent e-mail memos suggesting, among
other things, that the Lehman Brothers' top people forgo
multi-million dollar bonuses to "send a strong message to both
employees and investors that management is not shirking
accountability for recent performance." Lehman Brothers Investment
Management Director George Herbert Walker IV dismissed the
proposal, going so far as to actually apologize to other members of
the Lehman Brothers executive committee for the idea of bonus
reduction having been suggested. He wrote, "Sorry team. I am not
sure what's in the water at Neuberger Berman. I'm embarrassed and I
apologize."[48]
[edit] Controversies[edit] Controversy of executive pay during
crisis
Richard Fuld, head of Lehman Brothers, faced questioning from
the U.S. House of Representatives' Committee on Oversight and
Government Reform. Rep. Henry Waxman (DCA) asked: "Your company is
now bankrupt, our economy is in crisis, but you get to keep $480
million (276 million). I have a very basic question for you, is
this fair?"[49] Fuld said that he had in fact taken about $300
million (173 million) in pay and bonuses over the past eight
years.[49] Despite Fuld's defense on his high pay, Lehman Brothers
executive pay was reported to have increased significantly before
filing for bankruptcy.[50] On October 17, 2008, CNBC reported that
several Lehman executives, including Richard Fuld, have been
subpoenaed in a case relating to securities fraud.[51][edit]
Accounting manipulation
In March 2010, the report of Anton R. Valukas, the Bankruptcy
Examiner, drew attention to the use of Repo 105 transactions to
boost the bank's apparent financial position around the date of the
year-end balance sheet. The attorney general later Andrew Cuomo
filed charges against the bank's auditors Ernst & Young in
December 2010, alleging that the firm "substantially assisted... a
massive accounting fraud" by approving the accounting
treatment.[52] On April 12, 2010, a New York Times story revealed
that Lehman had used a small company, Hudson Castle, to move a
number of transactions and assets off Lehman's books as a means of
manipulating accounting numbers of Lehman's finances and risks. One
Lehman executive described Hudson Castle as an "alter ego" of
Lehman. According to the story, Lehman owned
one quarter of Hudson; Hudson's board was controlled by Lehman,
most Hudson staff members were former Lehman employees.[53][edit]
Section 363 Sale
On February 22, 2011, Judge James M. Peck of the U.S. Bankruptcy
Court in the Southern District of New York rejected claims by
lawyers for the Lehman estate that Barclays had improperly reaped a
windfall from the section 363 sale. "The sale process may have been
imperfect, but it was still adequate under the exceptional
circumstances of Lehman Week."
Case Study: The Collapse of Lehman BrothersOn September 15,
2008, Lehman Brothers filed for bankruptcy. With $639 billion in
assets and $619 billion in debt, Lehman's bankruptcy filing was the
largest in history, as its assets far surpassed those of previous
bankrupt giants such as WorldCom and Enron. Lehman was the
fourth-largest U.S. investment bank at the time of its collapse,
with 25,000 employees worldwide. Lehman's demise also made it the
largest victim, of the U.S. subprime mortgageinduced financial
crisis that swept through global financial markets in 2008.
Lehman's collapse was a seminal event that greatly intensified the
2008 crisis and contributed to the erosion of close to $10 trillion
in market capitalization from global equity markets in October
2008, the biggest monthly decline on record at the time. (For more
information on the subprime meltdown, read Who Is To Blame For The
Subprime Crisis?)
The History of Lehman Brothers Lehman Brothers had humble
origins, tracing its roots back to a small general store that was
founded by German immigrant Henry Lehman in Montgomery, Alabama, in
1844. In 1850, Henry Lehman and his brothers, Emanuel and Mayer,
founded Lehman Brothers. While the firm prospered over the
following decades as the U.S. economy grew into an international
powerhouse, Lehman had to contend with plenty of challenges over
the years. Lehman survived them all the railroad bankruptcies of
the 1800s, the Great Depression of the 1930s, two world wars, a
capital shortage when it was spun off by American Express in 1994,
and the Long Term Capital Management collapse and Russian debt
default of 1998. However, despite its ability to survive past
disasters, the collapse of the U.S. housing market ultimately
brought Lehman Brothers to its knees, as its headlong rush into the
subprime mortgage market proved to be a disastrous step. (To learn
more about previous financial disasters, be sure to check
out our Crashes Special Feature.) The Prime Culprit In 2003 and
2004, with the U.S. housing boom (read, bubble) well under way,
Lehman acquired five mortgage lenders, including subprime lender
BNC Mortgage and Aurora Loan Services, which specialized in Alt-A
loans (made to borrowers without full documentation). Lehman's
acquisitions at first seemed prescient; record revenues from
Lehman's real estate businesses enabled revenues in the capital
markets unit to surge 56% from 2004 to 2006, a faster rate of
growth than other businesses in investment banking or asset
management. The firm securitized $146 billion of mortgages in 2006,
a 10% increase from 2005. Lehman reported record profits every year
from 2005 to 2007. In 2007, the firm reported net income of a
record $4.2 billion on revenue of $19.3 billion. (Check out the
answer to our frequently asked question What is a subprime
mortgage? to learn more about these loans.) Lehman's Colossal
Miscalculation In February 2007, the stock reached a record $86.18,
giving Lehman a market capitalization of close to $60 billion.
However, by the first quarter of 2007, cracks in the U.S. housing
market were already becoming apparent as defaults on subprime
mortgages rose to a seven-year high. 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. The Beginning of the End As the credit
crisis erupted in August 2007 with the failure of two Bear Stearns
hedge funds, Lehman's stock fell sharply. During that month, the
company eliminated 2,500 mortgage-related jobs and shut down its
BNC unit. In addition, it also closed offices of Alt-A lender
Aurora in three states. Even as the correction in the U.S. housing
market gained momentum, Lehman continued to be a major player in
the mortgage market. 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. (Read more in
Dissecting The Bear Stearns Hedge Fund Collapse.) Hurtling Toward
Failure Lehman's high degree of leverage - the ratio of total
assets to shareholders equity - was 31 in 2007, and its huge
portfolio of mortgage securities made it increasingly vulnerable to
deteriorating market conditions. On March 17, 2008, following the
near-collapse of Bear Stearns - the second-largest underwriter of
mortgage-backed securities - Lehman shares fell as much as 48% on
concern it would be the next Wall Street firm to fail. Confidence
in the company returned to some extent in April, after it raised $4
billion through an issue of preferred stock that was convertible
into Lehman shares at a 32% premium to its price at the time.
However, the stock resumed its decline as hedge fund managers
began questioning the valuation of Lehman's mortgage portfolio. On
June 9, Lehman announced a second-quarter loss of $2.8 billion, its
first loss since being spun off by American Express, and reported
that it had raised another $6 billion from investors. The firm also
said that it had boosted its liquidity pool to an estimated $45
billion, decreased gross assets by $147 billion, reduced its
exposure to residential and commercial mortgages by 20%, and cut
down leverage from a factor of 32 to about 25. (Read Hedge Fund
Failures Illuminate Leverage Pitfalls to learn more about the
double-edged sword of leverage.) Too Little, Too Late However,
these measures were perceived as being too little, too late. Over
the summer, Lehman's management made unsuccessful overtures to a
number of potential partners. The stock plunged 77% in the first
week of September 2008, amid plummeting equity markets worldwide,
as investors questioned CEO Richard Fuld's plan to keep the firm
independent by selling part of its asset management unit and
spinning off commercial real estate assets. Hopes that the Korea
Development Bank would take a stake in Lehman were dashed on
September 9, as the stateowned South Korean bank put talks on hold.
The news was a deathblow to Lehman, leading to a 45% plunge in the
stock and a 66% spike in credit-default swaps on the company's
debt. The company's hedge fund clients began pulling out, while its
short-term creditors cut credit lines. On September 10, Lehman
pre-announced dismal fiscal third-quarter results that underscored
the fragility of its financial position. The firm reported a loss
of $3.9 billion, including a write-down of $5.6 billion, and also
announced a sweeping strategic restructuring of its businesses. The
same day, Moody's Investor Service announced that it was reviewing
Lehman's credit ratings, and also said that Lehman would have to
sell a majority stake to a strategic partner in order to avoid a
rating downgrade. These developments led to a 42% plunge in the
stock on September 11. With only $1 billion left in cash by the end
of that week, Lehman was quickly running out of time. Last-ditch
efforts over the weekend of September 13 between Lehman, Barclays
PLC and Bank of America, aimed at facilitating a takeover of
Lehman, were unsuccessful. On Monday September 15, Lehman declared
bankruptcy, resulting in the stock plunging 93% from its previous
close on September 12. Conclusion 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) 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. (To learn more about the financial crisis, read The
2007-08 Financial Crisis In Review.)
Three Lessons of the Lehman Brothers Collapse
Employees of Lehman Brothers exit the company headquarters in
midtown Manhattan on the day that the company filed for bankruptcy
A year ago today, the venerable investment-banking firm Lehman
Brothers filed for bankruptcy protection after the Federal Reserve
and the Treasury Department pointedly refused to bail the company
out, and no other Wall Street outfit was willing to step into the
breach. It was the largest bankruptcy ever in the U.S., but the
really big news was what happened afterward. First came a financial
panic that threatened to shatter the global capitalist order, then
came an unprecedented, and unprecedentedly expensive, effort by
governments on both sides of the Atlantic to patch things up. You
already knew all this, of course. It happened just last year, and
in recent days the news media have engaged in an orgy of
commemoration and explanation of the Lehman collapse and its
aftermath. So here's the $64 trillion question: What, if anything,
have we learned from the experience? (See the top 10 financial
collapses of 2008.) Three main lessons present themselves. First,
our complex financial system is awfully fragile. Second, government
action is capable of keeping a financial panic from snowballing
into a complete economic disaster along the lines of the Great
Depression. Third, the government has in large part because of its
success in averting disaster found it difficult to take any actions
that would make the financial system less fragile in the future.
That would, apparently, be too much government intervention. First,
the fragility. Allowing Lehman to fail cited often as the
government's biggest boo-boo started a chain reaction. There was a
run on money-market funds after one big money-market fund revealed
that it owned a lot of suddenly worthless Lehman debt. London-based
hedge funds that relied on Lehman for day-to-day financing found
themselves unable to do business because their accounts with
Lehman's U.K. subsidiary were frozen. Similar dislocations played
out around the world. Before long, financial institutions were
paralyzed by fear. They simply didn't trust each other anymore, and
didn't want to lend to each other. The financial system proved too
fragile to handle the stress. (See 25 people to blame for the
financial crisis.)
That brings us to lesson No. 2. In the early 1930s, powerful
voices at the Treasury and Federal Reserve argued that the deep
pain of financial crisis was a necessary economic corrective.
"Liquidate labor, liquidate stocks, liquidate the farmers,
liquidate real estate," Treasury Secretary Andrew Mellon advised
President Herbert Hoover. "It will purge the rottenness out of the
system." Late last year, you could hear a few people arguing this
case on CNBC and even on the floor of the House of Representatives.
But after Lehman's failure, no one at Treasury or the Fed talked
that way. Instead, the consensus among the policymakers who
mattered, in the U.S. and overseas, was that the panic had to be
stopped at any cost. The cost was a bailout that placed trillions
of taxpayer dollars at risk. It was expensive, it was messy, it was
unfair. It struck many people as downright un-American. But it
worked. "I've abandoned free-market principles to save the
free-market system," is how President George W. Bush described it
last December. Mission accomplished so far, at least. In the face
of a financial shock worse than the Crash of 1929, massive
government intervention averted a second Great Depression. Yes,
we've still ended up in the worst economic downturn the U.S. has
seen since. But while there are surely lots of potholes and wrong
turns ahead, there's ample evidence that the economy both in the
U.S. and worldwide is in the early stages of a rebound. And we have
decisions made by government officials to thank for that. Then
again, decisions made by Congress, the Bush and Clinton
administrations and federal regulators in the years before the
crisis also played a key role in allowing things to get so bad.
From ill-considered deregulation of banking and derivatives to
over-the-top encouragement of home ownership, Washington's
fingerprints were all over the crisis. Almost nothing has been done
so far to right these wrongs, or otherwise rein in the excesses of
the financial system. Which brings us to lesson No. 3: It's really
hard for a democracy to make big changes in the absence of crisis.
President Barack Obama did warn in his speech to Wall Street on
Monday that "normalcy cannot breed complacency." But normalcy is
breeding complacency perhaps because complacency is normal.
Consider the financial reforms that the Obama Administration wants
to push through Congress before year-end creating a Consumer
Financial Protection Agency, giving the Federal Reserve the job of
systemic risk regulator, and establishing a "resolution regime" to
wind down troubled nonbank financial institutions (like Lehman) and
complex bank holding companies in an orderly fashion. Steps in the
right direction? Probably. Truly major reforms? Not so much. In the
months after Franklin D. Roosevelt took office in 1933, Congress
legislated a complete transformation of Wall Street and the banking
sector with the creation of the Securities and Exchange Commission
and the Federal Deposit Insurance Corp., and the segregation of
commercial banks from Wall Street. It's not obvious that we need
such a drastic overhaul now, but still, the contrasts with 1930s
are stark. Ironic, too. By following their belief that financial
markets should work out their own problems, Andrew Mellon and his
kindred spirits at the Fed triggered a financial collapse that more
or less ensured major, permanent government participation in the
financial sector. By intervening aggressively, Hank Paulson and his
kindred
spirits at the Fed haven't quite ensured a continuation of the
status quo some reforms will come, and banks and their regulators
will tread more gingerly for at least a few years but they do seem
to have headed off a re-enactment of the New Deal.