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Bankruptcy is a situation when a business entity is not able to repay its debts and falls into a financial crisis. The Lehman Brothers Bankruptcy 2008 was the biggest bankruptcy in the corporate history of the United States of America was that of the Lehman Brothers Holdings Inc. (the ‘Lehman Brothers’), a one of a kind, where the giant collapsed overnight. It was one of the biggest companies in America and was put under the ‘too big to fail’ category. The impact of its fall was felt by the market and the economy, not only immediately, but for many years to come. A company of this stature fell overnight because of various reasons; one of which was the crisis in the real estate business of 2007 – 08. A company which survived the two world wars and the great depression was jeopardised because of a minimal crisis in one sector? Seemed unlikely!
The incompetent decision of venturing into subprime lending was the key factor that led to its downfall. Back in the mid 2000s, the housing market was in boom and Lehman Brothers invested heavily by issuing mortgage securities and collateral debt obligations. This turned out to be one of the best decisions for the company as it flourished day and night for the next couple of years. In 2007, the company’s annual revenue was a record $19.3 billion and its net income soared to $4.3 billion. However things changed soon thereafter, and for the worse. The housing market crashed and all the subprime mortgages started defaulting in payment. This led to the failure of the company leading to bankruptcy when the company recorded an annual loss of $3.9 billion in the third quarter of 2008.With this, the liquidation and the impending disintegration of the company became irresistible. Lehman Brothers was acquired by various companies in bits and pieces. This is how it disintegrated and fell into ruins.
Lehman Brothers Holdings Inc. – The Saga
Lehman Brothers was a global financing firm in the USA. It was involved in investment banking, equity, fixed income sales and trading, research and investment management. It was established in the year 1850 and was functional for 158 years before it became dysfunctional in 2008. In September 2008, the firm filed for Bankruptcy Protection under Chapter 11 of Bankruptcy Code of USA (the ‘Code’). The company faced major losses after the majority of its clients departed, leading to a drastic fall in the rate of shares of the company. Lehman Brothers was found to be involved in successive mortgages and had a fall in its assets. The liquidity filing of Lehman Brothers was historical in nature because it was the largest bankruptcy filing ever in America and is even considered to be one of the key factors behind the financial crisis of 2007-08 the world over.
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The Company was officially found in the year 1850, but the business started initially in the year 1844 when Henry Lehman opened a goods store in Alabama, United States. Soon, in the year 1847, he was joined by his younger brother Emanuel Lehman followed by the youngest brother Mayer Lehman in 1850. That is when the name of the business was changed to Lehman Brothers and the company was established. At that time, cotton was grown all around America heavily; poor people relied on paying it instead of money in their transactions. This gave them an idea to expand their business. From the cotton that they collected, they started their second business – the trade of cotton. This grew so rapidly that it eventually became their prime business. The eldest Lehman brother died in the year 1855 but the rest of them continued their operations and expanded their business in the field of commodities-trading and brokerage. In 1862, the company teamed up with a merchant named John Durr. The newly formed company was named Lehman, Durr & Co. They together re-established Alabama after the civil war. Then the company expanded its business in the fields of railroad bonds and financial advisory. In the year 1899, the company offered its shares in the public stocks for the first time. It was seen as the real venturing of this company into the corporate spiral when it partnered with Goldman, Sachs & Co and went into multiple underwritings. After the retirement of Philip Lehman in 1925, his son Robert Bobbie Lehman took over the company and decided to focus into venture capital and equity markets as the country was still recovering from the Great Depression and there was an urgent need to flow capital in the market. In the 150 years of its existence, the company went through various ups and downs, mergers and takeovers and venturing into new fields of business. The company faced a major setback after the 9/11 attacks on the World Trade Center where it had its main office. The office had fallen under the debris and was rendered unusable. The company was questioned by the Securities and Exchange Commission for improperly associating itself with the firms’ investment-banking revenues. A settlement deed of $1.4 billion was levied on the company worldwide, and its research and investment department were ordered to be completely separated. The company then kept functioning but was undergoing multiple mortgages which eventually led to its collapse.
Lehman Brothers Bankruptcy 2008
When a business goes through extreme losses and fails to pay its creditors, the company is stuck and can neither move forward nor pay back. Bankruptcy provides a solution to such debtors; they free themselves by fairly paying back the creditors in lieu of which the law protects them. Bankruptcy comes in two forms- Liquidation and Reorganisation. The Federal Bankruptcy Court under the Federal Bankruptcy Laws of the United States protects the business entity in case of bankruptcy. There are two main divisions of this law which were relevant in the present context, Chapter 7 and Chapter 13 of the Code. Chapter 7 governs the process of liquidation, which allows repayment of the debt by selling the assets the assets of the company to repay the debt whereas Chapter 13 of the Code provides for a reorganisation process for private high earning individuals. Under this process, you are allowed to retain your assets but are bound to pay the creditors in a time-bound manner, the value of non-exempt assets. The law for bankruptcy provides for investors to secure their payments.
Chapter 11 of the Code states that any person who applies for bankruptcy can apply for legal protection. Under this, the debtor stays in possession and control of his business operations as ‘debtor in possession’, but is bound to report to a competent court at all times. This also gives the debtor opportunities for the reconstruction of the business and is permitted to take loans on special concessions. Further, if protection is granted by the court, it acts as a stay against any litigation against the company, for any liability, with respect to bankruptcy. All creditors are heard by the court before granting this remedy to the debtor as a matter of right. The rationale is that sometimes the goodwill of the company is so huge that even in a case of financial crisis, the value of the business entity remains much more than its assets. The Continuance or revival of such a business is far better for the economy and in the best interest of the creditors. This helps a company for applying for protection under the Bankruptcy laws.
The Beginning of the End
Lehman Brothers was one of the first companies to transact business in mortgages. Lehman Brothers purchased various small companies which allowed it to become the biggest company. By 2008, Lehman Brothers had assets worth $680 billion, supported by $22.5 billion of total capital. Lehman Brothers even ventured into real estate under the guise of investment banking. Its equity position became very risky. Lehman Brothers had borrowed significant amounts from various investors. The company mortgaged its housing assets which made the markets more vulnerable. The company was falling in goodwill and its mortgage was rising. The final blow to the company came with the unprecedented loss because of its subprime mortgage crisis.
The US Subprime Mortgage Crisis is the term given to the national financial crisis occurring throughout the USA due to a massive decline in the home prices which led to mortgage delinquency and devaluation of housing securities. It remains to be one of the largest filings of bankruptcy in the history of the USA while having more than $600 billion in its assets.
The Final Blow
When the financial crisis came to the notice of the Federal Reserve Bank of New York, it called for a meeting of all stakeholders of Lehman Brothers for discussing the course of action, for a possibility of an emergency liquidation of the assets of the company. The top officials at Lehman Brothers declined to sell off the assets and informed that there was a proposal to sell off the whole company to Bank of America and Barclays. However, the proposal was rejected by both the parties. Barclays backed out as the British Exchequer felt this transaction was too sudden and could affect stockholding regulations of UK. Left with no option, Lehman brothers filed for Bankruptcy protection under Chapter 11 and cited bank debts of $613 billion, a bond debt of $155 billion and their total assets worth $639 billion. It also announced that bankruptcy proceedings will apply not only to their subsidiary which shall function normally. The Wall Street provided financial assistance in liquidation and the Federal Reserve agreed to swap lower-quality assets in lieu of the loans taken by Lehman Brothers from the Government. Brian Marsal was appointed as the Co-Chief Executive of the new firm resulting from the restructuring who subsequently became the CEO of the company.
It went through major debacles as the same day the Australian Securities Exchange suspended the subsidiaries of Lehman Brothers from the stock exchange of Australia. The value of its shares fell by 90 per cent which was the largest drop in a single day since the 9/11 attacks. Lehman Brothers had to go through similar proceedings in the UK and Japan. The company was delisted from the New York Stock Exchange on 17 September 2008 which is seen as the official extinguishment of the company.
Falling of a corporate giant of this standing overnight was nothing less than a shock to the corporate culture worldwide. A detailed analysis of some of the causes for the decline, which impacted the major economies of the world are as follows is:
- Manipulation of accounts– An inquiry appointed by the court found out that the top officials of the company were involved in manipulation of accounts at the end of every quarter to increase the profit margin. This was done to hide the recurrent losses that the company was facing. For this, the company entered into agreements to sell its properties with a condition of resale. This allowed them to remove certain non-performing assets from its balance sheet. The sale never acted like a sale but was rather just a manipulation to mislead the investors and regulators into presenting a picture different than it was and to hide the deteriorating financial health of the company in 2007- 08.
- Subprime Mortgage Crisis– Lehman Brothers faced an unprecedented financial crisis because of its impeding mortgages. The time of 2007-08 was difficult for real estate, the rates of house properties kept on falling and the investors had to undergo grave losses. Lehman Brothers relied highly on investments in real estate. Therefore, this loss was the main cause that led to the liquidity crisis of the company. In August 2007, the losses had become so high that the company had to shut down its major mortgage firm BNC Mortgage leading to elimination of 1200 employees and shutting down of 23 offices.
- Short-selling- As the charges of bankruptcy erupted, Lehman Brothers resealed statements of confidence and naked short selling attacks were made followed by false rumours. This refers to a process of selling any asset, without borrowing the security. It is an illegal practice as it attempts to sell the assets which are yet not been determined and are contingent in existence.
- Too big to fail? – One of the causes of this collapse can be stated as the federal governments ‘too big to fail’ policy too. The laws were more stringently applied to these companies. Lehman Brothers was not given the option of the bailout. Even the Federal Reserve Bank of New York provided no support to the company in its last days.
The fallout of a company of this stature cannot be an easy-going thing at all and was disastrous. At the collapse of this company, approximately 6 million people were rendered jobless, which raised the overall unemployment by 10 percent (report of Dow Jones Industrial Average). The international ripple effect of the collapse was very crude as it severely hit the economies of Latvia, Hungary, Lithuania and the whole of the European Union. Iceland’s banking sector also faced a major liquidity crisis and even Pakistan had to borrow sums from the International Monetary Fund to protect itself from the crisis.
Needless to mention, the most adverse impact was seen in the United States. The then President, George Bush, had to rescue the remaining of the Financial Sector with a bail-out plan of $700 billion. The Dodd-Frank Act was also passed by the Congress to assist in increasing financial regulations. This Act aimed to promote financial stability, improve accountability and provide for greater transparency in the financial system. It ended the ‘too big to fail’ system and bail-out and laid down provisions for the protection of consumer from unfair financial practices.
What happened to Lehman Brothers was a classic example of economic failure which had a far-reaching impact people as they lost faith in public investments. All countries rely heavily on public offerings for the economic growth of the country, which slowed down multifariously after the 2008 crisis. The trust that once accompanied financial institutions was no longer implicit.
Leman Brothers sold a majority of its investment business to certain firms, mainly Bain Capital Partners and Hellman & Friedman, for a consideration of $2.15 billion on September 29, 2008. The transaction was approved by the bankruptcy court in the month of December the same year and it became functional on December 3, 2008. The creditors of Lehman Brothers retained 49 per cent common equity interest in the new formed company known as Neuberger Berman Group LLC. The quantitative asset management business for Europe was acquired by the employees of Lehman Brothers and has been renamed as TOBAM. Norma Holdings, a Japanese brokerage company, bought the Asian division of Lehman Brothers for a consideration of $225 million. Another major acquisition was announced by Barclays PLC to take over most of Lehman Brothers’ operations in North America for a minimal consideration of $1.75 billion. Another deal was concluded by Barclays to acquire the core business and office buildings of Lehman Brothers for $1.35 billion. The motion went for approval from the Bankruptcy Court at Manhattan. The transaction was approved and the takeover was affected. Judge James Peck, who was presiding over the matter made an interesting observation: “I have to approve this transaction because this 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 have ever sat through. It can never be deemed precedent for future cases. It’s hard for me to imagine a similar emergency.” This statement in itself is a testament to the shock waves created by the sudden demise of this corporate giant.
Three have been many times when the economy of the United States has been put under shock due to huge corporate failures. However, this one was one of the most historic events of the corporate world of the United States. The company which was flourishing day and night for decades together would suddenly meet with this fate – this was not easy for everyone accept. A corporate failure of this scale, in a country like America, which is known for its very stringent laws, was a shock worldwide. It was evident that the company failed to oversee and disastrously collapsed. Its collapse was not only an individual break down but an institutional failure which had far-more reaching impact than one could ever expect. Various factors like the uncertainty of the market, corrupt officers and non-futuristic plans for investments by companies also contributed in its downfall. In history, this case will also be remembered as a classic example of how the fate of a company’s collapse not only affects itself and its employees but also the Wall Street to its core. It takes the economy way back and all its progress comes to a standstill. Even though there was very little role to be played by the Government in this entire scenario, it shook the entire economy. It is imperative for the Government to take the responsibility so that we can to prevent such incident(s) in future by formulating precautionary rules as and when necessary. There is a need for bringing up new laws which can successfully tackle such situations which were never seen before by the corporate scenario throughout the globe.
Lehman Brothers Bankruptcy 2008