The Bankruptcy of Lehman Brothers

Introduction

In September 2008, Lehman Brothers announced that the bank would file a bankruptcy case. There was anxiety in various places worldwide particularly in America, Europe, and Asian economic circles after the announcement. The employment of over 25,000 Lehman Brothers employees was certainly over with a large portion of fortune lost (Thomas, 2008). The consequences of the failure by the bank had just begun for the rest of the financial world.

This study explores factors surrounding Lehman Brothers’ bankruptcy. The paper examines how bankruptcy affected the income and the wealth of individuals. It also examines how the bankruptcy affected the income and wealth of different types of companies and firms. Finally, it examines whether the investment bank will be in a position to pay its debts in Europe.

Factors surrounding Lehman Brothers’ bankruptcy

In 2008, the federal government saved many financial institutions from collapse. Instead of following the typical rescue of the giant institution, the government let the bank to fail. Different commentators offering the reasons that led to the collapse of the bank give diverse grounds. Politics, derivatives, and financial negligence are attributed to the collapse of the investment bank (Maux & Morin, 2011). These are misconceptions as financial experts later came to learn. The Bush administration is said to have created economic uncertainties in the financial market given its economic philosophy. Some commentators affiliated the failure by the bank to the inability of the administration to create good-paying jobs that allowed the Americans to pay their bills.

The economic policies according to critics did not provide for the Americans to make future savings and to be able to pay for mortgages. The exposure of the bank to the distressed mortgage market led to its ultimate collapse. When the bank collapsed, the Bush administration watched without offering any assistance. According to a report by Lehman Brothers, derivatives did not lead to the collapse of the bank (Barkhausen, 2010). The report blamed the high lack of liquidity and poor management for the bankruptcy. The main factors that led to the collapse of the bank do not either include politics or derivatives. However, sharp lack of liquidity and poor management may be pointed at as the cause of the bankruptcy.

First, the management of the bank constantly overlooked its risk thresholds. The bank consistently invested in commercial real estate despite the prevailing recession and inability of the Americans to settle their mortgages. To illustrate this, in July 2007, the individual risk boundary dealings established by the risk managers were violated through the breach of thirty real estate dealings (Summe, 2011). The senior management of the bank waived the breach every time. The Security Exchange Commission (SEC), the bank’s controller, overlooked the management’s ignorance of the risk limits. Additionally, the stress testing of Lehman Brothers excluded the commercial real estate assortment that is the bank’s riskiest assets.

Second, the Lehman Brothers’ liquidity was sharply low. Five days before the bankruptcy declaration, the management had released statements indicating that the bank had $41 billion in the liquidity pool. There was an obvious infringement of the statutory proceedings given that the liquidity band of the depository incorporated chattels that were drawn like deposit by Lehman Brothers’ reimbursement reservoirs. The Security Exchange Commission was very aware of the infringement although opted for assent.

Third, Lehman Brothers heavily relied on the approach of ‘quarter-end’ to lower the bank’s leverage ratio significantly. The bank attained this by moving certain assets on a provisional basis off the balance sheet. Most banks stopped using this approach but the SEC never inquired into the practice as employed by Lehman Brothers.

How the bankruptcy affected the income and wealth of individuals

The failure by Lehman Brothers had far-reaching financial implications on the individual investors in the company. The management of the bank continuously reassured the investors that the financial risks posed by the declining home demand and home delinquencies would not affect the company. The chief finance officer stated that this had been well contained. It would have minimal or no impact on the earnings of the company. Apparently, there was no foreseeable challenge in the subprime market. However, the tribulations were dispersing fast to the remaining home souks while the financial system of the United States was impairing.

The collapse of the bank saw the company eliminate more than 2,500 jobs. The employees lost a significant size of fortune as the stock of the firm fell down. The employees hanged in uncertainty given that the bank could not find a rescuer with the federal government watching the company collapse. The deep insolvency of the bank meant that the bank was incapable of settling wages and salaries of the employees. The company had benefit plan for the employees as well as the human resources were likely to lose it since it fell under the bank’s unsecured claims (Thomas, 2008). The sudden decline of the bank gave limited opportunity for the individuals to withdraw their money.

How the bankruptcy affected the income and wealth of different types of companies and firms

The filing of the bankruptcy by Lehman Brothers had dire financial implications on companies and firms worldwide. The event led to an almost instantaneous effect in the aggravation of the credit value of all financial institutions in the Lehman Brothers’ economic network (Sieczka, Sornette, & Holyst, 2011). Considering the size of Lehman Brothers, its position in the United States and internationally, the collapse of the bank roiled the financial markets for a long time. In 2004, the housing boom led the bank to acquire a number of mortgage lenders so that it would situate itself in a competitive advantaged position in the real estate industry.

The lenders included Aurora Loan Services and BNC Mortgage. However, the BNC Mortgage was a subprime lender while Aurora Loan Services specialized in Alt-A loans. Thus, the revenues in the capital market surged to 56 percent between 2004 and 2006. The growth indicated a faster growth rate than any other business in the asset management and investment banking. Many companies and firms bought shares in the bank to have a share of the increasing profitability in the bank. In 2006, these companies and firms enabled the bank to securitize $146 billion in mortgages, an increase of 10 percent from 2005. Since then, the bank recorded profits until 2007. From the revenue of $19.3 billion, the bank recorded $4.2 billion in net income in 2007.

The credit crisis that hit the roof in August 2007 led to a sharp fall in Lehman Brothers’ stock. Firms that had signed contracts with the bank suffered as the bank shut down the BNC unit and Alt-A lender offices in three states. More than 2,500 mortgage-related jobs were eliminated. The profitability of these firms significantly suffered. Shareholders in these firms rushed to sell their shares that were losing value on a daily basis. The wealth of the companies was affected as shareholders downloaded their shares in the stock market. Companies that relied on transacting business with the bank including the construction firms and building material suppliers suffered losses. The inability of the bank to find a rescuer meant that the big state-sponsored funds would not be involved in rescuing the bank.

Repayment of debts in Europe

According to a report by Price Waterhouse Coopers, the creditors of Lehman Brothers European division may recover all the money. The bank has been making development in permissible agreement with the commercial sectors of this financial institution in Luxembourg, Switzerland alongside U.S. In fact, this has resulted in the release of $9.1 billion meant to repay creditors in Europe (Scott, 2013). Price Waterhouse Coopers has been overseeing the return of money to clients and assets to the creditors in Europe totaling to $11 billion. More than 1,500 creditors received assets and money by the end of April 2013.

Price Waterhouse Coopers had arrangement of dispensing another schedule of refund to customers and agreements to financiers by the end of April 2013. According to reports by Price Waterhouse Coopers, it would take more than a decade for all the creditors of the European unit to be compensated.

Conclusion

The insolvency affirmation by Lehman Brothers reservoir could be measured to have a direct impact on aggravating the banks credit significance. The consequences of the filing reached the creditors of the bank since the bank could not pay them. The declaration also had a psychological impact on financial institutions since they learnt that the federal government and the US Treasury was not willing to protect them anymore.

The three major factors that led to the failure by Lehman Brothers include the overlooking of the bank’s risk thresholds by the management and the Security Exchange Commission, the extremely low liquidity of the bank, as well as the bank’s heavy reliance on the approach of ‘quarter-end’ to significantly lower the bank’s leverage ratio. Employees lost their livelihood, investors lost their investment that the bank could not liquidify, creditors’ lost income owed by the bank, and companies that had contracts with the bank lost business.

References

Barkhausen, H. (2010). Derivatives in bankruptcy: Some lessons from Lehman Brothers. The Journal of Structured Finance, 2(2), 7-10.

Maux, J. & Morin, D. (2011). Black and white and red all over: Lehman Brothers’ inevitable bankruptcy splashed across its financial statements. International Journal of Business and Social Science, 2(20), 39-65.

Scott, M. (2013). Creditors of Lehman’s European unit could be completely repaid. Web.

Sieczka, P., Sornette, D. & Holyst, J. A. (2011). The Lehman Brothers effect and bankruptcy cascades. The European Physical Journal, 82(1), 257-269.

Summe, K. (2011). Misconceptions about Lehman Brothers’ bankruptcy and the role derivatives played. Stanford Law Review Online, 64(16), 16-21.

Thomas, L. (2008). Examining the ripple effect of the Lehman bankruptcy. Web.