Death of Lehman Brothers

Death of Lehman Brothers

Introduction

Lehman Brothers made history in 2008 when they initiated their push for bankruptcy as per Chapter 11 laws on legal protection of assets. The corporation declared more than $613 billion in debts and approximately $639 billion ownership in assets. At the time, Lehman was the fourth-largest U.S. investment bank and boasted a human resource base of 25,000 employees in its subsidiaries distributed across the globe Indeed, It was a far cry from its humble beginnings in the mid-1800s, when it commenced operations as a store for dry good in Montgomery, Alabama. Many analysts brushed off the idea of Lehman Brothers’ bankruptcy, stating that it was “too big to fail.” In fact, the federal government did not employ extraordinary measures required to save Lehman from the brink of collapse (Stevens, 2009). Bailouts are expected for large corporations that form the backbone of the United State economy.  

 Lehman's demise was a seminal event in the global financial crisis that commenced in the U.S. subprime mortgage industry in 2007 and had rippling effects for most economies linked directly to US corporations and financial aids including Europe, Australia, and other Westernized states. As if not enough, the recession spread  had devastating effects in stock and credit markets (Baba, 2009).An assessment of economic damage to the US economy alone based on lost output ranges from a few trillion dollars to an upwards of $10 trillion in 2016 dollar rates. It is even despite the unparalleled and relentless efforts of the U.S. Federal Reserve, the U. S. Treasury, the Federal Deposit Insurance Corporation (FDIC), and the European central bank to implement intervention strategies and stabilize the global economy from imminent collapse.

History of Lehman Brothers

During the early 1800s, Mayer, Emanuel, and Henry Lehman became economic migrants to the United States from Germany. They settled in Montgomery, Alabama and immediately established a miniature shop that specialized in grocery sales to farmers working in cotton plantations across the state. The brothers soon realized their overdependence on dry cotton because it served as a form of currency for the farmers. Therefore, they shifted their focus towards engaging in cotton trade and by 1858, the brothers had set up a regional office in New York office. Positioning themselves in such a strategic location became a cornerstone for New York Cotton Exchange formation. The brothers also diversified their trade to other valuable commodities. They offered assistance to start-up firms by raising capital in the bond and equity markets. 1887 is the official year when Lehman Brothers Inc. was registered as a member of the New York Stock Exchange, resulting in its establishment in securities trading as an underwriter.

In the early 1910s, Lehman Brothers ventured into banking industry to provide intermediate funding for the evolving groups of retail, transport, and industrial corporations formed during this period. Robert Lehman (Emanuel Lehman grandson) took over the leadership mantle of the organization in the mid-1920s and became an active contributor to its progress until his death. During Robert Lehman’s leadership, Lehman Brothers positioned itself as a global investment bank, working hand-in-hand with leading U.S. ventures and other reputed multinationals to underwrite securities, to provide financial advice, and assist corporations during mergers and acquisitions. Lehman was structured as a partnership. It was owned privately and was under family control until Robert’s demise in the year 1969. Notably, he became one of the last members of the Lehman family to work at the organization.

Growth and investments

Over the years, the company grew to be a formidable force in international trade and other businesses. By the year 2006, Lehman was subdivided into three sections that included capital markets department, investment banking, and investment management. It provided a full array of services in fixed income sales and equity, trading and research and investment banking. Other areas included asset management, private equity, and private investment management. The Organization had its headquarters in New York and regional head office in London and Tokyo. International bureaus were used to steer a complex and sophisticated networks worldwide business. Lehman’s operations were subjected to governmental and industrial regulations in the U.S. and abroad. They included the U.S. Securities and Exchange Commission (SEC) which was the U. S. investment banks regulating body, and the (U.K.) Financial Services Authority.

In the course of investments, Lehman used high-risk models to turn over its rate of profits at a tune of billions. There was a striking similarity between Lehman’s high-leverage and risky business model and that of his peers. Each investment bank leveraged by leading up  to the crisis took its toll. The strategy let them push for growth and profit increase while ensuring proper maintenance of limited capital.

Extreme leverage was later exposed as one of the lead factors that made a significant contribution to the financial crisis. Real estate markets started to show signs of instability from July 2007. Lehman Brothers and other investment corporations came under tight scrutiny regarding the value of their assets that are closely related to the real estate business sector as well as the liquidity status of their firm. Business analysts, experts, and economic prospectors grew increasingly concerned and started to propose that the investment banks review and minimize their leverage. To cut on leverage, business entities are presented with two choices: selling assets or increasing liquidity. It was questionable that Lehman Brothers made plans to sell its assets while a few months back, it has raised more than 6 billion dollars.

Beginning of Lehman Brothers downfall

Some of the factors that contributed significantly to Lehman Brothers’ fall include:

(1) The business policies that entailed  high leverage and poor risk-taking strategies propelled by limited equity.

(2) The organizational culture was based on risk taking, hence its non-viability during harsh economic times.

(3) The complexity of corporate structures and organizational products.

(4) Ignorance of regulatory gaps with regards to systemic risks caused by large multinationals like Lehman.

Short-term debt funded the corporation’s sustainability and long-term assets, for instance, during the peak of the recession, Lehman borrowed resources on a daily basis from wholesale funding markets in ensuring business continuity. Other lending institutions were unwilling to accept Lehman securities as collateral in 2008. Other times, such lenders demanded additional collateral for limited provision of finances, thus denting Lehman's Capability to sustain its short-term commitments. Bear Stearns, on the other hand, was on a brink of collapse in March 2008 because of a liquidity crisis. As a result, rumors surfaced the mainstream media that Lehman would be the next financial institution to cease operations.

In the wake of the company’s challenges and turn of events, they tried applying many solutions. The solutions did not take form, and during late 2008, Lehman made an announcement that that it will write-downs more than 5 billion dollars in toxic assets and was set to make losses of u to $4 billion by the end of its third quarter. It also announced its plans to spin off  a total of $50 billion in toxic assets to a stable organization to guarantee their continued operations.

Lehman Faced high credit cost as the introduced stimulus program failed to improve the organization's prospects. It resulted in most of its lenders withdrawing their commitment to the firm by turning down repose rollover. Others on noticing the firm's desolate situation demanded bigger haircuts or discounts while some agreed to narrow collateral. They turned down Lehman’s assets that were linked to real estate business by declaring them defective (Pichardo, 2009). For instance, for three months in late 2008, the company submitted approximately $9.8 billion as additional delivery to J.P. Morgan Chase in support of its multi-party services and to clear securities. In return, J.P. Morgan acted as Lehman’s agent for repo transactions.

After the federal government rejected bailout plans for the organization, Timothy Geithner, (NYFED president) and Henry Paulson (then U.S. treasury secretary) met with administrators and managers of major Wall Street financial corporations to source for a non-government solution for Lehman bailout. Options or federal bailout were omitted from a list of potential solutions.

After the leaders failed to reach an amicable solution, it dawned on the management of Lehman Brothers that its operations could not be sustained for more than a day. It marked a turning point in its history as the organization faced an imminent demise in less than a day. Eventually, the board filed for bankruptcy protection in the month of September the same year. The move offered the ailing firm an opportunity to dismantle a section of its operations as required by a bankruptcy court.

Insight on ethical issues

The collapse of Lehman brothers was not as a result of one miscalculated by a single employee. If so, bringing the Wall Street financial giant to its knees would have been impossible because of one isolated event (Azadinamin, 2013). The Wall Street giant has stood the test of time by going through many handles and challenges in its time.

The corporation's fall and demise were as a result of cumulative effects of missteps which were perpetrated by different parties and individuals. The perpetrated offenses that led to the downfall of the company were ethical. The reasons behind the fall have been classified as negligence. Ethically, the demise of the company could have been regulated or prevented if only the management of the company were keen on running the company professionally.

In the year 2007, the housing sector was poorly performing and Fuld considered the application of a leveraged model of business operation. They opted to act against conventional Wall Street knowledge by evaluating the strategy being used by Feud and had foreseen the collapse of the mortgage defaults and possible consequences. However, Fuld did not go back to the drawing board to rethink his strategy. Fuld went ahead and indulged into security investments that were backed by mortgages making the investments of Lehman brothers’ asset portfolio to skyrocket. However, the portfolio was of high risks given the volatility of the market conditions. By the time the chief executive, Fuld, came to his senses to recognize the error, he denied the responsibility of the methodology approach neither did he admit to being at fault. Fuld had the opportunity to voice his concerns about the financial position of the company that it was operating on short-term risky loans worth billions but instead he squandered the opportunity and assured Wall Street investors that the company had no foreseeable alarms.

Ethically, Fuld lied about the financial position of the company putting the company in a very dangerous position of collapse. Had he decided to be truthful to Wall Street investors, the company would have employed very useful solutions backed by the advantage of time. The company would not have faced its demise of financial hemorrhage that was on the horizon.

In as much as admitting a wobbly outlook would have been negative for the company as well as the directors, the heavy investors of Wall Street would have appreciated the transparency and in some way came up with a strategy to save their investments in the company.  On the other hand, if the federal government and the media gained awareness on strategies considered behind closed doors to save the Wall Street giant, more financial aid for the company would have been available to minimize losses and avoid collapse. Fuld would have had the advantage and opportunity to utilize the various solutions at hand to save the company from collapse and cut losses which amounted to billions of dollars. Since he made his decision, all the repercussions and the fall down of the company operations would rest on his shoulders. Had he been ethical from the start, Lehman’s brothers story could be a different topic of discussion today.

The second ethical error that can be termed as fundamentally and premeditated incorrectly was the approval of Callans to transfer or siphon assets from the accounts of Lehman to Hudson Castle. Castle was a subsidiary phantom company created for the benefit or positive outlook of the parent company. This misinterpretation of assets was to create a good impression of the company’s performance while in real senses it aimed at fooling the stakeholders. Misappropriation was achieved by use of Repo 105 which by coincidence was used twice in consecutive quarters. This created a major problem in the balance sheet and the overall financial position of the company. It could have looked steady on the outside but it was a collapsing and sinking boat.

The work of the Repo as applied by the finance manager was not to reduce the amount of taxable income but to siphon away the assets reducing the number of assets in the balance sheet to create an impression of a steady company (Jeffers, 2011). If the executive of the company had been able to handle the issue, this would have been a temporary use of the Repo because they would have used the available measures and solutions to bring back the balance sheet to its normal state. Erroneously, for the next six months of the company’s operations, the leverages were so high such that the company’s executive had no alternative but to mislead the stakeholders. Lehman Brothers could have rebounded had the management correctly disclosed the financial position and details (Stevens, 2009). They would have got the advantage of credibility and more time to strategize and organize their financial books. It can now be seen that the resulting downfall of the company was due to lack of ethics by the management being led by the chief executive officer Fuld.

Finally, the third ethical error was made by Ernst & Young who was the third party known to the happenings of the company. They failed to disclose the levels at which the management had gone to so as to conceal the financial position of the company. A company of such high value such as Ernst and Young should have done their best to make it known to the public and stakeholders at large the happenings at the company. However, this was not the case. A firm of certified accountants should uphold industry ethics to the highest standards possible. Therefore, the demise of the company Lehman brothers has partly contributed the auditing company, Ernst & Young. Their action of turning a blind eye was unethical of them. Their failure to act discretely and transparently discredited them in the market (Stevens, 2009). Ernst and young was responsible for ensuring that correct information is submitted to the stakeholders of the companies. In this regard, Young failed entirely, as the board of directors were aware of behind the scenes modifications of the financial statements. Ernst & Young played a part in deceiving the stakeholders for the purpose of preserving a paycheck which was unethical of them as well as Lehman brothers executive.

Reference

Azadinamin, A. (2013). The bankruptcy of Lehman Brothers: Causes of Failure & recommendations going forward. Available at SSRN 2016892.

Baba, N., & Packer, F. (2009). From Turmoil to Crisis: Dislocations in the FX Swap Market beforehand after the failure of Lehman Brothers. Journal of International Money and Finance, 28(8), 1350-1374.

Jeffers, A. E. (2011). How Lehman Brothers used Repo 105 to Manipulate their Financial Statements. Journal of Leadership, Accountability, and Ethics,8(5), 44.

Pichardo, C., & Bacon, F. (2009). The Lehman Brothers Bankruptcy: A test of Market Efficiency. In Allied Academies International Conference (Vol. 14, No. 1, pp. 43-48).

Stevens, B. (2009). Corporate Ethical Codes as Strategic Documents: An Analysis of Success and Failure.