Bankruptcy of Lehman Brothers
The
The bankruptcy triggered a 4.5% one-day drop in the
As of May 2022, parent company Lehman Brothers Holdings, Inc. remained in liquidation before the Bankruptcy Court for the Southern District of New York. Caretaker offices in the US and abroad have continued to oversee payments to the company's creditors.[1]
Background
Rise of mortgage origination (1997–2006)
Lehman Brothers was one of the first Wall Street firms to move into the business of mortgage origination. In 1997, Lehman bought Colorado-based lender Aurora Loan Services, an Alt-A lender. In 2000, to expand their mortgage origination pipeline, Lehman purchased West Coast subprime mortgage lender BNC Mortgage LLC. Lehman quickly became a force in the subprime market. By 2003 Lehman made $18.2 billion in loans and ranked third in lending. By 2004, this number topped $40 billion. By 2006, Aurora and BNC were lending almost $50 billion per month.[2]
Lehman had morphed into a real estate hedge fund disguised as an investment bank.[3] By 2008, Lehman had assets of $680 billion supported by only $22.5 billion of firm capital. From an equity position, its risky commercial real estate holdings were thirty times greater than capital. In such a highly leveraged structure, a three- to five-percent decline in real estate values would wipe out all capital.[4]
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 investment 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.[5] 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 of equity.[6] Investment banks such as Lehman were not subject to the same regulations applied to depository banks to restrict their risk-taking.[7]
In August 2007, Lehman closed its
Lehman's final months
In 2008, Lehman faced an unprecedented loss due to the continuing subprime mortgage crisis. Lehman's loss resulted from having held onto 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 decided to raise $6 billion in additional capital by offering new shares.[9][10] In the first half of 2008 alone, Lehman stock lost 73% of its value as the credit market continued to tighten.[9] In August 2008, Lehman reported that it intended to lay-off 6% of its work force, 1,500 people, just ahead of its third-quarter-reporting deadline in September.[9]
On August 22, shares in Lehman closed up 5% (16% for the week) on reports that the state-controlled Korea Development Bank was considering buying Lehman.[11] 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."[12] It culminated on September 9, 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.[13]
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 nearly 300 points the same day, on investors' concerns about the security of the bank.[14] The U.S. government did not announce any plans to assist with any possible financial crisis that emerged at Lehman.[15]
On September 10, Lehman announced a loss of $3.9 billion and their intent to sell off a majority stake in their investment-management business, which included Neuberger Berman.[16][17] The stock slid 7% that day.[17][18]
On September 12,
Bankruptcy filing
Lehman Brothers filed for Chapter 11 bankruptcy protection on Monday, 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 JPMorgan Chase & Co. provided Lehman Brothers with a total of $138 billion in "Federal Reserve-backed advances". The "Federal Reserve-backed advances" as provided by JPMorgan Chase were for $87 billion on September 15 and $51 billion on September 16.[24]
The filing remains the largest bankruptcy filing in U.S. history, with Lehman holding over $600 billion in assets.[25]
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 seven-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."[26]
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."[27] 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. 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.[28] 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.[29][30]
On September 22, 2008,
Impact of bankruptcy filing
The 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
Lehman's bankruptcy was 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
Several
On Monday, September 15, 2008, the market staged a run on AIG with shares plummeting 61 percent. Shareholders also fled from Goldman Sachs and Morgan Stanley. Two weeks later, the Fed agreed to give the bank holding company status which provided vital access to the Fed discount window.[38]
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 money-market funds to prevent their shares from falling.[39] This move to cover $494 million of Lehman assets in the funds also raised fears about Wachovia's ability to raise capital.[40]
Close to 100 hedge funds used Lehman as their
In Japan, banks and insurers announced a combined 249 billion yen ($2.4 billion) in potential losses tied to the Lehman shock.
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.[47]
After
The Federal Agricultural Mortgage Corporation or Farmer Mac said it would have to write off $52.4 million in Lehman debt in the form of senior debt securities it owned as a result of the bankruptcy. Farmer Mac said it might not be in compliance with its minimum capital requirements at the end of September.[51]
In Hong Kong, more than 43,700 individuals in the city had invested in
Neuberger Berman
In October 1999, the firm conducted an
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.[58]
An article in
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.
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 multimillion-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."[60]
Controversies
Controversy of executive pay during crisis
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 New York attorney general Andrew Cuomo later 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.[64]
On April 12, 2010, a story in
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."[66]
See also
- Michael Ainslie
- Report of Anton R. Valukas
- The Last Days of Lehman Brothers
- Bear Stearns
- List of entities involved in 2007-2008 financial crises
- Subprime crisis impact timeline
- United States housing market correction
- Federal takeover of Fannie Mae and Freddie Mac
- A Colossal Failure of Common Sense
- Aurora Bank
- Hudson Castle Group
- Margin Call, a 2011 film about investment fraud.
- Free Money Day
- Too Big to Fail, a 2010 HBO docudrama about the 2008 financial crisis.
- The Big Short, a 2015 film about bank fraud.
- C, a 2011 anime inspired by the bankruptcy of Lehman Brothers.
- Overend, Gurney and Company, a British bank active in wholesale markets which collapsed in 1866.
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External links
- Channel 4 News: How Britain could have saved Lehman Brothers
- "Why Lehman Brothers had to go bankrupt" — as told by a former employee