Financial Crisis

Financial Crisis – Bankrupcy (Handout 2008/10/09)

Lehman Brothers Holdings Inc. was a global financial-services firm prior to its bankruptcy and sale in 2008. The firm did business in investment banking, equity and fixed-income sales, research and trading, investment management, private equity, and private banking. It was a primary dealer in the U.S. Treasury securities market. Its primary subsidiaries included Lehman Brothers Inc., Neuberger Berman Inc., Aurora Loan Services, Inc., SIB Mortgage Corporation, Lehman Brothers Bank, FSB, Eagle Energy Partners, and the Crossroads Group. The firm's worldwide headquarters were in New York City, with regional headquarters in London and Tokyo, as well as offices located throughout the world.

On September 15, 2008, the firm filed for Chapter 11 bankruptcy protection; the filing marks the largest bankruptcy in U.S. history. The following day, Barclays plc announced its agreement to purchase, subject to regulatory approval, Lehman's North American investment-banking and trading divisions along with its New York headquarters building. On September 20, 2008, a revised version of that agreement was approved by Judge James Peck

Lehman Brothers was founded in 1850 by two cotton brokers in Montgomery, Ala. The firm moved to New York City after the Civil War and grew into one of Wall Street's investment giants, despite period brushes with death. On September 14, 2008, the investment bank announced that it would file for liquidation after huge losses in the mortgage market and a loss of investor confidence crippled it and it was unable to find a buyer.

Lehman's slow collapse began as the mortgage market crisis unfolded in the summer of 2007, when its stock began a steady fall from a peak of $82 a share. The fears were based on the fact that the firm was a major player in the market for sub-prime and prime mortgages, and that as the smallest of the major Wall Street firms, it faced a larger risk that large losses could be fatal.

As the crisis deepened in 2007 and early 2008, the storied investment bank defied expectations more than once, just it had many times before, as in 1998, when it seemed to teeter after a worldwide currency crisis, only to rebound strongly.

Lehman managed to avoid the fate of Bear Stearns, the other of Wall Street's small fry, which was bought by JP Morgan Chase at a bargain basement price under the threat of bankruptcy. Lehman and Bear Stearns had a number of similarities. Both had relatively small balance sheets, they were heavily dependent on the mortgage market, and they relied heavily on the repurchase market, most often used as a short-term financing tool.

But by the summer of 2008 the rollercoaster ride started to have more downs than ups. A series of write offs was accompanied by new offerings to seek capital to bolster its finances.

Lehman also fought a running battle with short sellers. The company accused them of spreading rumors to drive down the stock's price; Lehman's critics responded by questioning whether the firm had come clean about the true size of its losses. As time passed and losses mounted, an increasing number of investors sided with the critics.

On June 9, 2008, Lehman announced a second-quarter loss of $2.8 billion, far higher than analysts had expected. The company said it would seek to raise $6 billion in fresh capital from investors. But those efforts faltered, and the situation grew direr after the government on September 8 announced a takeover of Fannie Mae and Freddie Mac. Lehman's stock plunged as the markets wondered whether the move to save those mortgage giants made it less likely that Lehman might be bailed out.

On September 10, the investment bank said that it would spin off the majority of its remaining commercial real estate holdings into a new public company. And it confirmed plans to sell a majority of its investment management division in a move that it expects to generate $3 billion. It also announced its latest round of bad news -- an expected loss of $3.9 billion, or $5.92 a share, in the third quarter after $5.6 billion in write-downs.

By the weekend of September 13-14, it was clear that it was do or die for Lehman. The Treasury had made clear that no bailout would be forthcoming. Treasury Secretary Henry M. Paulson Jr. and Federal Reserve officials did encourage other financial institutions to buy Lehman, but by the end of the weekend the two main suitors, Barclay's and Bank of American, had both said no. Lehman had reached the end of the line. Bank of American decided to buy Merrill Lynch.

In New York, shortly before 1 a.m. at September 15th, Lehman Brothers Holdings announced it would file for Chapter 11 bankruptcy protection citing bank debt of $613 billion, $155 billion in bond debt, and assets worth $639 billion. It further announced that its subsidiaries will continue to operate as normal. A group of Wall Street firms agreed to provide capital and financial assistance for the bank's orderly liquidation and the Federal Reserve, in turn, agreed to a swap of lower-quality assets in exchange for loans and other assistance from the government.
Barclays Reaches $1.75 Billion Deal for a Lehman Unit

Two days after Barclays, the British bank, failed to reach a deal that would have salvaged Lehman Brothers, it moved closer to its prize on Tuesday, striking a tentative agreement to buy the broken investment firm’s core capital markets businesses for $1.75 billion — far less than Lehman had hoped for.

Discuss question:

1. What do you think that kills Lehman Brothers?
2. Why do you think Bank of American helped Merrill Lynch rather than Lehman Brothers?
3. What do you think is the best investment way in this uncertain economy?
4. What do you think about Barclays’ doing? Smart or un-ethical?

Vocabularies:

1. Term investment - In general, an investment instrument (bond, debenture, preferred stock/preference shares) that matures in more than 10 years.
2. Bond - Finance. a certificate of ownership of a specified portion of a debt due to be paid by a government or corporation to an individual holder and usually bearing a fixed rate of interest.
3. Fund - a sum of money or other resources whose principal or interest is set aside for a specific objective
4. Subprime mortgage - A type of mortgage that is normally made out to borrowers with lower credit ratings. As a result of the borrower's lowered credit rating, a conventional mortgage is not offered because the lender views the borrower as having a larger-than-average risk of defaulting on the loan. Lending institutions often charge interest on subprime mortgages at a rate that is higher than a conventional mortgage in order to compensate themselves for carrying more risk.
5. announce - to make known publicly or officially; proclaim; give notice of
6. accuse - to charge with the fault, offense, or crime
7. liquidation - the process of realizing upon assets and of discharging liabilities in concluding the affairs of a business, estate, etc.
8. rollercoaster - to go up and down like a roller coaster; rise and fall