How Big is Lehman Brothers

8/9/2019 How Big is Lehman Brothers

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How big is Lehman Brothers?

Founded in 1850 by three immigrants from Germany, Lehman Brothers has been aprominent investment bank in Wall Street for decades.

It operates at a wholesale level, dealing with governments, companies and other financialinstitutions, employing 25,000 people worldwide, including 5,000 in the UK.

Its core business includes buying and selling shares and fixed income assets, trading andresearch, investment banking, investment management and private equity.

As the crisis in financial markets gathered momentum, it saw its share price collapsefrom $82 to less than $1.

reason for bankruptcy

Investment banks have been aiding or buying peers since the US Treasury Departmentand the Federal Reserve established that its rescue of Bear Stearns Cos in March hadntset a precedent and declined to save Lehman before it filed for bankruptcy with debt ofmore than $613 billion. JPMorgan is also reported to be working with AmericanInternational Group Inc, along with Goldman Sachs Group Inc, after AIG was told not toexpect a loan from the central bank. Merrill Lynch & Co agreed to be acquired by Bankof America Corp, leaving Goldman Sachs and Morgan Stanley as the two largestremaining investment banks Barclays Walks: Barclays Plc, the UKs third-biggest bank,walked away from a reported deal to buy all of Lehman just before its bankruptcy, and

may instead buy Lehmans trading and investment banking business, a person withknowledge of the matter said on Tuesday .Lehman, based in New York, was the fourth-largest investment bank when it sought bankruptcy protection.

Why didn't the US Treasury save Lehman Brothers?

When Bear Stearns ran into trouble, the US Treasury made the terms favourable for JPMorgan Chase to buy it. And just last week, the US government effectively nationalisedFannie Mae and Freddie Mac, which between them own or guarantee about half of the

$12 trillion US mortgage market.

So already the US tax payer has been put at risk of shouldering the burden of billions ofdollars of losses, and it is becoming politically less acceptable for the government to keepbailing out private companies.


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By not giving UK bank Barclays a guarantee for Lehman's trading obligations as part of adeal to buy the business, analysts say the US Treasury has put a line under its willingnessto use public money to rescue banks which have made wrong decisions.

Instead, government officials have focused on supporting the financial system in other

ways, announcing measures to ease access to emergency credit for struggling financialcompanies.

Effects

Nobody possesses Lehman Brothers cheque book or current account. The company is aninvestment bank that specializes in big and complex deals and investments. Despite this,Lehman's collapse and the troubles of other financial institutions will probably be felt bymillions of people around the world - at least indirectly. Most of our banks and pensionfunds have dealings with Lehman, or with firms like hedge funds that traded extensivelywith Lehman. Unwinding Lehman's complex deals will take months if not years. During

that time the global financial system will be snarled up. Many banks won't know for surehow much they are exposed to Lehman, and will have difficulty freeing up the money inthose deals.

This in turn is likely to intensify the credit crunch, with potentially dire consequences forbusinesses and consumers. And the dramatic collapse of Lehman Brothers has alsoshaken the financial markets, with share prices slumping around the world. Every onewill feel the impact even if you are not a banker or shareholder. pension fund may have awobble. The employer may find it more difficult to do business. And there can b moredifficulty getting a personal loan or mortgage.

Are any other firms in trouble?

Well, for starters there is Merrill Lynch. US authorities and many bankers feared thatafter Lehman's demise the attention of investors and speculators would have moved toMerrill.The biggest worry, though, is insurance giant AIG. The company is running outof cash to cover its losses and has asked the government for an emergency bridging loan,reportedly to the tune of $40bn. If AIG is in trouble, it would directly affect millions ofconsumers and companies around the world. It would also hurt the whole financialsystem, because AIG is in the centre of a web of complex financial deals. And comparedwith AIG, the crisis surrounding Lehman is small beer.

Why did Lehman fail?

1. leverage.

The best way to enhance your returns is to gear up borrowings to invest in assets whichare rising and have the potential future .this enables you to increase ur returns which is


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useful when interest rates are low and on same hand it also magnifies the losses whenasset prices r falling. Lehman were very high ac far as leverage is concerned .In 2004Lehman leverage was running around 20 that means for every 1 of cash and othercapital it would lend 20.Later it rose to thirties and reached in the incredible 44in 2007.thus Lehman was leveraged 44 to 1 when assets prices began heading down .it was like

person of salary of rs 10000 buying a house of rs 440000

2. liquidity

Most of the business fall not because of lack of profits but bcoz of cash flow problems.like all other banks Lehman was like an upturned pyramid balanced on a small silver ofcash .Lehman didnot have enough in way of liquidity in other words it lacked ready cashand other easily sold assets as market fell other banks started 2 worry about the shakyfinancial conditions of Lehman. and stated to protect their own interested by pullingLehmans credit as a result it was losing liquidity fast an if a bank loses confidence itloses everything

3. losses

After the terrorist attacks of 11 September 2001, US interest rates plummeted, causing afive-year boom in domestic and commercial property prices. This boom ended in 2006and US housing prices have since fallen for three years in a row.

Lehman was heavily exposed to the US real-estate market, having been the largestunderwriter of property loans in 2007. By the end of that year, Lehman had over $60

billion invested in commercial real estate (CRE) and was very big in subprime mortgages(loans to risky homebuyers). Also, it had huge exposure to innovative yet arcaneinvestments such as collateralised debt obligations (CDO) and credit default swaps(CDS).

As property prices crashed and repossessions and arrears sky-rocketed, Lehman wascaught in a perfect storm. In its third-quarter results, Lehman announced a $2.5 billionwrite-down due to its exposure to commercial real estate. Lehman's total announcedlosses in 2008 came to $6.5 billion, but there was far more 'toxic waste' waiting to beunearthed.

Lessons learnt

Lesson one: Shadow banks are time bombs. There are two type of bank 1 regulatory 2shadow. regulatory banks are those banks who are subject to Federal Reserve scrutiny(maybe not enough, but certainly some), and the shadow bank system made up mainly ofLehman, Merrill Lynch, Morgan Stanley, and Goldman Sachs. While the regulated banks


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were forced to make reports to the government and were subjected to bank examinations,shadow banks were pretty much required to tell us only what they wanted us to know,and nothing more. In the past year, the shadow banking system went from being biggerand more important than the regulated banks to being nonexistent. We now know prettymuch everything we need to know about how the big banks operate. There are no more

surprises to be had, at least no giant ones. There are no more Lehmans lurking that canalmost destroy the system again.

Lesson two: Banks shouldnt loan more money than they can afford to.

Lehmans demise spelled the end to reckless highly leveraged lending. The FederalReserve and Treasury have since made it clear that banks must raise their capital levelsand cut back on lending losses. To meet the Feds demands, banks have to take in morecash and lend a lot less, making sure the money they do lend is given only to people withvery good household balance sheets and companies with long records of being able topay back their debts. In a years time, we have gone from a world where you could

borrow $30 million to buy toxic mortgage bonds with just a million dollars in yourpocket to a world where a million bucks in the bank might allow you to get a $500,000mortgage to buy a house ifyou can prove you can keep your job. The standards havegotten that tight. And if you do make too many bad loans, the Feds will seize your bankand put you out of business. Yes, tight credit may slow the pace of the recovery in theshort run, but its a dose of stringency the system sorely needed.

Lesson three: Moral hazard is not a policy, its a suicide pact. On the eve of Lehmanscollapse, in a series of weekend meetings, Fulds lieutenants told thenNew York FederalReserve head Tim Geithner and thenTreasury Secretary Henry Paulson that if thegovernment let Lehman collapse, a trillion dollars in credit could vanish overnight,

financial institutions worldwide would experience liquidity shortages, and even ATMmachines might not work because companies and people would panic and pull theirmoney out of financial institutions. Paulson and Geithner wouldnt listen. They wanted tobe tough guys and show that they werent going to kowtow to Wall Street anymore. Theywere worried about the moral hazard of having to bail out still one more errant universemaster. They should have been worried about the nuclear hazards ofnotdoing so,because, on this point anyway, the Lehman folks were right. When Lehman went under,banks worldwide experienced colossal withdrawals as everyone from corporate treasurersto individuals transferred money out of their cash accounts into treasuries. Worries ofmoral hazard proved penny-wise and ton-foolish as almost every major bankinginstitution, not just in America but worldwide, needed capital to make up for the post-Lehman withdrawals. Of course they should have bailed out Lehman that weekend

Lesson four: The shorts are too powerful. Lehman didnt collapse because of the shorts;it collapsed because it made billions in overly risky loans. But the shorts did play asignificant role in the downfall of the firm because they never let the stock lift or stabilizelong enough to give the beleaguered outfit the time it needed to find a buyer or deep-


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pocketed investors. If the SEC brings back the uptick rule and rigorously enforcesanother measure known as the naked short regulationand I expect it will do both soonthe investing playing field will have been leveled between the shorts and the longs andthe markets will be far safer and honest for all, especially retail investors, than they havebeen in years.

Lesson five Avoid excessive risksSmart people can make dumb decisions, especially when theyre arrogant enough tobelieve the laws of investing dont apply to them. One such law is that leverage, the actof borrowing other peoples money to invest, can work both waysfor you and againstyou. Lehman financed $600 billion worth of assets with only $30 billion of equity. Thatslike you putting five percent down to buy a home. It only takes a minor drop in prices towipe out all your equityand you still have your mortgage payment. Clearly, this is anexample of taking excessive risk

Lesson six Banking Regulationthe debate on banking regulation should focus on what

needs to be regulated and not who the regulators should be. Changing ceos cant be theanswer to this problem

Summary...

Lehman once employed 28,000 people across the world, including 5,000 in London. Attheir peak, its shares traded at $85, but they are now roughly 10. Lehman's remains wereshared out between Barclays, which bought its US broking arm, and Japanese giantNomura, which bought its European and Asian assets. These firms, plus number-oneinvestment bank Goldman Sachs, have profited most from picking over the bones ofLehman's businesses.

In short, Lehman Brothers -- a company with a 158-year history, including 14 years as anNYSE-listed giant -- failed simply because it took on too much risk in a booming market.In the end, its move from the safety of corporate finance and M&A (mergers andacquisitions) income into the risky world of proprietary trading proved to be its downfall.The lesson here is that any firm, no matter how big and powerful, can be dashed to pieceson the rocks of leverage , liquidity and losses !

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How Big is Lehman Brothers