What happened to Lehman Brothers? The Lehman Brothers Failure Explained

On September 15, 2008, the company filed for Chapter 11 bankruptcy proceedings following an exodus of clients, share price depreciation, and devaluation of assets. With $613 billion in debt, it was the largest such filing in United States history and is generally accepted to have precipitated the Global Financial Crisis (GFC).

What caused Lehman Brothers collapse?

Lehman Brothers Holdings Inc. was a global financial services firm founded in 1847 by brothers Henry, Emanuel, and Mayer Lehman. Lehman Brothers was the fourth-largest investment bank in the United States. The company had interests in investment banking, research, private equity, and fixed-income sales and trading, among other things.

With the advent of “innovative financial derivatives” thanks also to the macroeconomic policy of the Federal Reserves since the 2000s, to ease economic activities, these financial instruments were brought outside the balance sheets, thus making the overall risk of the financial system much more opaque.

This led to one of the greatest crises we had in the American and global financial history.

Subprime mortgage lending

Four years before the GFC, Lehman Brothers acquired five mortgage lenders including subprime lenders BNC Mortgage and Aurora Loan Services. These organizations specialized in Alt-A loans which were made to borrowers without full documentation.

The company continued to successfully invest in securitized mortgages in the following years with record profits. As the housing market started to crash, however, the company’s large stake in mortgage securities made it especially vulnerable.

In February 2007, Lehman Brothers reached a market capitalization of nearly $60 billion at a time when the U.S. housing market was showing signs of further weakness. Defaults on subprime mortgages rose to a seven-year high in March, but the company publicly stated it was unworried by the developments.

The credit crisis deepens

In August 2007, the crisis deepened with the failure of two Bear Stearns hedge funds. 

Lehman Brothers terminated 1,200 mortgage-related jobs and shut down the BNC Mortgage unit it had acquired years earlier. 

Despite the housing market correction gaining momentum, Lehman Brothers continued to be active in underwriting mortgage-back securities. The company amassed an $85 billion portfolio and its share price rebounded as global equity markets and fixed-income asset prices recovered.

Unfortunately, this recovery was only temporary. 

Last-ditch attempts

Exposed with its large mortgage securities portfolio, market sentiment turned negative after investors feared another Bear Stearns-like collapse.

Lehman Brothers announced billion-dollar losses in mid-2008, punctuated by multiple capital raisings which boosted liquidity to an estimated $45 billion. The company also reduced its exposure to residential and commercial mortgages by 20% and decreased gross assets by over $100 billion.

By the summer of 2008, the writing was on the wall. Lehman Brothers attempted to secure further funding from investment partners, but none was forthcoming. The market became spooked, causing the share price to decline by 77% in the first week of September. A further decline of 45% occurred after the Korea Development Bank walked away from taking a stake in the company.

Hedge fund clients and short-term creditors then began abandoning the company, with Lehman Brothers announcing a $3.9 billion loss in its third-quarter fiscal report. In a last-ditch effort to reverse its fortunes, Barclays and the Bank of America tried to facilitate a takeover of Lehman Brothers. The takeover – which was facilitated by the U.S. government – was unsuccessful and bankruptcy was declared just two days later.

Key takeaways:

  • Lehman Brothers was a global financial services firm founded in 1847. After more than 150 years in operation, the company entered into the largest bankruptcy proceedings in U.S. history.
  • Lehman Brothers’ large stake in mortgage securities made it especially vulnerable to the looming credit crisis in 2007. It made a half-hearted effort to reduce its exposure in the industry but continued to be an active player after its share price experienced a temporary rebound.
  • Market sentiment turned against Lehman Brothers as investors questioned its heavy exposure to mortgage securities. Capital raisings, investment partnerships, and takeover attempts only delayed the inevitable bankruptcy in September 2008.

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