Lehman Brothers: the demise

Sub Prime: Sub Prime as the word defines, means subordinate to primary. The word is used in the lending industry to define a borrower who does not have a good credit history

How did it start?

Sub Prime Crisis: It all started in 2006 with US Market tumbling down due to defaults by the sub prime borrowers. The doubled edged sword, increase in interest rates and simultaneously fall in property prices, hit the market leading to sub prime mortgage crisis. Between the years 2000-2005, along with very low interest rates, property prices were also on a rising trend and the sub prime borrowers were able to meet their obligations as they were building equity by selling the properties or getting the properties refinanced. However, in 2005, the property prices started falling, interest rates started touching the roof top, leaving no room for the sub prime borrowers to meet their liabilities leading to meltdown of the US sub prime mortgage industry.

CAUSES OF SUB-PRIME CRISIS

SECURITIZATION MORTGAGE BACKED SECURITIES INACCURATE CREDIT RATINGS

GOVERNMENT SPONSERED ENTERPRISES

Lehman Brothers Holdings Inc. was a global financial services firm. Before declaring bankruptcy in 2008, Lehman was the fourth largest investment bank in the US (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, and private banking.
At 1:45AM on September 15, 2008, the firm filed for bankruptcy protection following the massive exodus of most of its clients, drastic losses in its stock, and devaluation of its assets by credit rating agencies. Lehman Brothers' bankruptcy filing is the largest bankruptcy in U.S. history, and is thought to have played a major role in the unfolding of the late-2000s global financial crisis.

1)Market complacency 2)Bad regulation 3)Lack of transparency Unregulated growth in the markets Low level of collateral

Of the five big investment banks that were in operation at the outset of 2008, The Bear Stearns cos had already failed and been taken over and Lehman Brothers were trying to avoid a similar fate.

In its 2008 Annual Report, Lehman boasted of having a culture of risk management at every level of the firm". They took risk management measures but it mostly used the "Value at Risk" system invented by J.P. Morgan Chase and Co(JPM) in the early 1990s.

VaR assesses the "99% confidence limit" of the loss that may be incurred by each trading position at most 1% of the time. But the top managers of the investment banks were led to believe that this 1% didn't matter.

VaR was calculated from daily price movements and even the 1% accounted to a significant value.
A problem with VaR is that in most cases, it depends on an assessment of the "volatility" of the security concerned. Volatility is by definition low in quiet markets and much higher in turbulent markets. So the system's assessment of risk is low when the markets are quiet, allowing traders to pile on positions and then zoom upward. When things go wrong, at that point, positions cannot be unwound.

Lehman Had to Die So Global Finance Could Live

By Joe Nocera September 12, 2009

The article is a deliberation on the Goliath that was Lehman Brothers, a company which is most commonly remembered as a tragic bankruptcy, the biggest of its kind in history. An anniversary since, Joe Nocera reports on how the collapse, even if preventable, was certainly not the worst thing that could happen during the Great Recession.

The sub-prime crisis was one of a kind, a consequence of the complacence of the American banking system, lending loans to its customers impartially. The colossal dominoes fell, one by one. The companies were failing to hold up and needed rescue from the government. The reporter is of the opinion that the bankruptcy of the Lehman Bros could have been avoided but that saving it would have possibly led to a much worse crisis in the financial market.

Nocera writes that had the Lehman Brothers been saved, the Congress wouldnt have taken the bailout resolution as seriously as it did after the collapse. The panic caused by the bankruptcy caught the full fledged attention of the government so much that the companies that collapsed soon after were provided the bailout money. Also, another good thing that came out of the tragedy was that they averted a much worse catastrophe. Merill Lynch or an A.I.G default would have blown up the reeling state of the American economy as these firms or institutions have their roots that penetrate deep into the Main Street. The damage would have been of monumental proportions and the carnage would have devastated an already battered economy. Lehman Brothers, on the other hand, were not connected to the Main Street in a palpable way.

I personally agree with Noceras insight into the crisis. Throwing Lehman Brothers under the bus may not have been the worst thing, after all. Speaking figuratively, the other passengers of the bus were saved and the Lehman Brothers were but a small sacrifice for the greater good. Nocera sums up his article by saying that the authorities involved acted with tenacity, both Ben Bernanke and Timothy Geithner. They may not have known the full consequences of their actions but they sure got lucky and he gives them that.