Background
Lehman Brothers started its business journey back in 1844. Henry Lehman started a general store, and he was an immigrant from Germany. The general store was created in Montgomery, Alabama. Later, by 1850, Henry Lehman and his brothers Emanuel and Mayer started their joint business venture named Lehman Brothers. The firm had several prosperous years in the United States and became a reason for boosting the US economy over many years. Lehman Brothers became a huge investment banking system in the country. Lehman Brothers also faced several challenges in the 19th and 20th centuries and successfully handled these challenges. The challenges included railroad bankruptcy in 1800, the era of the Great Depression in 1930, the time of two massive world wars, the collapse of long-term capital management, and the Russian collapse in 1998. These were all huge disasters, but the firm Lehman Brothers survived all of them. But the 21st century started with many unpredictable market crises, and the US housing market crisis negatively impacted the firm of Lehman Brothers and brought it to its knees. The major reason for the failure was the interest and huge spending of Lehman Brothers in the subprime mortgage market, which became a hugely disastrous step and ended the prosperous era of Lehman Brothers.
The Major Guilty Party
At the start of the 21st century, the United States housing boom spread all over the country. In 2003 and 2004, Lehman Brothers chose to acquire five mortgage lenders, which initially provided the firm with a huge rate of profit. These lenders included the subprime lender BNC Mortgage and Aurora Loan Services. All these service providers were based on the specialties of Alt-A loans. These types of loans were designed to provide borrowers with the opportunity to take loans without a complete set of documentation processes. These purchases sounded risky in the first place, but Lehman Brothers achieved a huge rate of profit due to its investment procedures. The real estate business of Lehman Brothers generated a revenue flow of 56% from 2004 to 2006. These real estate business revenues were far higher than those of the other Lehman Brothers businesses, including the investment banking business and the asset management business. Lehman Brothers observed a $146 billion business in the area of mortgages in 2006, which led to a 10 percent increase from 2005. The yearly profits of Lehman Brothers were recorded, and they were better than before. From 2005 to 2007, the reported net income crossed $4.2 billion on Lehman Brothers revenues of $19.3 billion.
A Gigantic Mistake Or Miscalculation
In 2007, the circumstances started to change as the stock reached $86.18. Lehman Brothers gained an edge in the market, with market capitalization of nearly more than $50 billion. But this was the start of the problems that began to arise in the US housing market. In the first quarter of 2007, cracks started to emerge in the US housing markets, and they were visible in all the markets in the country. On the other side, defaults linked with subprime mortgages started to increase. In March 2007, the stock faced the biggest one-day drop in the last five years, and one day later, it was predicted that it would impact Lehman Brothers’ profit rates. However, Lehman Brothers reported record revenues and profit for the first quarter of the year. Predictions were made that the changing pattern of the US housing market would impact the profitability of Lehman Brothers, but the Chief Financial Officer of Lehman Brothers stated some different views. According to his views, the risks that were arising in the markets would not impact or might have little impact on the profit and earning rate of the Lehman Brothers firm. In his opinion, there were no risks linked with the subprime markets and the rest of the US housing markets that could hurt the United States economy.
The Problems Arise And Lead To Failure Of Lehman Brothers
The year 2007 was not a good one for the US markets, as in August 2007, the markets faced a huge credit crisis. It was the result of the crisis of two Bear Stearns hedge funds. This led to the first cracks in the foundation of Lehman Brothers. The stock of the firm started to decrease and fell quickly. This negatively impacted its reputation, and the firm had to take serious steps to survive. The company had no other option but to eliminate mortgage-related jobs, and it eliminated more than 2,300 jobs. The company had to face several problems, and due to these problems, the company shut down its BNC unit. The problems were not resolved as they kept increasing, and the firm closed its offices associated with ALT-A loans in three states of the country. The US housing market stock rates were unpredictable, and the problems seemed to increase; this did not impact the mortgage reputation of Lehman Brothers, and it was still the major player in the market. However, insecurities about the future led Lehman Brothers to sign different liabilities in mortgage-backed securities. It was based on a portfolio of more than $80 billion, and it was far higher than the shareholders’ equity level. The fourth quarter of 2007 brought back the profit rate for Lehman Brothers, and its stock rebounded. The global trending markets faced new high-profit rates and increases in the prices of fixed-income assets. All these scenarios created a temporary return for Lehman Brothers in the market. Lehman Brothers started to take the initiative to settle in the market again, but the firm did not accept the opportunity to spend on the mortgage portfolio. It led to a hugely disastrous situation for the firm, as it was the last opportunity for the company to stabilize.
Lehman Moves Towards The End
The conditions of the US housing market and the mortgage system negatively impacted the reputation of Lehman Brothers. The ratio of the firm’s total assets compared with its shareholders’ equity level was 31 in 2007. The huge rate of spending in the mortgage portfolio and its required securities level increased the firm’s vulnerability in the markets. Its condition started to decline, and the mortgage value of securities started to weaken its foundations in the markets. Later, at the start of 2008, the company’s reputation and condition did not improve, and the collapse of Bear Stearns impacted its profit rate more negatively. It was the collapse of the second-largest institution of mortgage securities that led to the start of cracks in the foundation of Lehman Brothers. Due to the collapse of Bear Stearns, the shares of Lehman Brothers fell instantly, and it was predicted that it would lead to a huge disaster and the massive failure of the successful Wall Street firm Lehman Brothers. The shares of Lehman Brothers fell by 48% in the markets. In June 2008, Lehman Brothers announced its second-quarter loss in the markets, which was more than $2 billion. Several measures were taken, but all of them were considered late measures that did not contribute positively to the reputation of the company. In September 2008, the firm reported a huge loss of $3.9 billion. At the end of that week, Lehman Brothers had only $1 billion in cash left. Bank of America and Barclays PLC started their measures to take over Lehman Brothers, but it was too late, and their efforts remained unsuccessful. The end of Lehman Brothers was considered the worst and most dangerous market fall of 2008, and it negatively impacted world financial markets for many weeks.
Reasons Of Fall And Failure
An ethical lapse existed in the fall and failure of the Lehman Brothers firm. The most wrong and inappropriate measure was the manipulation of assets done by the administration of the company. It included the approval of assets that were taken away from the accounts of Lehman Brothers. The approval was made by the company’s Chief Financial Officer, Erin Callan. This huge misinterpretation negatively impacted the financial scenario of the company. This manipulation technique was used twice in two quarters before the fall of the company. The movement of assets from the company’s balance sheet was an intentional measure taken to create an imaginary stance that everything was alright and secure. The executive team of the company had taken several wrong turns and decisions to balance the reputation of the company in the international markets. The management was unable to determine the right steps to take and failed to handle the issues properly. Banking leverage was high for six consistent months, and they had no choice but to mislead the shareholders, but they needed a better solution and a better step. They should have applied strategic measures and provided accurate financial information to their shareholders. They could then have received better options and more time from the market to stabilize, and the situation would not have led to this disastrous end.
The story and failure of Lehman Brothers include not only the crash and fall of the markets but also wrong decisions in its investment processes. It also includes a lack of ethical behavior and a lack of professionalism shown by its administrative staff and professional advisors. They did not acknowledge the fact of failure and consistently made misleading decisions and manipulated the financial information of the company. The consequences were severe and led to the end of the world’s famous investment banking system, Lehman Brothers. The major and profound message that could be gained from the huge failure of the company is that ethical behavior is required and was required at the time of its fall. Transparency and accountability measures were important and paramount in the case of Lehman Brothers. Unethical decisions and spending in the wrong ways led it to collapse, and its unethical business practices ended its business journey. Global crises occur in the business world, and these are not preventable enough to avoid negatively impacting any business venture. The responsibility lies with firms that need to take transparent measures, make ethical decisions, and apply accountability measures for their firm’s strength and long-term prospects. (Financial Crisis Inquiry Commission, 2011) (U.S. Government Publishing Office, 2010) (Valukas, A. R., 2010)
References
Valukas, A. R. (2010). Lehman Brothers Holdings Inc. Chapter 11 proceedings examiner’s report. https://web.stanford.edu/~jbulow/lehmandocs/origIndex.html
Financial Crisis Inquiry Commission. (2011). The Financial Crisis Inquiry Report. U.S. Government Publishing Office. https://www.govinfo.gov/content/pkg/GPO-FCIC/pdf/GPO-FCIC.pdf
U.S. Government Publishing Office. (2010). Financial Crisis Inquiry Commission records: Lehman Brothers Holdings Inc. https://www.govinfo.gov/app/details/CRI-2010/CRI-2010-LEHMAN-BROTHERS-HOLDINGS-INC
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