Bankruptcy of Lehman BrothersFinancial services firmLehman Brothersfiled forChapter 11bankruptcy protectionon September 15, 2008. The filing remains thelargest bankruptcy filing in U.S. history, with Lehman holding over $600 billion in assets.[1]

Background[edit]Exposure to the morgage market[edit]Lehman borrowed significant amounts to fund its investing in the years leading to its bankruptcy in 2008, a process known asleveragingor gearing. A significant portion of this investing was in housing-related assets, making it vulnerable to a downturn in that market. One measure of this risk-taking was its leverage ratio, a measure of the ratio of assets to owners equity, which increased from approximately 24:1 in 2003 to 31:1 by 2007.[2]While generating tremendous profits during the boom, this vulnerable position meant that just a 34% decline in the value of its assets would entirely eliminate its book value of equity.[3]Investment banks such as Lehman were not subject to the same regulations applied to depository banks to restrict their risk-taking.[4]In August 2007, Lehman closed itssubprime lender, BNC Mortgage, eliminating 1,200 positions in 23 locations, and took a $25-million after-tax charge and a $27-million reduction ingoodwill. The firm said that poor market conditions in the mortgage space "necessitated a substantial reduction in its resources and capacity in the subprime space".[5]Lehman's final months[edit]In 2008, Lehman faced an unprecedented loss due to the continuingsubprime mortgage crisis. Lehman's loss was apparently a result of having held on to large positions in subprime and other lower-rated mortgagetrancheswhen securitizing the underlying mortgages. Whether Lehman did this because it was simply unable to sell the lower-rated bonds, or made a conscious decision to hold them, is unclear. In any event, huge losses accrued in lower-rated mortgage-backed securities throughout 2008. In the second fiscal quarter, Lehman reported losses of $2.8 billion and decided to raise $6 billion in additional capital.[6]In the first half of 2008 alone, Lehman stock lost 73% of its value as the credit market continued to tighten.[6]In August 2008, Lehman reported that it intended to release 6% of its work force, 1,500 people, just ahead of its third-quarter-reporting deadline in September.[6]On August 22, 2008, shares in Lehman closed up 5% (16% for the week) on reports that the state-controlledKorea Development Bankwas considering buying Lehman.[7]Most of those gains were quickly eroded as news emerged that Korea Development Bank was "facing difficulties pleasing regulators and attracting partners for the deal."[8]It culminated on September 9, 2008, when Lehman's shares plunged 45% to $7.79, after it was reported that the state-run South Korean firm had put talks on hold.[9]Investor confidence continued to erode as Lehman's stock lost roughly half its value and pushed theS&P 500down 3.4% on September 9, 2008. TheDow Joneslost nearly 300 points the same day on investors' concerns about the security of the bank.[10]The U.S. government did not announce any plans to assist with any possible financial crisis that emerged at Lehman.[11]On September 10, 2008, Lehman announced a loss of $3.9 billion and their intent to sell off a majority stake in their investment-management business, which includedNeuberger Berman.[12][13]The stock slid 7% that day.[13][14]On September 13, 2008,Timothy F. Geithner, then president of theFederal Reserve Bank of New Yorkcalled a meeting on the future of Lehman, which included the possibility of an emergency liquidation of its assets.[15]Liquidity of assets alarmed every bank and company in 2008 according toMidOcean PartnersCEOTed Virtue. Lehman reported that it had been in talks withBank of AmericaandBarclaysfor the company's possible sale.[15]The New York Timesreported on September 14, 2008, that Barclays had ended its bid to purchase all or part of Lehman and a deal to rescue the bank from liquidation collapsed.[16]It emerged subsequently that a deal had been vetoed by theBank of Englandand the UK'sFinancial Services Authority.[17]Leaders of major Wall Street banks continued to meet late that day to prevent the bank's rapid failure.[16]Bank of America's rumored involvement also appeared to end as federal regulators resisted its request for government involvement in Lehman's sale.[16]Bankruptcy filing[edit]Barclaysacquired the investment banking business ofLehman Brothersin September 2008Lehman Brothers filed for Chapter 11 bankruptcy protection on September 15, 2008. According toBloomberg, reports filed with the U.S. Bankruptcy Court, Southern District of New York (Manhattan) on September 16 indicated thatJPMorgan Chase & Co.providedLehman Brotherswith a total of $138 billion in "Federal Reserve-backed advances." The cash-advances byJPMorgan Chasewere repaid by the Federal Reserve Bank of New York for $87 billion on September 15 and $51 billion on September 16.[18]Breakup process[edit]On September 22, 2008, a revised proposal to sell the brokerage part of Lehman Brothers holdings of the deal, was put before the bankruptcy court, with a $1.3666 billion (700 million) plan forBarclaysto acquire the core business ofLehman Brothers(mainly Lehman's $960 millionMidtown Manhattanoffice skyscraper), was approved.Manhattancourt bankruptcy Judge James Peck, after a 7-hour hearing, ruled: "I have to approve this transaction because it is the only available transaction. Lehman Brothers became a victim, in effect the only true icon to fall in a tsunami that has befallen the credit markets. This is the most momentous bankruptcy hearing I've ever sat through. It can never be deemed precedent for future cases. It's hard for me to imagine a similar emergency."[19]Luc Despins, the creditors committee counsel, said: "The reason we're not objecting is really based on the lack of a viable alternative. We did not support the transaction because there had not been enough time to properly review it."[citation needed]In the amended agreement, Barclays would absorb $47.4 billion in securities and assume $45.5 billion in trading liabilities. Lehman's attorneyHarvey R. MillerofWeil, Gotshal & Manges, said "the purchase price for the real estate components of the deal would be $1.29 billion, including $960 million for Lehman's New York headquarters and $330 million for two New Jersey data centers. Lehman's original estimate valued its headquarters at $1.02 billion but an appraisal from CB Richard Ellis this week valued it at $900 million."[citation needed]Further, Barclays will not acquire Lehman's Eagle Energy unit, but will have entities known as Lehman Brothers Canada Inc, Lehman Brothers Sudamerica, Lehman Brothers Uruguay and its Private Investment Management business for high-net-worth individuals. Finally, Lehman will retain $20 billion of securities assets in Lehman Brothers Inc that are not being transferred to Barclays.[20]Barclays had a potential liability of $2.5 billion to be paid asseverance, if it chooses not to retain some Lehman employees beyond the guaranteed 90 days.[21][22]On September 22, 2008,Nomura Holdings, Inc.announced it agreed to acquire Lehman Brothers' franchise in the Asia Pacific region including Japan, Hong Kong and Australia.[23]The following day, Nomura announced its intentions to acquire Lehman Brothers' investment banking and equities businesses in Europe and the Middle East. A few weeks later it was announced that conditions to the deal had been met, and the deal became legally effective on Monday, October 13.[24]In 2007, non-US subsidiaries of Lehman Brothers were responsible for over 50% of global revenue produced.[25]Impact of bankruptcy filing[edit]The Dow Jones closed down just over 500 points (4.4%) on September 15, 2008, at the time the largest drop by points in a single day sincethe days followingthe attacks on September 11, 2001.[26](This drop was subsequently exceeded by an even larger 7.0% plunge on September 29, 2008.)Lehman's bankruptcy was expected to cause some depreciation in the price of commercial real estate. The prospect for Lehman's $4.3 billion in mortgage securities getting liquidated sparked a selloff in thecommercial mortgage-backed securities(CMBS) market. Additional pressure to sell securities in commercial real estate was feared as Lehman got closer to liquidating its assets. Apartment-building investors were also expected to feel pressure to sell as Lehman unloads its debt and equity pieces of the $22 billion purchase ofArchstone, the third-largest United Statesreal estate investment trust(REIT). Archstone's core business was the ownership and management of residential apartment buildings in major metropolitan areas of the United States. Jeffrey Spector, a real-estate analyst atUBSsaid that in markets with apartment buildings that compete with Archstone, "there is no question that if you need to sell assets, you will try to get ahead" of the Lehman selloff, adding "Every day that goes by there will be more pressure on pricing."[27]Severalmoney fundsand institutional cash funds had significant exposure to Lehman with the institutional cash fund run byThe Bank of New York Mellonand the Primary Reserve Fund, amoney market fund, both falling below $1 per share, called "breaking the buck", following losses on their holdings of Lehman assets. In a statement The Bank of New York Mellon said its fund had isolated the Lehman assets in a separate structure. It said the assets accounted for 1.13% of its fund. The drop in the Primary Reserve Fund was the first time since 1994 that a money-market fund had dropped below the $1-per-share level.Putnam Investments, a unit of Canada'sGreat-West Lifeco, shut a $12.3 billion money-market fund as it faced "significant redemption pressure" on September 17, 2008.Evergreen Investmentssaid its parentWachovia Corporationwould "support" three Evergreen money-market funds to prevent their shares from falling.[28]This move to cover $494 million of Lehman assets in the funds also raised fears about Wachovia's ability to raise capital.[29]Close to 100 hedge funds used Lehman as theirprime brokerand relied largely on the firm for financing. In an attempt to meet their own credit needs, Lehman Brothers International routinelyre-hypothecated[30]the assets of their hedge funds clients that utilized theirprime brokerageservices. Lehman Brothers International held close to 40 billion dollars of clients assets when it filed for Chapter 11 Bankruptcy. Of this, 22 billion had been re-hypothecated.[31]Asadministratorstook charge of the London business and the U.S. holding company filed for bankruptcy, positions held by those hedge funds at Lehman were frozen. As a result, the hedge funds are being forced to de-lever and sit on large cash balances inhibiting chances at further growth.[32]This in turn created further market dislocation and overall systemic risk, resulting in a 737 billion dollar decline in collateral outstanding in the securities lending market.[33]In Japan, banks and insurers announced a combined 249 billion yen ($2.4 billion) in potential losses tied to the Lehman shock.Mizuho Trust & Banking Co.cut its profit forecast by more than half, citing 11.8 billion yen in losses on bonds and loans linked to Lehman. TheBank of JapanGovernor Masaaki Shirakawa said "Most lending to Lehman Brothers was made by major Japanese banks, and their possible losses seem to be within the levels that can be covered by their profits," adding "There is no concern that the latest events will threaten the stability of Japan's financial system."[34]During bankruptcy proceedings a lawyer fromThe Royal Bank of Scotland Groupsaid the company is facing between $1.5 billion and $1.8 billion in claims against Lehman partially based on an unsecured guarantee from Lehman and connected to trading losses with Lehman subsidiaries, Martin Bienenstock.[35]Lehman was a counterparty to mortgage financierFreddie Macin unsecured lending transactions that matured on September 15, 2008. Freddie said it had not received principal payments of $1.2 billion plus accrued interest. Freddie said it had further potential exposure to Lehman of about $400 million related to the servicing of single-family home loans, including repurchasing obligations. Freddie also said it "does not know whether and to what extent it will sustain a loss relating to the transactions" and warned that "actual losses could materially exceed current estimates." Freddie was still in the process of evaluating its exposure to Lehman and its affiliates under other business relationships.[36]AfterConstellation Energywas reported to have exposure to Lehman, its stock went down 56% in the first day of trading having started at $67.87. The massive drop in stocks led to theNew York Stock Exchangehalting trade of Constellation. The next day, as the stock plummeted as low as $13 per share, Constellation announced it was hiringMorgan StanleyandUBSto advise it on "strategic alternatives" suggesting a buyout. While rumors suggested French power companylectricit de Francewould buy the company or increase its stake, Constellation ultimately agreed to a buyout byMidAmerican Energy, part ofBerkshire Hathaway(headed by billionaireWarren Buffett).[37][38][39]TheFederal Agricultural Mortgage Corporationor Farmer Mac said it would have to write off $52.4 million in Lehman debt in the form of senior debt securities it owned as a result of the bankruptcy. Farmer Mac said it may not be in compliance with its minimum capital requirements at the end of September.[40]In Hong Kong more than 43,700 individuals in the city have invested inHK$15.7 billion of "guaranteedmini-bonds" () from Lehman.[41][42][43]Many claim that banks and brokers mis-sold them as low-risk. Conversely, bankers note that minibonds are indeed low-risk instruments since they were backed by Lehman Brothers, which until just months before its collapse was a venerable member of Wall Street with high credit and investment ratings. The default of Lehman Brothers was a low probability event, which was totally unexpected. Indeed, many banks accepted minibonds as collateral for loans and credit facilities. AnotherHK$3 billion has been invested in similar like derivatives. TheHong Kong governmentproposed a plan to buy back the investments at their current estimated value, which will allow investors to partially recover some of their loss by the end of the year.[44]HK chief executiveDonald Tsanginsisted the local banks respond swiftly to the government buy-back proposal as theMonetary Authorityreceived more than 16,000 complaints.[41][43][44]On October 17 He Guangbe, chairman of theHong Kong Association of Banks, agreed to buy back the bonds, which will be priced using an agreed upon methodology based on its estimated current value.[45]This episode has deep repercussions on the banking industry, where misguided investor sentiments have become hostile to both wealth management products as well as the banking industry as a whole. Under intense pressure from the public, all political parties have come out in support of the investors, further fanning distrust towards the banking industry.Neuberger Berman[edit]Neuberger BermanInc., through its subsidiaries, primarilyNeuberger Berman, LLC, is an investment-advisory firm founded in 1939 byRoy R. Neubergerand Robert Berman, to manage money forhigh-net-worth individuals. In the decades that followed, the firm's growth mirrored that of the asset-management industry as a whole. In 1950, it introduced one of the firstno-loadmutual fundsin the United States, theGuardian Fund, and also began to manage the assets ofpension plansand other institutions. Historically known for itsvalue-investingstyle, in the 1990s the firm began to diversify its competencies to include additional value andgrowth investing, across the entirecapitalizationspectrum, as well as new investment categories, such as international,real-estate investment trustsandhigh-yieldinvestments. In addition, with the creation of a nationally and several state-chartered trust companies, the firm became able to offer trust and fiduciary services. Today the firm has approximately $130 billion inassets under management.In October 1999, the firm conducted aninitial public offeringof its shares and commenced trading on theNew York Stock Exchange, under the ticker symbol "NEU". In July 2003, shortly after the retired Mr. Neuberger's 100th birthday, the company announced that it was inmergerdiscussions withLehman Brothers Holdings Inc.These discussions ultimately resulted in the firm's acquisition by Lehman on October 31, 2003, for approximately $2.63 billion in cash and securities.On November 20, 2006, Lehman announced its Neuberger Berman subsidiary would acquire H. A. Schupf & Co., a money-management firm targeted at wealthy individuals. Its $2.5 billion of assets would join Neuberger's $50 billion in high-net-worth client assets under management.[46]An article inThe Wall Street Journalon September 15, 2008, announcing that Lehman Brothers Holdings filed forChapter 11bankruptcy protection, quoted Lehman officials regarding Neuberger Berman: "Neuberger Berman LLC and Lehman Brothers Asset Management will continue to conduct business as usual and will not be subject to the bankruptcy case of the parent company, and its portfolio management, research and operating functions remain intact. In addition, fully paid securities of customers of Neuberger Berman are segregated from the assets of Lehman Brothers and aren't subject to the claims of Lehman Brothers Holdings' creditors, Lehman said."[47]Just before the collapse of Lehman Brothers, executives at Neuberger Berman sent e-mail memos suggesting, among other things, that the Lehman Brothers' top people forgo multi-million dollar bonuses to "send a strong message to both employees and investors that management is not shirking accountability for recent performance."Lehman Brothers Investment Management DirectorGeorge Herbert Walker IVdismissed the proposal, going so far as to actually apologize to other members of the Lehman Brothers executive committee for the idea of bonus reduction having been suggested. He wrote, "Sorry team. I am not sure what's in the water at Neuberger Berman. I'm embarrassed and I apologize."[48]Controversies[edit]Controversy of executive pay during crisis[edit]Richard Fuld, head of Lehman Brothers, faced questioning from theU.S. House of Representatives'Committee on Oversight and Government Reform. Rep.Henry Waxman(D-CA) asked: "Your company is now bankrupt, our economy is in crisis, but you get to keep $480 million (276 million). I have a very basic question for you, is this fair?"[49]Fuld said that he had in fact taken about $300 million (173 million) in pay and bonuses over the past eight years.[49]Despite Fuld's defense on his high pay, Lehman Brothers executive pay was reported to have increased significantly before filing for bankruptcy.[50]On October 17, 2008,CNBCreported that several Lehman executives, including Richard Fuld, have been subpoenaed in a case relating to securities fraud.[51]Accounting manipulation[edit]In March 2010, thereport of Anton R. Valukas, the Bankruptcy Examiner, drew attention to the use ofRepo 105transactions to boost the bank's apparent financial position around the date of the year-endbalance sheet. The New York attorney generalAndrew Cuomolater filed charges against the bank's auditorsErnst & Youngin December 2010, alleging that the firm "substantially assisted... a massive accounting fraud" by approving the accounting treatment.[52]On April 12, 2010, aNew York Timesstory revealed that Lehman had used a small company,Hudson Castle, to move a number of transactions and assets off Lehman's books as a means of manipulating accounting numbers of Lehman's finances and risks. One Lehman executive described Hudson Castle as an "alter ego" of Lehman. According to the story, Lehman owned one quarter of Hudson; Hudson's board was controlled by Lehman, most Hudson staff members were former Lehman employees.[53]Section 363 Sale[edit]On February 22, 2011, JudgeJames M. Peckof the U.S. Bankruptcy Court in the Southern District of New York rejected claims by lawyers for the Lehman estate that Barclays had improperly reaped a windfall from thesection 363sale. "The sale process may have been imperfect, but it was still adequate under the exceptional circumstances of Lehman Week."