The Rise and fall or Lehman Brothers Introduction The Lehman Brothers, an investment bank dating back to 1850, filed for bankruptcy in 2008. An institution that managed to survive the Great Depression, two world wars and even all calamities in more than 158 years is no longer in business. On September 15th 2008, the Lehman Brothers, which was once know as one of the biggest investment banks, provided that it was going to file for bankruptcy protection (Mamudi). This news was received by the world at the time the market was expecting that someone will come out and help this organization. The bankruptcy of the Lehman Brothers was not expected by anyone, and many people hoped that either a private company or the government was going to bail out the firm and prevent the bankruptcy move. Before that, there were talks indicating that, Barclays bank and Bank of Africa wanted to take over the investment bank (Sorkin). However, other organizations like the Federal Reserve that aided Bear Stearns to deal with the US Treasury were not willing to help the Lehman Brothers with their problem (Sorkin). The firm filed for bankruptcy with about $639 billion in assets and about $619 billion in debt, which makes its bankruptcy filing the largest in history, while its assets surpassed the assets of the previous bankrupt giants like Enron and WorldCom. According to Qatinah (2012), the organization was the fourth largest US investment bank at the time it collapsed, with more than 25,000 employees. The history of the Lehman Brothers can be traced back to 1844 when Henry Lehman travelled to the US for Bavaria and decided to settle in Montgomery, Alabama. He opened store “H. Lehman” that dealt in dry goods. The name of the firm was changed to “H. Lehman and Bro” in 1850 after Emanuel Lehman, Henry’s brother, arrived in the city. The firm managed to pull off its operations and succeeding in several fronts. However, even with many successful operations, the firm at last filed for bankruptcy in 2008. While many people did not expect the Lehman Brothers to file for bankruptcy, it is essential to evaluate the failure of the firm and how its failure affected the economy.
Lehman Brothers’ Governance Structure Larcker and Tayan (2010) assert that the governance experts at Lehman Brothers placed a considerable emphasis on the structural attributes of the company’s board. In that sense, it was not possible to distinguish the structure in terms of regulatory independence, personal, size and professional composition. Before the investment bank filed for bankruptcy, it was evident that the bank was not doing badly as far as its staff was concerned. The bank’s staff members were provided with disproportionately high percentage of their pay. According to media reports, the company was regarded as one big family with its entire staff sharing the success of one another. In 2007, the company was regarded as the largest trader of stocks in the London stock market. The investment bank also had a role in a fifth of the corporate takeovers (Sieczka, Sornette and Holyst). In 2010, Professor Arturo Bris came up with a report suggesting that the failure of the Lehman Brothers was due to failure in governance and not financial markets (Bris). According to the CEO of Lehman Brothers, the institution had the required access to money market and it was not easy for the company to fail after the Federal Reserve allowed all investment banks to borrow finances after the debacle of Bearn Stearns (Ryback). According to Ryback (2011), Lehman Brothers had high leverages and was not required to take any steps in order to get borrowing out of control. However, the company’s governance structure was not as good as many people believed it was since the institution had to announce that it had incurred a larger loss, which was followed by liquidity problems (Sieczka, Sornette and Holyst). Additionally, the institution was being threatened by the credit agency to be downgraded unless it came up with some reasonable plan.
How the Company got Bigger To understand how Lehman Brothers got bigger, it is essential to note that the firm has a long and interesting history. The firm was founded in 1850. Initially, the Lehman Brothers was a family business, which was operated by three brothers that migrated to the US. The creation of the Lehman Brother investment bank started like a shop that later went into cotton trading (Sieczka, Sornette and Holyst). During its more than 150 years of existence, the company emerged as one of the largest financial firms in the US. It can be pointed out that the success of Lehman Brothers emerged from the sale of cotton in the 1850s; at the time the brothers were initiating their investment, cotton was the most significant crop. The Lehman brothers capitalized on the high market value of cotton. In the process, they began accepting raw cotton from their clients as merchandise payment, and eventually they started trading with cotton as their second business (Ryback). The cotton business grew within a few years and became their most significant operation. The cotton business was followed by other businesses, including involvement in railroad bonds and the financial-advisory business, before the bothers decided to enter into investment banking business. In fact, Lehman Brothers had smaller operations moving from one business to another and at the same time trying to help other firms stabilize in the market. It is in 1975 that the firm was recognized as an investment financial bank, and after some time, it was regarded as the fourth highest investment bank in the industry (Ryback). Despite that, the firm was faced with a number of challenges. Notably, the firm suffered significantly when none of the brothers was in charge of the firm and the economy was going through a rough time in the early 1970s. However, one of the brothers managed to resurrect the firm and helped it attain high credentials in the market. The firm also suffered when there was hostilities between Lehman Brothers bankers and traders that were driven by the firm’s profits. It is also essential to mention that the firm managed to acquire its status after promoting Lewis Glucksman, and made him the firm’s president. To ensure that there was as immediate positive results, Glucksman implemented some immediate changes. Even though these changes brought about tension, it helped to strengthen Lehman Brothers position in the market. Despite that, it is essential to note that, the firm managed to grow in status by acquiring other companies including Cowen & Co and later it aggressively re-entered into the business of assets management, which had existed since 1989 (Ryback). Although the firm began with as low as $2 billion in assets, it managed to acquire the Crossroads Group, the Neuberger Berman and Lincoln Capital Management fixed income division (Boris). These businesses, together with other investments, helped the company to become one of the largest financial investment banking in the US. For 8 years, Lehman Brothers managed to earn revenues from trade and fixed income sales. The firm’s fixed income sales came from security business that is based on mortgage, structured and derivative products and commodities, and energy. These business activities provided Lehman Brothers with the required leverage to grow their business. Furthermore, the firm managed to become bigger due to its investment management. The firm’s investment management provided them with an earning base that was stable. This is because the organization’s fee-based structure generated revenues that were based on assets that were under management and not the total number of transactions of the organization (Ryback). In other words, Lehman Brothers continued to generate revenues that were steady even if their transactions were substantially fewer (Boris). However, in order for them to continue growing, they needed to ensure their total assets that were under management did not decrease significantly. This concept of the firm was viewed as a big gain since it offset a number of instabilities, which came with the firm being heavily reliant on capital markets.
Why did Lehman Brothers collapsed? In an attempt to provide an answer to the question: Lehman Brothers; Too Big to Fail? Ryback (2011) provides that the CEO of Lehman Brothers investment Bank had a belief that the bank possessed sufficient access to the money market. This means, there was no chance that the firm was going to fail even after the Federal Reserve allowed investment banks to borrow after the debacle of Bear Stearns. According to Ryback, Lehman Brothers was highly leveraged and he did not see the need to take any steps to get borrowing under control. However, after the US government liberated Freddie Mac and Fannie Mae, Lehman announced that they had recorded a third quarter loss, and later the bank provided that it had started having a number of liquidity problems (Boris). Afterward, a large New York clearing bank required the firm to provide them with more collateral so that they can protect any daylight open position that might arise (Ryback). As if that was not enough, the firm received threats from credit rating agencies, who were threatening to downgrade the firm unless the firm came up with some reasonable plan to restore suitable funding and capital. However, the firm did not have such a plan, and with the government announcing that there was no public money that was going to flow in their direction, the firm was forced to file for bankruptcy. However, as Azadinamin (2012) points out, the firm’s cause of failure is attributable to many factors, including the greed of Wall Street traders and the structure of the firm. In that case it cannot be said that the failure of the firm was only caused by its internal structure. Despite that, the internal structure of the firm significantly contributed to its failure in many ways. For instance, the firm’s accounting department provided extensive accounting manipulations, which according to many analysts, might have largely contributed to the firms collapse (Azadinamin).
Many studies provide that Lehman executives manipulated the firm’s financial information deliberately. To add on that, the firm’s editors, Ernst & Young, closed their eyes to the information on balance sheets from the early 2000s. Their belief was that Lehman employed repo 105 and failed to disclose it to the US government and its investors. However, the question that many investors asked, and continue to ask themselves is: why did Lehman Brother, one of the largest investment banks in the US collapsed? There are a number of reasons that led to Lehman Brothers collapse. Some of them are outlined below.
• Colossal Miscalculations
In 2007, Lehman Brothers stocks reached a record $86.18, giving the firm a market capitalization that was close to $60 billion (Lehman Brothers). However, before the first quarter of 2007, the cracks that had started showing in the US housing market had already started to reveal obvious defaults on subprime mortgages, which rose to about seven years high (Lehman Brothers). On 2007 March 14th, which was also the day that the stocks recorded their biggest one day drop in five years, there were concerns that the rising default was going to affect the profitability of Lehman. However, the firm managed to report record revenues as well as profits for their fiscal first quarter. According to the firm’s CFO, the risk that was possessed by the rising home delinquencies had been well contained, which means, if they had any impact on the firm’s profitability credentials them the impact would be very little. However, the CFO failed to foresee problems that existed in the subprime market, which was spreading to other housing market or was providing negative impact to the US economy (Boris).