Lehman Brothers collapse: A race to the bottom

Updated

Before its demise, Lehman Brothers was one of titans of Wall Street. It was the fourth biggest investment bank behind Goldman Sachs, Morgan Stanley and Merrill Lynch leading into the global financial crisis.

It still holds the record for the largest bankruptcy in US history. At the time Lehman Brothers shut down on September 15, 2008 it had $US639 billion in assets and $US619 billion in debt.

It traced its history back to the 1850s when German brothers Henry, Emanuel and Mayer Lehman, transformed their small store in the deep south of Alabama into a bank.

From the late 1990s Lehman Brothers sought to capitalise on the US housing boom, acquiring five big mortgage lenders, including BNC Mortgage and Aurora Loan Services.

BNC and Aurora were pioneers in sub-prime lending, selling high-risk mortgages with little documentation.

It was a punt that would ultimately destroy Lehman Brothers, leave Wall Street teetering above the abyss and help spark a global recession.

Real estate hedge fund

2003

The shift into property financing catapulted Lehman Brothers from being just another bond-trader to a massive, full service investment bank.

It specialised in highly risky and highly rewarding bridging finance in big real estate deals.

In 2006, the year before things started unravelling, the property unit was responsible for around 20 per cent of banks' $US4 billion profit.

Many argued it was not really a bank anymore, but a real estate hedge fund.

Cracks appear

February, 2007

By February 2007 Lehman Brothers' shares hit a record high of $86, giving it a market capitalisation of around $US60bn. It was all downhill from there.

A month later the company conceded that defaults in its roughly $US150 billion worth of securitised mortgages could impact the profits, a comment that turned out to be one of the larger understatements in US corporate history.

Nonetheless, it continued to write more mortgage-backed securities than any other bank.

The beginning of the end

August 2007

While an exact starting point of the global financial crisis is hard to pinpoint, August 9, 2007 is as good a date as any.

It was the day big French bank BNP Paribas froze a number of investment funds loaded with US mortgage-backed securities, and collateralised debt obligations (CDOs) as defaults on sub-prime loans started mounting up at an alarming rate.

BNP simply could not work out what they were worth, or indeed if they were worth anything.

It was the same month Lehman Brothers closed BNC Mortgage, sacking 1,200 employees. At that stage the damage appeared limited to a $US50 million impairment charge.

Bear Stearns collapses

March 2008

The second biggest underwriter of sub-prime loans, and Lehman Brothers' arch rival, Bear Stearns finally capitulated to its toxic load of debt on March 14, 2008.

After the New York Federal Reserve back-tracked on a planned bail out, Bearn Stearns was sold to JP Morgan Chase for $2 a share, a fraction of the value of its pre-crisis highs.

The market bet Lehman Brothers would be the next big bank to fall and its share price was cut in half almost overnight.

Sinking rapidly, deck chairs thrown overboard

June 2008

Lehman Brothers went to its investors to raise another $US6 billion in capital.

It cut its exposure to real estate by 20 per cent, disposed of about $US150 billion in assets and slashed debt. The bank also reported it lost almost $US3 billion in the previous three months.

Soon enough, like Bearn Stearns, Lehman Brothers was looking for someone to buy it.

For sale. No bids

August 2008

August started positively enough. George Soros, the legendary investor with a reputation for knowing value, ploughed in and bought a large lick of Lehman Brothers' shares.

The share price ebbed and flowed on news of various buyers kicking the bank's rapidly deflating and threadbare tyres.

Singapore's government-owned investment vehicle Temasek reportedly had a look. So did Hong Kong-based giant HSBC. South Korean and Chinese banks as well.

The failed talks were disastrous for sentiment. The share price halved again and defaults on the company's massive mountain of debt jumped by 66 per cent.

Last rites

September 2008

Losses were accelerating. $US4 billion was lost over the quarter and another $US5.6 billion written off.

Remarkably, Lehman Brothers was down to its last $1 billion in cash. US Treasury secretary, and former Goldman Sachs banker, Hank Paulson said there would be no goverment bail-out of the distressed bank.

An emergency weekend meeting on September 13 was organised. Mr Paulson and the New York Federal Reserve boss Tim Geithner hauled in a number of banks to broker a last-minute takeover.

The bank bosses from the likes of Goldman Sachs, Morgan Stanley, JP Morgan Chase and Citigroup, all who had problems of their own, didn't want a bar of it.

Everyone left the meeting knowing Lehman Brothers was dead and life for the rest of them would become immeasurably harder.

Gone

September 15, 2008

Wall Street opened on Monday morning to the news Lehman Brothers had filed for bankruptcy.

The market immediately shed more than 4 per cent, the largest single day fall since the September 11 attacks in 2001.

The banks were hammered. The giant insurer AIG, which insured CDOs against default, went into freefall.

This time the US government acted, and within two days seized AIG's assets to stem the haemorrhaging.

An emergency deal to save Merrill Lynch was struck with Bank of America.

Too big to fail

October 2008

Lehman Brothers' demise prompted a full-blown bank crisis in the US, Europe and large parts of Asia.

The Bush administration hurriedly came up with the Troubled Assets Relief Program (TARP), a $US700 billion slush fund to buy toxic assets from the banks that had engineered them.

It helped stem the outright panic. Ultimately the banks chewed through more than $400 billion of TARP money stumped up by taxpayers, although the government ended up making a small profit on the salvage operation.

Lehman Brothers was the only big bank that was allowed to collapse.

Its legacy for the survivors, or what are now known as systemically important banks, is taxpayers will have to stand behind them with the "too big to fail" guarantee.

Topics: banking, industry, business-economics-and-finance, united-states

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