Lehman Brothers Crisis

Who are Lehman Brothers?

Lehman Brothers went bust on September 15, 2008 and is often cited as the trigger for the 2008-09 global financial crisis. As an investment bank founded in 1850 they were a major player in the financial markets, especially in mortgage origination and securitisation. This post looks at the history of Lehman Brothers, their business model and the events that led to their demise, and why it was such a big deal.

Lehman Brothers

Lehman Brothers was founded in 1850 and quickly became an investment bank. Over the decades they expanded and grew in various financial sectors. By the end of the 20th century they had diversified into mortgage origination, a move that would ultimately be their undoing.

The Lehman Brothers Business Model

Lehman Brothers were busy sourcing debts, packaging them up as securitised assets and selling them to investors. This process, known as securitisation, involves pooling various types of debt – mortgages, car loans, credit card debt etc – into financial instruments that can be sold to investors. These securities provided higher returns and many investors lapped them up. But Lehman also held a lot of these securitised assets on their balance sheet, which exposed them to big risks.

The Mortgage Market and Securitisation

In 1997 Lehman Brothers bought Aurora Loan Services, an Alt-A lender, and entered the subprime mortgage market. Subprime mortgages are loans to borrowers with lower credit ratings and often come with higher interest rates because of the higher risk of default. By 2003 Lehman were a major player in this market with $18.2 billion in loans and third place in the league tables.

Lehman’s involvement in the subprime market and subsequent securitisation meant when property prices started to fall in 2006 they were exposed. Despite the falling market Lehman continued to securitise mortgages, adding to the risks in the housing market’s eventual collapse.

Leverage

Leverage is a common practice in banking where borrowed money is used to amplify returns on investment. Lehman Brothers used leverage when buying new assets, including securitised loan products. Instead of using customer deposits or internal capital, debt was often used to fund these purchases. This made Lehman very vulnerable to market moves.

The Fall of Lehman Brothers

As the housing market fell Lehman Brothers suffered huge losses on their asset backed securities portfolio. Their high leverage meant that even small declines in asset values had a big impact on their balance sheet. On September 15, 2008 Richard Fuld, the CEO of Lehman Brothers, announced the company was filing for bankruptcy. The news sent shockwaves through the financial markets and the global economy went into meltdown.

Why Was Lehman Brothers So Big?

Lehman Brothers was not just an investment bank; it was a pillar of Wall Street and was involved in many areas of finance. Its entry into mortgage origination and the subprime market was a trend that other firms followed. By the time it went down, Lehman was deeply embedded in the system so its collapse was a key moment in the 2008-09 financial crisis.

Lehman’s fall showed the world the fragility of the global financial system and the dangers of too much risk and leverage. It spooked investors and banks and caused a credit freeze that affected businesses and consumers everywhere. The impact of Lehman’s bankruptcy was felt across many sectors – from real estate to manufacturing – and showed how interconnected modern finance is.

The Human Cost of Lehman’s Collapse

While the financial impact of Lehman Brothers’ collapse was huge, the human impact was just as big. Thousands of people lost their jobs overnight, many more in the financial sector were uncertain and unstable. The effects went beyond Wall Street, to ordinary people who had no connection to the bank.

Employees and Families

Lehman Brothers had over 25,000 employees globally. The sudden bankruptcy meant that these people were overnight without a job, causing financial and emotional distress for them and their families. Many employees had invested a significant portion of their savings and retirement funds in Lehman stock which became worthless overnight.

Investors and Retirement Funds

Investors – including pension funds and individual retirees who had Lehman stock – lost big. The erosion of retirement savings created long term financial problems for millions of people and a loss of faith in the system.

Homeowners and Borrowers

Lehman’s collapse and the subsequent credit crunch made the housing crisis worse. Homeowners who had subprime mortgages found they couldn’t refinance or sell their homes and so more foreclosures and a bigger drop in property values. This further deepened the recession.

Broader Economic Impact

The mass unemployment and financial chaos led to a big drop in consumer spending which in turn affected businesses across the board. Companies had reduced demand for their products and services and more layoffs and a long recession.

Conclusion

Lehman Brothers was more than a financial collapse; it was a human disaster that showed us how connected the world is and how far reaching the impact of corporate failures can be. The lessons from Lehman’s collapse teaches us about responsible banking, robust regulation and putting employees and consumers first alongside profits. As the world moves on from the 2008 crisis and evolves, the story of Lehman Brothers is a powerful reminder to stay vigilant and honest in the financial industry.