The Lehman brothers collapse and how the economy has changed today

In one of the most massive bankruptcies in US history, the collapse of Lehman Brothers marks its tenth anniversary in September 2018. The demise of the firm is almost synonymous with a financial crisis in 2008 and the economy in still feels the consequences. But how did one of the largest investment banks fall catastrophically?

How did Lehman Brothers collapse?

Although the failure of the company could be explained by several reasons, the housing crisis in 2008 was the main cause of its failure.

The company has survived several of the world's biggest disasters, including two world wars, the Great Depression and numerous crises. However, it was his over-indebtedness and lack of rigor in high-risk loans that caused his final collapse.

And while the company itself was just one of the many factors contributing to the economic disaster of 2008 and beyond, it may have been the catalyst for the collapse of the banking and real estate sectors and proved that even bankrupt the next.

History of Lehman Brothers

Lehman Brothers was created by a German immigrant in 1844 in Montgomery, Alabama, as a general store and dry goods merchant. Founded by Henry Lehman, the company was quickly joined by his brothers Emanuel and Mayer in 1850, earning the name of Lehman Brothers.

Society has become a place of choice and power, both nationally and internationally. After owning the company for nearly 10 years, in 1994, American Express (AXP) created Lehman Brothers and created its initial public offering with a capitalization of $ 3.3 billion. And, after the 1999 repeal of the Glass-Steagall Act, Lehman Brothers expanded its offering (with the new freedom to combine commercial banking and investment activities).

With new capabilities in proprietary banking, securities and asset management, Lehman Brothers has expanded its services, which could be the beginning of the end.

Financial crisis of 2008

By the mid-2000s, the real estate boom was booming and Lehman, like many other companies, was increasingly involved in the issuance of mortgage-backed securities, MBSs and securities. claim or OCB. However, Lehman reached a new milestone between 2003 and 2004 by expanding the credit acquisition process to three other lenders, BNC Mortgage and Aurora Loan Services, both of which specialize in subprime lending.

Between 2004 and 2006, the Capital Markets unit jumped 56% thanks to Lehman's real estate operations – which led the company to become one of the world's leading investment and asset management services firms. fastest growth. In 2007, Lehman reported significant figures – with revenues of $ 19.3 billion and a record net income of $ 4.2 billion.

But things would change radically for the banking giant.

For a number of reasons, including failing lenders on risky loans and unsustainable mortgages, the real estate market began to collapse in 2006 – but without getting discouraged, Lehman Brothers has doubled its share of the real estate market. $ 111 billion in assets and securities in 2007. As they became clearer and lighter, these loans were ill-advised and hurt the health of businesses – Bear Stearns discovered the hard way first .

When Lehman Brothers competitor Bear Stearns was bought by J.P. Morgan Chase (JMP) as part of a Federal Reserve backed operation in 2008, Lehman's fate was questioned. Weakened by the use of repurchase agreements ("repo"), which gave them short-term financing for their day-to-day operations, Lehman had to boost investor confidence in record time by raising $ 6 billion. in June 2008. But it was not as convincing as the cabinet wanted.

In September, Lehman announced an expected loss of $ 3.9 billion in the third quarter, as well as a loss of nearly $ 5.6 billion in impairments of so-called "toxic" assets. But in a desperate attempt to keep his head out of the water, Lehman claimed he increased his cash to about $ 45 billion, reduced mortgages by 20% and reduced his leverage by about 7 points. Despite these measures, after the company announced plans to divert $ 50 billion of toxic assets in September, the rating agency Moody's plans to reduce Lehman's rating and the Federal Reserve (led by the Chairman of the Federal Reserve, Timothy Geithner). has come together to consider the future of the company.

During the first week of September, Lehman's stock dropped drastically – about 77%. Investor doubts grew as CEO Richard Fuld attempted to keep the company afloat by selling asset management units, trying to develop a relationship with Korea Development Bank and creating commercial real estate assets. . Once it was clear to investors that Lehman was sinking, an increase in credit swaps of about 66% and withdrawal of investors from hedge funds indicated that everyone was in the process of jump.

Once Moody's told Lehman that he would have to sell a majority stake in his company to investors to maintain his ratings, the stock fell again by about 42% on Sept. 11, leaving Lehman with only $ 1 billion dollars at the end of the week.

Despite attempts by Barclays (BCS) and Bank of America (BAC) to launch Lehman following a takeover, efforts were unsuccessful. And before September 15, 2008, Lehman Brothers declared bankruptcy, resulting in a 93% drop in the company's stock three days earlier.

With the collapse of one of the largest and most successful banks in the world, the markets have experienced an unprecedented beating that, in some ways, is still felt today.

What caused the collapse of Lehman Brothers?

Fortune magazine named Lehman Brothers as the "most admired securities firm" in 2007 – a year before the bankruptcy filing. So how did Lehman fail after being at the top of his game a year ago?

Although several factors contributed to its collapse, many experts seem to agree that it was largely a lack of confidence, excessive debt, poor long-term investments and unstable financing.

One of the main causes of the firm's collapse was due to its overzealous lending during the real estate bubble from 2003 to 2004. By acquiring five lending companies focused primarily on subprime lending, Lehman was investing in a risky venture. capitalization in 2007 of about $ 60 billion, quickly collapsed due to a record number of unsecured loan failures – and, despite assurances from the firm, it inevitably returned to bite them. The company was over-indebted and the value of its mortgage portfolio was no longer convincing.

But many questioned the role of the federal government's policy "too big to fail" with regard to Lehman. If Lehman Brothers was really one of the biggest companies in the world, why was not it too important to fail?

According to Fed Chairman Ben Bernanke, Treasury Secretary Henry Paulson and Timothy Geithner, chairman of the Federal Reserve Bank of New York, other companies like Bear Stearns and AIG had guarantees covering the bailout. This fact, the Guardian reported earlier this week, made "illegal" Lehman's release by the Fed. Yet even today, many do not think that the Fed's explanation has covered all the basics – in fact, according to an email sent by Paulson's chief of staff to his press secretary, the things were maybe a little darker.

"I can not do it anymore, I can not be Mr. Bailout." Paulson's chief of staff wrote to Paulson's press secretary, the Guardian reported. "I can not believe that returning Lehman … will look horrible in the press, is not it?"

But despite persistent skepticism about the Fed's reasons, the bailout was Lehman's last option.

Once the Fed did not provide any help, Lehman had to stop doing so.

The bailout has only increased the mistrust of the Fed, which still seems present today. But despite claims that the Fed could have helped keep Lehman afloat, the company itself was responsible for its miscalculations and risk management.

Once Lehman surrendered, Judge James Peck approved an agreement for Barclays to acquire part of the company's investment and capital market activities (and, at the same time, save some 10,000 jobs). ). But the judge seemed to make it clear that Lehman was an exception.

"I have to approve this transaction because it's the only transaction available," Peck told the court. "Lehman Brothers has become a victim, in fact the only real icon to have fallen into a tsunami that hit the credit markets.This is the largest bankruptcy hearing I've ever had. me to imagine a similar emergency situation. "

Following the collapse of the Lehman brothers

The fallout from the collapse of Lehman Brothers has been disastrous.

While other factors certainly contributed to the economic crisis that followed, the failure of society seemed to be the trigger that triggered the effects of the generalized recession. According to ABC News, according to the ABC News, the Dow Jones Industrial Average (DOW) fell by 10%, unemployment rose by 10%, unemployment rose by 10%, and international fallout devastated economies like Latvia, Hungary, and Lithuania (not to mention the European Union). Even Pakistan has asked for a bailout from the International Monetary Fund (IMF) after the crisis, and Iceland has been facing a crisis when authorities announced that the government had no funds to support major banks of the country.

"The bankruptcy of Lehman will forever be synonymous with the financial crisis and the destruction of the resulting wealth," said Paul Hickey, founder of Bespoke Investment Group, ABC News.

But what are the implications of the failure of the company in the United States?

President George Bush announced a $ 700 billion rescue package to help save what was left of the financial sector. In addition, as a result of the 2008 financial crisis, the Dodd-Frank Act was implemented to help strengthen financial regulation.

How did Lehman Brothers lose confidence?

Trust remained a huge question mark after Lehman's collapse. The public, which had previously placed so much trust (and money) in companies "too big to fail" like Lehman, was suddenly skeptical of the economy. The Lehman example has turned out to be a turning point in finance to a historical degree.

"This has shaken the market's confidence and pushed people to believe that the whole system could explode," John Garvey, head of US financial services at PricewaterhouseCoopers, told ABC News. "I do not think anyone has understood the impact of trust and what it means for the proper functioning of the system."

It seems clear that the collapse of Lehman had a no less decisive effect on the economy – and, as Andrew Ross Sorkin wrote for the New York Times on the eve of Lehman's bankruptcy, he had "reshaped[d] the landscape of American finance. "

The trust that once accompanied large financial institutions is no longer implicit.

Is Deutsche Bank the new Lehman Brothers?

There has been a long history of comparisons between Deutsche Bank (DB) and Lehman Brothers – particularly in recent years. Deutsche has experienced some of the highest credit default swap rates in the past, reaching 235 basis points (the highest among investment banks) in 2016. In addition, the bank has failed for several years in its resistance test. in 2018, according to Reuters. And while several other historical factors have consistently established comparisons between the bank and Lehman, others suggest that it could be more closely related to the Fannie Mae and Freddie Mac crisis.

Bloomberg reported this year that Deutsche currently holds $ 145 billion of "absorbed capital," or TLAC, which is losing value and could eventually cause the bank to collapse. But, according to Bloomberg, the government could choose to take over the bank (much like the US government did with Fannie Mae and Freddie Mac during the financial crisis).

"Unlike Lehman, Deutsche Bank can not fail," wrote Alastair Winter, Daniel Stewart's chief economist, to CNBC in 2016. "It is also likely that they will be much more aware of their problems, even if they can not or do not want to quantify them correctly. "

Although the crisis is only speculation for Deutsche, Lehman Brothers' edifying narrative may nevertheless be relevant – as for economies around the world.

Is the 2018 economy still affected by the crash?

The real question should be, what did we learn from Lehman?

While some may argue that the financial sector has not yet learned its lesson, the abandonment of high-risk activities such as the resale or repackaging of mortgages could be a sign that banks are getting better. manage risks. And investors seem to have learned that they need to diversify further.

"The collapse of Lehman Brothers has prompted financial institutions to realize that the most precious thing entrusted to them is trust – and that getting it back would require structural and cultural changes unimaginable a few years ago." Fontayn, EMEA President of BNY Mellon wrote to CNBC in 2016. "Since 2008, banks around the world have strengthened their balance sheets, hold more capital and more liquid assets, and have invested heavily in risk management. . "

Directed for the disaster?

But for many, the economy is gradually moving towards another financial crisis, undeterred by the warning signs of Lehman.

The global economy currently has a total debt of $ 237 trillion, some $ 70 trillion more than before the collapse of Lehman Brothers, according to the Financial Times. In addition, concerns over monetary policy and quantitative easing, as well as consequential negative growth in GDP, could contribute to another recession.

In addition, despite a much better number of jobs (unemployment is around 3.9% currently – compared to 10% in 2008), a bull market and a revitalized real estate market, some experts believe economy makes the same mistakes as pre-Lehman times.

According to a report by the Federal Reserve Bank of San Francisco, the economy is "unlikely to regain" recession GDP figures before 2008 – after being reduced since the crisis. And, according to this year's New York Times, the current market could be overvalued – which, combined with the recent vote to reduce some aspects of the regulatory processes of the Dodd-Frank Act, could lead to another catastrophe comparable to the post-post fiasco -Lehman.

To make matters worse, TheStreet's Brian Sozzi says investors are still not looking for their stocks and may be starting to take advantage of their own balance sheets.

"Most tech stocks have gone through the roof without any consideration of valuations, people are just rolling around because everyone is and they can not read a cash flow statement," Sozzi wrote this week. . "Some continue to take lessons from Lehman, but I think the majority has evolved without re-examining this period every quarter – as it should be.It's sad and it will come back bite investors right here five years . "

However, the stock market has recently peaked, but speculation about an expanding bear market seems to be giving way to the market.

Sozzi believes that the daily line of 73 performance indexes from its peak of 2018 is a red flag – all the more so as the market has seen a sharp correction every time.

But in addition to the economic impact of the collapse of the bank, some have argued that a major change in the Democratic Party in favor of greater regulation of banks was a direct consequence of the disaster from Lehman. According to CNBC, movements like Occupy Wall Street in 2011, as well as increasingly populist politicians like Senator Bernie Sanders and Senator Elizabeth Warren, are just examples of the growing movement.

"I think [the financial crisis] It has generally strengthened the confidence with which we Democrats defend a strong role for the government, "said former Rep. Barney Frank, who participated in the Dodd-Frank legislation. The importance of appropriate regulation. "

Lehman Collapse Has he influenced politics?

But some suggest that the collapse of the titan of finance has also unleashed a wave of democratic socialism that has only heightened a sense of anti-big financial institutions.

However, despite claims that the collapse of Lehman has affected leftist politics over the past 10 years, economic policy should not be at the center of the upcoming campaign in 2020, according to CNBC.

However, although banks have taken several steps towards better risk management, the financial sector continues to leave much to be desired.

"Ten years after the collapse of the Wall Street economy, one would think that Washington would always be vigilant about the risks to our economy and American families," Senator Senator Sherrod Brown told the Senate Committee. banks, this week. "But in one agency after another, the rules are being rewritten to meet special interests, increasing the risk that taxpayers will once again be concerned about the carelessness of Wall Street."

So, did Wall Street learn its lesson?