Lehman Brothers Case Study Question

Trading name

Lehman Brothers

Former type

Public
IndustryInvestment services
FateChapter 11bankruptcyliquidation
PredecessorH. Lehman and Bro.
Successors
Founded1850; 168 years ago (1850)
Montgomery, Alabama, U.S.[1]
FoundersHenry, Emanuel, and Mayer Lehman
Defunct2008; 10 years ago (2008)
HeadquartersNew York City, New York, United States

Area served

Worldwide

Key people

Products

Number of employees

26,200 (2008)
SubsidiariesLehman Brothers Inc., Neuberger Berman Inc., Aurora Loan Services, LLC, SIB Mortgage Corporation, Lehman Brothers Bank, FSB, Eagle Energy Partners, and the Crossroads Group
WebsiteBarclays Group Archives: Lehman Brothers

Lehman Brothers Holdings Inc. (former NYSE ticker symbol LEH) was a global financial services firm. Before declaring bankruptcy in 2008, Lehman was the fourth-largest investment bank in the United States (behind Goldman Sachs, Morgan Stanley, and Merrill Lynch), doing business in investment banking, equity and fixed-income sales and trading (especially U.S. Treasury securities), research, investment management, private equity, and private banking. Lehman was operational for 158 years from its founding in 1850 until 2008.[2]

On September 15, 2008, the firm filed for Chapter 11bankruptcy protection following the massive exodus of most of its clients, drastic losses in its stock, and devaluation of assets by credit rating agencies, largely sparked by Lehman's involvement in the subprime mortgage crisis, and its exposure to less liquid assets.[3][4][5]Lehman's bankruptcy filing is the largest in US history,[6] and is thought to have played a major role in the unfolding of the late-2000s global financial crisis. The market collapse also gave support to the "Too Big To Fail" doctrine.[7]

After filing for bankruptcy, global markets immediately plummeted. The following day, Barclays announced its agreement to purchase, subject to regulatory approval, Lehman's North American investment-banking and trading divisions along with its New York headquarters building.[8][9] On September 20, 2008, a revised version of that agreement was approved by U.S. Bankruptcy Judge James M. Peck.[10] The next week, Nomura Holdings announced that it would acquire Lehman Brothers' franchise in the Asia-Pacific region, including Japan, Hong Kong and Australia,[11] as well as Lehman Brothers' investment banking and equities businesses in Europe and the Middle East. The deal became effective on October 13, 2008.[12]

History[edit]

Under the Lehman family (1850–1969)[edit]

See also: Lehman family

In 1844, 23-year-old Henry Lehman,[13] the son of a Jewish cattle merchant, immigrated to the United States from Rimpar, Bavaria.[14] He settled in Montgomery, Alabama,[13] where he opened a dry-goods store, "H. Lehman".[15] In 1847, following the arrival of his brother Emanuel Lehman, the firm became "H. Lehman and Bro."[16] With the arrival of their youngest brother, Mayer Lehman, in 1850, the firm changed its name again and "Lehman Brothers" was founded.[15][17]

During the 1850s, cotton was one of the most important crops in the United States. Capitalizing on cotton's high market value, the three brothers began to routinely accept raw cotton from customers as payment for merchandise, eventually beginning a second business trading in cotton. Within a few years this business grew to become the most significant part of their operation. Following Henry's death from yellow fever in 1855,[15][18] the remaining brothers continued to focus on their commodities-trading/brokerage operations.

The Lehmans were also involved in the Atlantic slave trade in the 1850s.[19]

By 1858, the center of cotton trading had shifted from the South to New York City, where factors and commission houses were based. Lehman opened its first branch office at 119 Liberty Street,[18] and 32-year-old Emanuel relocated there to run the office.[15] In 1862, facing difficulties as a result of the Civil War, the firm teamed up with a cotton merchant named John Durr to form Lehman, Durr & Co.[20][21] Following the war the company helped finance Alabama's reconstruction. The firm's headquarters were eventually moved to New York City, where it helped found the New York Cotton Exchange in 1870;[18][22] Emanuel sat on the board of governors until 1884. The firm also dealt in the emerging market for railroad bonds and entered the financial-advisory business.

Lehman became a member of the Coffee Exchange as early as 1883 and finally the New York Stock Exchange in 1887.[18][22] In 1899, it underwrote its first public offering, the preferred and common stock of the International Steam Pump Company.[23]

Despite the offering of International Steam, the firm's real shift from being a commodities house to a house of issue did not begin until 1906. In that year, under Emanuel's son Philip Lehman, the firm partnered with Goldman, Sachs & Co.,[24][25] to bring the General Cigar Co. to market,[26] followed closely by Sears, Roebuck and Company.[26] During the following two decades, almost one hundred new issues were underwritten by Lehman, many times in conjunction with Goldman, Sachs. Among these were F.W. Woolworth Company,[26][27]May Department Stores Company, Gimbel Brothers, Inc.,[28]R.H. Macy & Company,[28]The Studebaker Corporation,[27] the B.F. Goodrich Co. and Endicott Johnson Corporation.

Following Philip Lehman's retirement in 1925, his son Robert "Bobbie" Lehman took over as head of the firm. During Bobbie's tenure, the company weathered the capital crisis of the Great Depression by focusing on venture capital while the equities market recovered.

Traditionally a family-only partnership, in 1924, John M. Hancock became the first non-family member to join the firm,[24][29] followed by Monroe C. Gutman and Paul Mazur in 1927. By 1928, the firm moved to its now famous One William Street location.

In the 1930s, Lehman underwrote the initial public offering of the first television manufacturer, DuMont, and helped fund the Radio Corporation of America (RCA).[30] It also helped finance the rapidly growing oil industry, including the companies Halliburton and Kerr-McGee. In the 1950s, Lehman underwrote the IPO of Digital Equipment Corporation. Later, it arranged the acquisition of Digital by Compaq.

An evolving partnership (1969–1984)[edit]

Robert Lehman died in 1969 after 44 years as the patriarch of the firm, leaving no member of the Lehman family actively involved with the partnership.[31] Robert's death, coupled with a lack of a clear successor from within the Lehman family, left a void in the company. At the same time, Lehman was facing strong headwinds amidst the difficult economic environment of the early 1970s. By 1972, the firm was facing hard times and in 1973, Pete Peterson, chairman and chief executive officer of the Bell & Howell Corporation, was brought in to save the firm.[31]

Under Peterson's leadership as chairman and CEO, the firm acquired Abraham & Co. in 1975, and two years later merged with the venerable, but struggling, Kuhn, Loeb & Co.,[31] to form Lehman Brothers, Kuhn, Loeb Inc., the country's fourth-largest investment bank, behind Salomon Brothers, Goldman Sachs and First Boston.[32] Peterson led the firm from significant operating losses to five consecutive years of record profits with a return on equity among the highest in the investment-banking industry.

By the early 1980s, hostilities between the firm's investment bankers and traders (who were driving most of the firm's profits) prompted Peterson to promote Lewis Glucksman, the firm's President, COO and former trader, to be his co-CEO in May 1983. Glucksman introduced a number of changes that had the effect of increasing tensions, which when coupled with Glucksman’s management style and a downturn in the markets, resulted in a power struggle that ousted Peterson and left Glucksman as the sole CEO.[33]

Upset bankers who had soured over the power struggle left the company. Stephen A. Schwarzman, chairman of the firm's M&A committee, recalled in a February 2003 interview with Private Equity International that "Lehman Brothers had an extremely competitive internal environment, which ultimately became dysfunctional." The company suffered under the disintegration, and Glucksman was pressured into selling the firm.

Merger with American Express (1984–1994)[edit]

Main article: Shearson Lehman Hutton

Shearson/American Express, an American Express-owned securities company focused on brokerage rather than investment banking, acquired Lehman in 1984, for $360 million. On May 11, the combined firms became Shearson Lehman/American Express.[33] In 1988, Shearson Lehman/American Express and E.F. Hutton & Co. merged as Shearson Lehman Hutton Inc.[34]

From 1983 to 1990, Peter A. Cohen was CEO and chairman of Shearson Lehman Brothers,[35] where he led the one billion dollar purchase of E.F. Hutton to form Shearson Lehman Hutton.[36] During this period, Shearson Lehman was aggressive in building its leveraged finance business in the model of rival Drexel Burnham Lambert. In 1989, Shearson backed F. Ross Johnson's management team in its attempted management buyout of RJR Nabisco but were ultimately outbid by private equity firm Kohlberg Kravis Roberts, who was backed by Drexel.

Divestment and independence (1994–2008)[edit]

In 1993, under newly appointed CEO, Harvey Golub, American Express began to divest itself of its banking and brokerage operations. It sold its retail brokerage and asset management operations to Primerica[37] and in 1994 it spun off Lehman Brothers Kuhn Loeb in an initial public offering, as Lehman Brothers Holdings, Inc.[38]

Despite rumors that it would be acquired again, Lehman performed quite well under chairman and CEO Richard S. Fuld, Jr.. By 2008, Fuld had been with the company for 30 years, and would be the longest-tenured CEO on Wall Street. Fuld had steered Lehman through the 1997 Asian Financial Crisis, a period where the firm's share price dropped to $22 USD in 1998, but he was said to have underestimated the downturn in the US housing market and its effect on Lehman's mortgage bond underwriting business. Fuld kept his job as the subprime mortgage crisis took hold, while CEOs of rivals like Bear Stearns, Merrill Lynch, and Citigroup were forced to resign.[39] In addition, Lehman's board of directors, which included retired CEOs like Vodafone's Christopher Gent and IBM's John Akers were reluctant to challenge Fuld as the firm's share price spiraled lower.[39]

Fuld had a succession of "number twos" under him, usually titled as president and chief operating officer. Chris Pettit was Fuld's second-in-command for two decades until November 26, 1996, when he resigned as president and board member. Pettit lost a power struggle with his deputies (Steve Lessing, Tom Tucker, and Joseph M. Gregory) back on March 15 that year that caused him to relinquish its COO title, likely brought about after the three men found out about Pettit's extramarital affairs, which violated Fuld's unwritten rules on marriage and social etiquette. Bradley Jack and Joseph M. Gregory were appointed co-COOs in 2002, but Jack was demoted to the office of the chairman in May 2004 and departed in June 2005 with a severance package of $80 million, making Gregory the sole COO. While Fuld was considered the "face" of Lehman brothers, Gregory was in charge of day-to-day operations and he influenced culture to drive the bottom line.[40] Gregory was demoted on June 12, 2008 and replaced as president and COO by Bart McDade, who had been serving as head of Equities, and McDade would see Lehman through bankruptcy.[41][42] McDade would later be one of a handful of Lehman executives offered a position with Barclays after their acquisition; he would step down after less than two months.[43]

In 2001, the firm acquired the private-client services, or "PCS", business of Cowen & Co.[44] and later, in 2003, aggressively re-entered the asset-management business, which it had exited in 1989.[45] Beginning with $2 billion in assets under management, the firm acquired the Crossroads Group, the fixed-income division of Lincoln Capital Management[45] and Neuberger Berman.[46] These businesses, together with the PCS business and Lehman's private-equity business, comprised the Investment Management Division, which generated approximately $3.1 billion in net revenue and almost $800 million in pretax income in 2007. Prior to going bankrupt, the firm had in excess of $275 billion in assets under management. Altogether, since going public in 1994, the firm had increased net revenues over 600% from $2.73 billion to $19.2 billion and had increased employee headcount over 230% from 8,500 to almost 28,600.

At the 2008 ALB China Law Awards,[47] Lehman Brothers was crowned:

  • Deal of the Year – Debt Market Deal of the Year
  • Deal of the Year – Equity Market Deal of the Year

Response to September 11, 2001 attacks[edit]

On September 11, 2001, Lehman occupied three floors of World Trade Center where one of its employees was killed in the terrorist attacks of that day. Its global headquarters in Three World Financial Center were severely damaged and rendered unusable by falling debris, displacing over 6,500 employees. The bank recovered quickly and rebuilt its presence. Trading operations moved across the Hudson River to its Jersey City, New Jersey, facilities, where an impromptu trading floor was built in a hotel and brought online less than forty-eight hours after the attacks. When stock markets reopened on September 17, 2001, Lehman's sales and trading capabilities were restored.

In the ensuing months, the firm fanned out its operations across the New York City metropolitan area in over 40 temporary locations. The investment-banking division converted the first-floor lounges, restaurants, and all 665 guestrooms of the Sheraton Manhattan Hotel into office space.[48]

The bank also experimented with flextime (to share office space) and telecommuting via virtual private networking. In October 2001, Lehman purchased a 32-story, 1,050,000-square-foot (98,000 m2) office building for a reported sum of $700 million. The building, located at 745 Seventh Avenue, had recently been completed, and not yet occupied, by rival Morgan Stanley.

With Morgan Stanley's world headquarters located only two blocks away at 1585 Broadway, in the wake of the attacks the firm was re-evaluating its office plans which would have put over 10,000 employees in the Times Square area of New York City. Lehman began moving into the new facility in January and finished in March 2002, a move that significantly boosted morale throughout the firm.[40]

The firm was criticized for not moving back to its former headquarters in lower Manhattan. Following the attacks, only Deutsche Bank, Goldman Sachs, and Merrill Lynch, of the major firms, remained in the downtown area. Lehman, however, pointed to the facts that it was committed to stay in New York City, that the new headquarters represented an ideal circumstance where the firm was desperate to buy and Morgan Stanley was desperate to sell, that when the new building was purchased, the structural integrity of Three World Financial Center had not yet been given a clean bill of health, and that the company could not have waited until May 2002 for repairs to Three World Financial Center to conclude.

After the attacks, Lehman's management placed increased emphasis on business continuity planning. Unlike its rivals, the company was unusually concentrated for a bulge-bracket investment bank. For example, Morgan Stanley maintains a 750,000-square-foot (70,000 m2) trading-and-banking facility in Westchester County, New York. The trading floor of UBS is located in Stamford, Connecticut. Merrill Lynch's asset-management division is located in Plainsboro Township, New Jersey. Aside from its headquarters in Three World Financial Center, Lehman maintained operations-and-backoffice facilities in Jersey City, space that the firm considered leaving prior to 9/11. The space was not only retained, but expanded, including the construction of a backup-trading facility. In addition, telecommuting technology first rolled out in the days following the attacks to allow employees to work from home was expanded and enhanced for general use throughout the firm.[49]

June 2003 SEC litigation[edit]

In June 2003, the company was one of ten firms which simultaneously entered into a settlement with the U.S. Securities and Exchange Commission (SEC), the Office of the New York State Attorney General and various other securities regulators, regarding undue influence over each firm's research analysts by its investment-banking divisions. Specifically, regulators alleged that the firms had improperly associated analyst compensation with the firms' investment-banking revenues, and promised favorable, market-moving research coverage, in exchange for underwriting opportunities. The settlement, known as the "global settlement", provided for total financial penalties of $1.4 billion, including $80 million against Lehman, and structural reforms, including a complete separation of investment banking departments from research departments, no analyst compensation, directly or indirectly, from investment-banking revenues, and the provision of free, independent, third-party, research to the firms' clients.

Rise of mortgage origination (1997-2006)[edit]

Lehman was one of the first Wall Street firms to move into the business of mortgage origination. In 1997, Lehman bought Colorado-based lender, Aurora Loan Services, an Alt-A lender. In 2000, to expand their mortgage origination pipeline, Lehman purchased West Coast subprime mortgage lender BNC Mortgage LLC. Lehman quickly became a force in the subprime market. By 2003 Lehman made $18.2 billion in loans and ranked third in lending. By 2004, this number topped $40 billion. By 2006, Aurora and BNC were lending almost $50 billion per month.[50] Lehman had morphed into a real estate hedge fund disguised as an investment bank.[51] By 2008, Lehman had assets of $680 billion supported by only $22.5 billion of firm capital. From an equity position, its risky commercial real estate holdings were three times greater than capital. In such a highly leveraged structure, a 3 to 5 percent decline in real estate values would wipe out all capital.

Collapse[edit]

Main article: Bankruptcy of Lehman Brothers

Causes[edit]

Malfeasance[edit]

A March 2010 report by the court-appointed examiner indicated that Lehman executives regularly used cosmetic accounting gimmicks at the end of each quarter to make its finances appear less shaky than they really were. This practice was a type of repurchase agreement that temporarily removed securities from the company's balance sheet. However, unlike typical repurchase agreements, these deals were described by Lehman as the outright sale of securities and created "a materially misleading picture of the firm’s financial condition in late 2007 and 2008."[52]

Subprime Mortgage Crisis[edit]

In August 2007 the firm closed its subprime lender, BNC Mortgage, eliminating 1,200 positions in 23 locations, and took an after-tax charge of $25 million and a $27 million reduction in goodwill. Lehman said that poor market conditions in the mortgage space "necessitated a substantial reduction in its resources and capacity in the subprime space".[53]

In 2008, Lehman faced an unprecedented loss to the continuing subprime mortgage crisis. Lehman's loss was a result of having held on to large positions in subprime and other lower-rated mortgage tranches when 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 was forced to sell off $6 billion in assets.[54] In the first half of 2008 alone, Lehman stock lost 73% of its value as the credit market continued to tighten.[54] 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.[54]

In September 2007, Joe Gregory appointed Erin Callan as CFO. On March 16, 2008, after rival Bear Stearns was taken over by JP Morgan Chase in a fire sale, market analysts suggested that Lehman would be the next major investment bank to fall. Callan fielded Lehman's first quarter conference call, where the firm posted a profit of $489 million, compared to Citigroup's $5.1 billion and Merrill Lynch's $1.97 billion losses which was Lehman’s 55th consecutive profitable quarter. The firm's stock price leapt 46 percent after that announcement.[40][55][56][57]

On June 9, 2008, Lehman Brothers announced US$2.8 billion second-quarter loss, its first since being spun off from American Express, as market volatility rendered many of its hedges ineffective during that time. Lehman also reported that it had raised a further $6 billion in capital. As a result, there was major management shakeup, in which Hugh "Skip" McGee III (head of investment banking) held a meeting with senior staff to strip Fuld and his lieutenants of their authority. Consequently, Joe Gregory agreed to resign as president and COO, and afterward he told Erin Callan that she had to resign as CFO. Callan was appointed CFO of Lehman in 2008 but served only for six months, before departing after her mentor Joe Gregory was demoted.[55][56][57] Bart McDade was named to succeed Gregory as president and COO, when several senior executives threatened to leave if he was not promoted. McDade took charge and brought back Michael Gelband and Alex Kirk, who had previously been pushed out of the firm by Gregory for not taking risks. Although Fuld remained CEO, he soon became isolated from McDade's team.[40][58]

On August 22, 2008, shares in Lehman closed up 5% (16% for the week) on reports that the state-controlled Korea Development Bank was considering buying the bank.[59] Most of those gains were quickly eroded as news came in that Korea Development Bank was "facing difficulties pleasing regulators and attracting partners for the deal."[60] It culminated on September 9, 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.[61]

Investor confidence continued to erode as Lehman's stock lost roughly half its value and pushed the S&P 500 down 3.4% on September 9. The Dow Jones lost 300 points the same day on investors' concerns about the security of the bank.[62] The U.S. government did not announce any plans to assist with any possible financial crisis that emerged at Lehman.[63]

The next day, Lehman announced a loss of $3.9 billion and its intent to sell off a majority stake in its investment-management business, which includes Neuberger Berman.[64][65] The stock slid seven percent that day.[65][66] Lehman, after earlier rejecting questions on the sale of the company, was reportedly searching for a buyer as its stock price dropped another 40 percent on September 11, 2008.[66]

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 multimillion-dollar bonuses to "send a strong message to both employees and investors that management is not shirking accountability for recent performance."[67]

Lehman Brothers Investment Management Director George Herbert Walker IV dismissed 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."[67]

Short-selling allegations[edit]

During hearings on the bankruptcy filing by Lehman Brothers and bailout of AIG before the House Committee on Oversight and Government Reform,[68] former Lehman Brothers CEO Richard Fuld said a host of factors including a crisis of confidence and naked short-selling attacks followed by false rumors contributed to both the collapse of Bear Stearns and Lehman Brothers. House committee Chairman Henry Waxman said the committee received thousands of pages of internal documents from Lehman and these documents portray a company in which there was "no accountability for failure".[69][70][71]

An article by journalist Matt Taibbi in Rolling Stone contended that naked short selling contributed to the demise of both Lehman and Bear Stearns.[72] A study by finance researchers at the University of Oklahoma Price College of Business studied trading in financial stocks, including Lehman Brothers and Bear Stearns, and found "no evidence that stock price declines were caused by naked short selling".[73]

Bankruptcy[edit]

On Saturday, September 13, 2008, Timothy F. Geithner, then the president of the Federal Reserve Bank of New York, called a meeting on the future of Lehman, which included the possibility of an emergency liquidation of its assets.[74] Lehman reported that it had been in talks with Bank of America and Barclays for the company's possible sale; however, both Barclays and Bank of America ultimately declined to purchase the entire company, in the former case because the British government (in particular, the Chancellor of the ExchequerAlastair Darling and the CEO of the Financial Services AuthorityHector Sants) refused to allow the transaction at the last minute, quoting stockholder regulations in the UK, despite a deal having apparently been completed.[74][75]

The next day, Sunday, September 14, the International Swaps and Derivatives Association (ISDA) offered an exceptional trading session to allow market participants to offset positions in various derivatives on the condition of a Lehman bankruptcy later that day.[76] Although the bankruptcy filing missed the deadline, many dealers honored the trades they made in the special session.[77]

Shortly before 1 am Monday morning (UTC−5), Lehman Brothers Holdings announced it would file for Chapter 11bankruptcy protection[78] citing bank debt of $613 billion, $155 billion in bond debt, and assets worth $639 billion.[79] It further announced that its subsidiaries would continue to operate as normal.[78] A group of Wall Street firms agreed to provide capital and financial assistance for the bank's orderly liquidation and the Federal Reserve, in turn, agreed to a swap of lower-quality assets in exchange for loans and other assistance from the government.[80] The morning witnessed scenes of Lehman employees removing files, items with the company logo, and other belongings from the world headquarters at 745 Seventh Avenue. The spectacle continued throughout the day and into the following day.

Later that day, the Australian Securities Exchange (ASX) suspended Lehman's Australian subsidiary as a market participant after clearing-houses terminated contracts with the firm.[81] Lehman shares tumbled over 90% on September 15, 2008.[82][83] The Dow Jones closed down just over 500 points on September 15, 2008, which was at the time the largest drop in a single day since the days following the attacks on September 11, 2001.[84]

In the United Kingdom, the investment bank went into administration with PricewaterhouseCoopers appointed as administrators.[85] In Japan, the Japanese branch, Lehman Brothers Japan Inc., and its holding company filed for civil reorganization on September 16, 2008, in Tokyo District Court.[86] On September 17, 2008, the New York Stock Exchange delisted Lehman Brothers.[87]

On March 16, 2011 some three years after filing for bankruptcy and following a filing in a Manhattan U.S. bankruptcy court, Lehman Brothers Holdings Inc announced it would seek creditor approval of its reorganization plan by October 14 followed by a confirmation hearing to follow on November 17.[88][89]

Liquidation[edit]

Barclays acquisition[edit]

On September 16, 2008, Barclays PLC announced that they would acquire a "stripped clean" portion of Lehman for $1.75 billion, including most of Lehman's North America operations.[8][90] On September 20, 2008, a revised version of the deal, a $1.35 billion (£700 million) plan for Barclays to acquire the core business of Lehman (mainly its $960-million headquarters, a 38-story office building[91] in Midtown Manhattan, with responsibility for 9,000 former employees), was approved.[92][93]Manhattan court 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."[94]

Luc Despins, then a partner at Milbank, Tweed, Hadley & McCloy, 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 attorney Harvey R. Miller of Weil, 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.[95] Barclays acquired a potential liability of $2.5 billion to be paid as severance, if it chooses not to retain some Lehman employees beyond the guaranteed 90 days.[96][97]

Nomura acquisition[edit]

Nomura Holdings, Japan's top brokerage firm, agreed to buy the Asian division of Lehman Brothers for $225 million and parts of the European division for a nominal fee of $2.[98][99] It would not take on any trading assets or liabilities in the European units. Nomura negotiated such a low price because it acquired only Lehman's employees in the regions, and not its stocks, bonds or other assets. The last Lehman Brothers Annual Report identified that these non-US subsidiaries of Lehman Brothers were responsible for over 50% of global revenue produced.[100]

Sale of asset management businesses[edit]

On September 29, 2008, Lehman agreed to sell Neuberger Berman, part of its investment management business, to a pair of private-equity firms, Bain Capital Partners and Hellman & Friedman, for $2.15 billion.[101] The transaction was expected to close in early 2009, subject to approval by the U.S. Bankruptcy Court,[102] but a competing bid was entered by the firm's management, who ultimately prevailed in a bankruptcy auction on December 3, 2008. Creditors of Lehman Brothers Holdings Inc. retain a 49% common equity interest in the firm, now known as Neuberger Berman Group LLC.[103] In Europe, the Quantitative Asset Management Business has been acquired back by its employees on November 13, 2008 and has been renamed back to TOBAM.

Financial fallout[edit]

Lehman's bankruptcy was the largest failure of an investment bank since Drexel Burnham Lambert collapsed amid fraud allegations 18 years prior.[80] Immediately following the bankruptcy filing, an already distressed financial market began a period of extreme volatility, during which the Dow experienced its largest one day point loss, largest intra-day range (more than 1,000 points) and largest daily point gain. What followed was what many have called the "perfect storm" of economic distress factors and eventually a $700bn bailout package (Troubled Asset Relief Program) prepared by Henry Paulson, Secretary of the Treasury, and approved by Congress. The Dow eventually closed at a new six-year low of 7,552.29 on November 20, followed by a further drop to 6626 by March of the next year. Durvexity spiked, due to funding issues at the major investment banks.[104]

The fall of Lehman also had a strong effect on small private investors such as bond holders and holders of so-called Minibonds. In Germany structured products, often based on an index, were sold mostly to private investors, elderly, retired persons, students and families. Most of those now worthless derivatives were sold by the German arm of Citigroup, the German Citibank now owned by Crédit Mutuel.

Ongoing litigation[edit]

On March 11, 2010, Anton R. Valukas, a court-appointed examiner, published the results of its year-long investigation into the finances of Lehman Brothers.[105]This report revealed that Lehman Brothers used an accounting procedure termed repo 105 to temporarily exchange $50 billion of assets into cash just before publishing its financial statements.[106] The action could be seen to implicate both Ernst & Young, the bank's accountancy firm and Richard S. Fuld, Jr, the former CEO.[107] This could potentially lead to Ernst & Young being found guilty of financial malpractice and Fuld facing time in prison.[108]

According to The Wall Street Journal, in March 2011, the SEC announced that they weren't confident that they could prove that Lehman Brothers violated US laws in its accounting practices.[109]

In October 2011 the administrators of Lehman Brothers Holding Inc. lost their appeal to overturn a court order forcing them to pay £148 million into their underfunded pensions plan.[110]

As of January 2016, Lehman has already paid more than $105 billion to its unsecured creditors. In addition, JPMorgan will pay $1.42 billion in cash to settle a lawsuit accusing JPMorgan of draining Lehman Brothers liquidity right before the crash. The settlement would permit another $1.496 billion to be paid to creditors and a separate $76 million deposit.[111]

Merger and acquisition history[edit]

The following is an illustration of the company's major mergers and acquisitions and historical predecessors (this is not a comprehensive list):[112]

Lehman Brothers
(1994, spun off by American Express;
2008, bankrupt – see Bankruptcy of Lehman Brothers)

Shearson Lehman Hutton
(merged 1988)
Shearson Lehman Brothers
(merged 1984)
Shearson/American Express
(merged 1981)

American Express
(est. 1850)


Shearson Loeb Rhoades
(acquired 1981)
Shearson Hayden Stone
(merged 1973)
Hayden Stone, Inc. (formerly CBWL-Hayden Stone, merged 1970)


Shearson, Hammill & Co.
(est. 1902)



Loeb, Rhoades, Hornblower & Co.
(merged 1978)



Lehman Brothers Kuhn Loeb
(merged 1977)
Lehman Brothers
(merged 1975)

Abraham & Co.
(est. 1938)



Lehman Brothers
(est. 1850)




Kuhn, Loeb & Co.
(est. 1867)





E. F. Hutton & Co.
(est. 1904)




Neuberger Berman
(est. 1939, acq. 2003,
sold to management 2009)



The former New York City headquarters now owned by Barclays.
Lehman Brothers headquarters in New York City on September 15, 2008

On September 15, 2008, Lehman Brothers filed for bankruptcy. With $639 billion in assets and $619 billion in debt, Lehman's bankruptcy filing was the largest in history, as its assets far surpassed those of previous bankrupt giants such as WorldCom and Enron. Lehman was the fourth-largest U.S. investment bank at the time of its collapse, with 25,000 employees worldwide.

Lehman's demise also made it the largest victim of the U.S. subprime mortgage-induced financial crisis that swept through global financial markets in 2008. Lehman's collapse was a seminal event that greatly intensified the 2008 crisis and contributed to the erosion of close to $10 trillion in market capitalization from global equity markets in October 2008 – the biggest monthly decline on record at the time.

The History of Lehman Brothers

Lehman Brothers had humble origins, tracing its roots back to a small general store that was founded by German immigrant Henry Lehman in Montgomery, Alabama in 1844. In 1850, Henry Lehman and his brothers, Emanuel and Mayer, founded Lehman Brothers.

While the firm prospered over the following decades as the U.S. economy grew into an international powerhouse, Lehman had to contend with plenty of challenges over the years. Lehman survived them all – the railroad bankruptcies of the 1800s, the Great Depression of the 1930s, two world wars, a capital shortage when it was spun off by American Express Co. (AXP) in 1994, and the Long Term Capital Management collapse and Russian debt default of 1998. However, despite its ability to survive past disasters, the collapse of the U.S. housing market ultimately brought Lehman to its knees, as its headlong rush into the subprime mortgage market proved to be a disastrous step.

The Prime Culprit

In 2003 and 2004, with the U.S. housing boom (read, bubble) well under way, Lehman acquired five mortgage lenders, including subprime lender BNC Mortgage and Aurora Loan Services, which specialized in Alt-A loans (made to borrowers without full documentation). Lehman's acquisitions at first seemed prescient; record revenues from Lehman's real estate businesses enabled revenues in the capital markets unit to surge 56% from 2004 to 2006, a faster rate of growth than other businesses in investment banking or asset management. The firm securitized $146 billion of mortgages in 2006, a 10% increase from 2005. Lehman reported record profits every year from 2005 to 2007. In 2007, the firm reported net income of a record $4.2 billion on revenues of $19.3 billion.

Lehman's Colossal Miscalculation

In February 2007, the stock reached a record $86.18, giving Lehman a market capitalization of close to $60 billion. However, by the first quarter of 2007, cracks in the U.S. housing market were already becoming apparent as defaults on subprime mortgages rose to a seven-year high. On March 14, 2007, a day after the stock had its biggest one-day drop in five years on concerns that rising defaults would affect Lehman's profitability, the firm reported record revenues and profit for its fiscal first quarter.

In the company's post-earnings conference call, Lehman's chief financial officer said that the risks posed by rising home delinquencies were well contained and would have little impact on the firm's earnings. He also said that he did not foresee problems in the subprime market spreading to the rest of the housing market or hurting the U.S. economy.

The Beginning of the End for Lehman

As the credit crisis erupted in August 2007 with the failure of two Bear Stearns hedge funds, Lehman's stock fell sharply. During that month, the company eliminated 2,500 mortgage-related jobs and shut down its BNC unit. In addition, it also closed offices of Alt-A lender Aurora in three states. Even as the correction in the U.S. housing market gained momentum, Lehman continued to be a major player in the mortgage market.

In 2007, Lehman underwrote more mortgage-backed securities than any other firm, accumulating an $85 billion portfolio, or four times its shareholders' equity. In the fourth quarter of 2007, Lehman's stock rebounded, as global equity markets reached new highs and prices for fixed-income assets staged a temporary rebound. However, the firm did not take the opportunity to trim its massive mortgage portfolio, which in retrospect, would turn out to be its last chance.

Lehman's Hurtling Toward Failure

Lehman's high degree of leverage – the ratio of total assets to shareholders equity – was 31 in 2007, and its huge portfolio of mortgage securities made it increasingly vulnerable to deteriorating market conditions. On March 17, 2008, following the near-collapse of Bear Stearns – the second-largest underwriter of mortgage-backed securities – Lehman shares fell as much as 48% on concern it would be the next Wall Street firm to fail.

Confidence in the company returned to some extent in April, after it raised $4 billion through an issue of preferred stock that was convertible into Lehman shares at a 32% premium to its price at the time. However, the stock resumed its decline as hedge fund managers began questioning the valuation of Lehman's mortgage portfolio.

On June 9, Lehman announced a second-quarter loss of $2.8 billion, its first loss since being spun off by American Express, and reported that it had raised another $6 billion from investors. The firm also said that it had boosted its liquidity pool to an estimated $45 billion, decreased gross assets by $147 billion, reduced its exposure to residential and commercial mortgages by 20%, and cut down leverage from a factor of 32 to about 25.

Too Little, Too Late for Lehman

However, these measures were perceived as being too little, too late. Over the summer, Lehman's management made unsuccessful overtures to a number of potential partners. The stock plunged 77% in the first week of September 2008, amid plummeting equity markets worldwide, as investors questioned CEO Richard Fuld's plan to keep the firm independent by selling part of its asset management unit and spinning off commercial real estate assets. Hopes that the Korea Development Bank would take a stake in Lehman were dashed on Sept. 9, as the state-owned South Korean bank put talks on hold.

The news was a deathblow to Lehman, leading to a 45% plunge in the stock and a 66% spike in credit-default swaps on the company's debt. The company's hedge fund clients began pulling out, while its short-term creditors cut credit lines. On Sept. 10, Lehman pre-announced dismal fiscal third-quarter results that underscored the fragility of its financial position.

The firm reported a loss of $3.9 billion, including a write-down of $5.6 billion, and also announced a sweeping strategic restructuring of its businesses. The same day, Moody's Investor Service announced that it was reviewing Lehman's credit ratings, and also said that Lehman would have to sell a majority stake to a strategic partner in order to avoid a ratings downgrade. These developments led to a 42% plunge in the stock on Sept. 11.

With only $1 billion left in cash by the end of that week, Lehman was quickly running out of time. Last-ditch efforts over the weekend of Sept. 13 between Lehman, BarclaysPLC and Bank of America Corp. (BAC), aimed at facilitating a takeover of Lehman, were unsuccessful. On Monday Sept. 15, Lehman declared bankruptcy, resulting in the stock plunging 93% from its previous close on Sept. 12.

The Bottom Line

Lehman's collapse roiled global financial markets for weeks, given the size of the company and its status as a major player in the U.S. and internationally. Many questioned the U.S. government's decision to let Lehman fail, compared with its tacit support for Bear Stearns, which was acquired by JPMorgan Chase & Co. (JPM) in March 2008. Lehman's bankruptcy led to more than $46 billion of its market value being wiped out. Its collapse also served as the catalyst for the purchase of Merrill Lynch by Bank of America in an emergency deal that was also announced on Sept. 15.

0 Replies to “Lehman Brothers Case Study Question”

Lascia un Commento

L'indirizzo email non verrà pubblicato. I campi obbligatori sono contrassegnati *