On This Day, Thirteen years Ago

On This Day, Thirteen years Ago. The story of Lehman Brothers

source: Dw.com

September 15, 2008, exactly thirteen years ago today, the US investment bank Lehman Brothers collapsed. Hundreds of employees left the building with their belongings stuffed in a box one by one.

At the time of bankruptcy, Lehman Brothers had $639 billion in assets and $613 billion in liabilities with more than 25,000 employees worldwide. It was the fourth-largest investment bank in the US. Its bankruptcy fuelled the ongoing fire of the financial/sub-prime mortgage crisis. The crisis turned into a raging inferno that wiped out more than $10 trillion in worldwide economic output.

Credit: Company Man

Lehman Brothers had a humble beginning. It started as a general store founded by German brothers Emanuel, Henry and Mayer Lehman in Alabama in 1844. Farmer back then used to pay for their goods with cotton, which led them into cotton trading. Soon they expanded their business services to commodity exchange and brokerage services.

The firm expanded as the US economy grew and became the powerhouse we know today. The company had its fair share of obstacles in its path navigating through the railroad bankruptcies in 1893, The Great Depression from 1929-39, World War I and II, Capital shortage in 1994, The Long Term Capital Management collapse and the 1998 Russian debt default.

Over time, it grew accustomed to excessive risk-taking. But the housing bubble turned out to be the black swan that brought it down to its knees.

On February 07, its stock price reached $86.18, giving it a market cap of almost $60 billion. On 14th March, the stock had its biggest drop in years as fear of the subprime mortgage loomed over the bank. Investors were worried that the cracks in the housing arm of the firm could potentially affect its profitability as subprime mortgage defaults were at a seven-year high. The firm reported record earnings and revenue for the first quarter and reassured investors that the risk and exposure are well contained, and it would have a little impact on the firm’s profitability.

The End Game

In August 2007, its stock fell sharply. During the same month, the company eliminated 1,200 Mortgage-related jobs and shut down its BNC unit. Even as the correction in the housing market picked up momentum, Lehman Brothers kept underwriting the mortgages. In 2007, Lehman underwrote more mortgage-backed securities than any other bank.

In the fourth quarter, the market stopped nose-diving temporarily. This was the last opportunity for the firm to trim its portfolio and reduce its exposure. The firm’s leverage was 31:1 for the year 2007. This means that the firms had $31 of debt for every dollar of their investor’s money. Its large portfolio in mortgage-backed securities made the firm susceptible to the current market conditions. Soon, the Investor rushed out of stock, and the stock fell 48% overnight, fearing the firm’s near-collapse.

In the first quarter of 2008, two bear stern hedge funds had gone up in flames and sold to JP Morgan for $2 a share. And Lehman Brothers reported a $2.8 billion loss for the first quarter alone.

In Q2, the firm went to investors to raise $6 billion and reduced its real estate portfolio to 20%. Soon enough, Lehman Brothers, just like bear stern, were looking for someone to buy it out. Loses had gone from 2.8 to $4 billion.

At this time, the firm was down to its last $1 billion. US treasury secretary said that there would be no bail-out for the distressed bank.

On September 13, an emergency weekend meeting was organised. The US treasury secretary and New York Federal Reserve Boss hauled many banks to broker a last-minute takeover.

The bosses from the likes of Goldman Sachs, JP Morgan Chase, Morgan Stanley and CitiGroup. All who had problems of their own didn’t want any of it. Everyone left the meeting knowing the Lehman Brothers was over, and their lives ahead would be measurably harder.

On September 15, Wall Street opened on Monday with the news that the Lehman Brothers had filed for bankruptcy. The market immediately sheds more than 4%, the biggest single-day drop since 9/11.

The demise started a chain reaction that turned into a full-blown bank crisis that affected the US, Europe and large parts of Asia.

According to theguardian.com, the risk for another financial crash hasn’t been diminished; it’s just taken out of sight.

Did We Learn Anything From The Collapse

There are a few things investors learnt after losing their hard-earned life savings and working through their retirement. It took almost six years for the US economy to heal from catastrophe. There are few lessons we can drive from the collapse of Lehman Brothers and the GFC.

There are a few things investors learnt after losing their hard-earned life savings and working through their retirement. It took almost six years for the US economy to heal from catastrophe. There are few lessons we can drive from the collapse of Lehman Brothers and the GFC.

  1. Never put all your eggs in one basket. - There is this famous saying that you must never put all your eggs in one basket. Never invest all your money with one company, one sector, or one country for that matter.
  2. Don’t panic — If you have followed rule one (don’t put all your eggs in one basket) and diversify your portfolio across different domains of investments. There is no need to panic if the market is plummeting right now. When there is pessimism in the stock market, investors sell their portfolios and buy gold as it’s more stable even though there isn’t much room for growth. If you already have gold as part of your portfolio and the stocks are doing good, other classes of investment will help you balance out the risk and exposure.
  3. Invest in high-quality investments — Many of the smartest investors practice value investing. Their priority is avoiding losses not making more money than the rest of the market. Warren Buffett has often said that he only follows two rules: 1) Never lose money and rule no. 2) Never forget rule 1.
  4. Risk Ignorance — Many early baby boomers that were about to retire at the rise of the second decade of the century had invested their life savings on investments that looked safe but, in reality, where are the result of creative finance. Why wouldn’t you invest with a bank that the government backs? The banks that have been in the business since mid 19th century have navigated successfully through the rough times of World War I and II. Little did they know!

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Categories: All Stories, Historic Events

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