What caused the demise of Lehman Brothers?

Till date, the biggest bankruptcy ever seen in US history is the crash of Lehman Brothers. The former fourth largest investment bank in the world filed for Chapter 11 Protection with more than $639 billion in assets 7 years ago. Images adorning the hallowed newspaper sheets in the days after its September 15, 2008 collapse were of its dejected employees leaving the company buildings, never to be seen again. However, opinions differ as to what actually caused this gargantuan crash. In truth, it is an amalgamation of many different factors that led to the collapse of the gigantic investment bank. Something so large can never collapse without a combination of different factors pulling it down into disaster, with the factors responsible ranging from the incompetence of its chief executive, Dick Fuld, to the massive levels of leverage used by the bank. Of course, in my opinion, one of the primary factors responsible for its collapse was the aforementioned reckless leveraging.

Leverage is when one borrows money for an investment, expecting to attain greater profits than the total value of all the interest they have to pay. For example, the sensible amount of leverage for a bank to run would be about 10, so for every £1 invested, they would gain an actual return of £10. However, Lehman’s leverage peaked at 44 in 2007, meaning that when the prices of financial instruments started to plummet in the wake of the financial crisis, the bank was heavily overexposed, and could do nothing about it. This is one of the reasons why bankers have gained a reputation for being reckless and insensible, when the reality is quite the opposite. When bankers indeed fall astray of what they need to do, a situation such as Lehman’s arises. This had immediate ramifications for the rest of the financial sector, with trust levels in banks falling to record low levels in the wake of the devastating financial crisis.

Massive overexposure to the real estate market was also a factor in Lehman’s downfall. In 2007, Lehman had over $60 billion invested in the real estate market, also with a large amount invested in collateralised debt obligations and credit default swaps, both being very risky investments. Unfortunately, this incredible gamble did not work to their favour, and when the property bubble finally burst in the US, Lehman could do nothing to save themselves from the massive losses that they had incurred. The mere $6.5 billion that they had lost in 2008 paled in comparison to the heavy losses that were to come for the troubled giant, with 35% of their total capital being invested into real estate. Again, a lack of rationality when making decisions was responsible for this colossal blunder, as there was no sense of safety when investing into a market where every day is a new day, so to speak.

However, even given these monumental mistakes, Lehman Brothers did have the chance to learn from them. Towards the end of 2007, stocks began to hit all time high on a wave of renewed optimism. Over $85 billion of Lehman’s capital (more than four times the amount they gave their shareholders) was invested in risky mortgage-backed securities, and as they appreciated in value, there was a golden opportunity to trim their portfolio. Alas, this did not occur, and with the 2008 financial crisis, their mortgage backed securities were reduced to junk, and the corporation folded. The lesson which, hopefully at least, investment banks have somewhat learnt from the collapse of this financial giant is never to go in with a “high risk, high reward” approach. Before the financial crisis, this attitude was heavily prevalent, and with Lehman, all of those thoughts came crashing down.

Even when we take into account all of these massive mistakes, the brunt of the blame all goes on to one man: Dick Fuld. His arrogance and unapologetic nature in carrying out crucial business decisions was eventually what led to the whole proverbial tower coming crashing down. From 2000 to 2008, Fuld was paid $480 million. The fact that he was valued so highly by Lehman inflated his own sense of self-worth, which was horribly grandiose to begin with. Even after the collapse of the corporation, Fuld was quoted as saying that all the past decisions he took were “prudent and appropriate”. Someone who speaks in this manner simply shows that he cannot take accountability for anything which he does, which is evidently the precursor for gigantic financial collapse. We can only hope in future that executives will be more prudent and pragmatic when making decisions, otherwise they, in amalgamation with other factors, will be the catalyst for another stupendous bankruptcy.

20 Comments Add yours

  1. G Srivastava says:

    Wow… great insight into the point!

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  2. Dev Khemani's Economic and Political blog says:

    so are banks to blame? Given this is regulation necessary?

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    1. Banks were to blame for the financial crisis. They need to be regulated.

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      1. Dev Khemani's Economic and Political blog says:

        you dick!

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  3. HB (Harry B) says:

    Dick Fuld, his first name says all the derogtary descriptions about him. This is what happens when people think they’re unbreakable. Good points, though. Let’s hope these dullards (especially Fuld) never gets the chance to work with money again.

    This outlines why we need to ask ourselves questions and have the right mind to accept everything that’s thrown at you. As you said, they has the chance to learn from their mistakes, but they chose not to. It’s shocking how much money they’ve invested and lost.

    I like the new look BTW.

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    1. Thanks hahaha glad to know that you liked the new look 🙂 I agree wholeheartedly about Fuld 🙂

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  4. HB (Harry B) says:

    Excuse my error in there I meant *had the chance. I was typing too fast ;-).

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      1. HB (Harry B) says:

        In perspective, considering how fragile the situation was, how would you of dealt with it?

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      2. Firstly, I would have immediately cut down on the leverage that I was using, and then I would significantly cut my real estate losses, reducing my exposure to the real estate markets. The stake that I had in collateralised debt obligations etc. would also be significantly reduced, leaving me with a small stake in them. From then, I would wait for my cash flow to stabilise and the market to calm down before making any serious investments again.

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      3. HB (Harry B) says:

        I like it. Your dealing with it is more organised and cleaner.

        Liked by 1 person

  5. Wow! Are you sure you’re only 15? LOL You provided great insight supported by excellent evidence. I learned some information that I didn’t know. Thanks for sharing!

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  6. caendicott says:

    You seem to have done your research. Very interesting read.

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  7. Karen G says:

    Great thought out points. Good for you.

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  8. contented82 says:

    Can’t believe you had such fabulous insight into something so complicated at such a young age. I’ve certainly learnt a lot from reading this

    Like

    1. Thank you so much 🙂

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  9. Marty says:

    I think Michael Lewis author of Liar’s Poker and the Big Short, the latter which was recently made into an acclaimed film cut through all the nonsense that happened in the Global Failure of Credit the reality behind the commonly known Global Financial Crisis or GFC. Lehmann’s weren’t alone in their over exposure to real estate and CDOs but were one of the few that weren’t bailed out like Bear Sterns. Those that were bailed out won’t learn from the experience and history will repeat until they do.

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