History of Lehman Brothers
Subprime Crisis Explained
Vicious circle & the fall of Lehman Brothers
Organizational Culture at Lehman Brothers
Lehman Brothers Holdings Inc, aka the fourth-largest investment financial institution in the US (behind Goldman Sachs, Morgan Stanley, and Merrill Lynch), was a 158 years old bank that had to declare its bankruptcy in September 2008. Led by its CEO, Richard Fuld, Lehman Brothers was a glorious and respected investment bank for which some of the most experienced and intelligent financial analysts/investors were working. How come then, than in a less than one week, the whole structure imploded and ...view middle of the document...
The History of Lehman Brothers
Lehman Brothers origins’ were pretty humble since it all started in a small general store that was founded in 1844, by German immigrant Henry Lehman in Montgomery, Alabama. Six years late, in 1850, the three Lehman brothers aka Henry, Emanuel and Mayer, founded what we now know as Lehman Brothers.
The years passed and the U.S. economy started to grow more and more until it became a international economic force. Meanwhile, the firm prospered even though the brothers and their company had to face many 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 in 1994, and the Long Term Capital Management collapse and Russian debt default of 1998.”1
Despite the fact that Lehman’s institution went through all those hard times, a very questionable risk management and organizational behaviour led it to its knees with the collapse of the U.S. housing market and the massive capital it invested in the subprime mortgages.
The subprime crisis explained
At the time, meaning in the beginning of the 21th century, the housing market was going well in the U.S. The prices in the real estate were going up and many citizens wanted to actually put money in order to buy their own house. In order to keep the economy as strong as possible, the interest rates were low, 1% at that moment, meaning that investing was bringing a real low rate of return. Many investors were thus keeping their money, or were looking for other opportunities abroad. On the flip-side, the investment banks, such as Lehman Brothers, could borrow money from the Federal Funds at a 1% interest rate. This was really interesting!
Let’s have a look at the graphic2 I’ve made in order to understand what happened to Lehman Brothers: As I previously said, many families were willing to buy a house at the moment. Most of them, could of course not pay the entire sum immediately; they were thus asking mortgage brokers to give them a mortgage. The mortgage broker was getting a commission, while the mortgage was being given to the families by the mortgage lender. So far, so good. Here is the moment when it becomes interesting: Investment banks in Wall Street, such as Lehman Brothers, had the brilliant idea to, using the leverage system. Let’s understand briefly how it works.
The leverage system is a financial operation which consists in buying a very large amount of something (stock options, goods, mortgages in this case), in order to sell them to make profit, but without having the money. The money to buy this large amount of things was actually borrowed and will have to be given back after the operation. What is interesting in this operation is that the profit is way more important than if you would have actually bought a smaller amount of things, only using your money.
Example: You buy one house 250.000$, you sell...