On September 15, 2008, Lehman Brothers filed for bankruptcy. At the time, it was the 4th largest investment bank in the U.S. behind Goldman Sachs, Morgan Stanley, and Merrill Lynch. In addition, it had 25,000 employees, $639B assets, and $613B debts.
As one of the most significant events in financial history, the fall of Lehman Brothers marked the climax of the subprime mortgage crisis and remains the largest bankruptcy filing in U.S. history.¹
Introduction
In 1850, Lehman Brothers was founded by three brothers in Montgomery, Alabama as a general dry-goods store. At some point, the company shifted towards cotton trading and moved their operations to New York.
In 1906, Lehman transitioned towards investment banking and partnered with Goldman Sachs on an IPO. Until 1926, it was involved with underwriting new equity issues, including Studebaker and Macy’s. In 1994, it had its own IPO.
By 2000, Lehman was heavily invested in risky mortgage-backed securities (MBS) due to the housing boom. These financial assets are similar to bonds, where a bundle of loans are sold to investors. By 2007, the firm was the largest holder of MBS and had acquired several lenders as well.
The firm was quoted to be “a real estate hedge fund disguised as an investment bank,” since most of its investments were in housing-related assets.¹
Downfall
As the housing market began to decline, the value of MBS (and all CDO) securities had dropped at an alarming rate. On September 10, Lehman reported a loss of $3.9B for Q3. Between September 12–14, Lehman sought a buyer, but could not secure a deal. Its business model was a combination of highly leveraged short-term debt.
Ultimately, Lehman Brothers was overwhelmed with mortgage-backed securities (MBS) that were mostly backed with subprime loans, many of which went into default.² Its state of illiquidity, lack of sufficient collateral, and risky assets forced it to surrender.
Aftermath
Barclays picked up Lehman’s headquarters building in NY and purchased its U.S. operations in investment banking and trading, while Nomura Holdings acquired the Asian and European operations. The Dow Jones Industrial Average lost 500 points, which was the lowest since the 9/11 terrorist attacks.
Not surprisingly, the event significantly contributed to regulatory reforms intended to prevent a similar crisis from happening again.
- Dodd-Frank Act: Imposed stricter regulations regarding excessive risk-taking
- Consumer Protection Act: Safeguards consumers against defective products and deceptive business practices
- Troubled Asset Relief Program (TARP): Provided bailout funds to stabilize the financial system
- Financial Stability Oversight Council (FSOC): Monitors the stability of the financial system and identifies risks that could threaten its stability