Why Lehmon Brothers Collapse

Why Lehmon Brothers Collapse

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  Lehman Brothers HoldingsInc.was a global financial services firm. Before declaring bankruptcy in 2008, Lehman was the fourth-largest investment bank in the US, doing business in investment banking, equity and fixed-income sales and trading(especially U.S. Treasury securities), research, investment management, private equity, and private banking. At 1:45AM 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. Lehman's bankruptcy filing is the largest in US history with Lehman holding over $639 billion in assets. The fall of Lehman Brothers marked the beginning of the public's awareness of the forthcoming credit crisis and recession of the late 2000s. 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 owner’s equity, which increased from approximately 24:1 in 2003 to 31:1 by 2007.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. In 2003 and 2004, with the U.S. housing boom (read, bubble) well under way, Lehmanacquired 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. 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. 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. Lehman reported that it had been in talks with Bank of America and Barclays for the company's possible sale. 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. It emerged subsequently that a deal had been vetoed by the Bank of England and the UK's Financial Services Authority. Leaders of major
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  Wall Street bankscontinued to meet late that day to prevent the bank's rapid failure.Bank of America's rumored involvement also appeared to end as federal regulators resisted its request for government involvement in Lehman's sale. 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 JPMorgan Chase & Co. provided Lehman Brothers with a total of $138 billion in "Federal Reserve-backed advances." The cash-advances byJPMorgan Chase were repaid by the Federal Reserve Bank of New York for $87 billion on September 15 and $51 billion on September 16.