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When the Lehman Brothers declared their bankruptcy on 15 September 2008, the response of the business world was pied. Some of them were anxious about the bankruptcy would cause while some found it appropriate that the big performer on the financial market in the end had to face the consequences of its own stroke. The demise of Lehman brothers can only be understood within the context of the current financial crisis the biggest crisis ever faced by US. As Lehman Brothers was considered one of the biggest dealers in the fixed interest trading and fourth biggest in the investment banking on the Wall Street (BBC, 16 September 2008).
The rise of this sturdy investment bank started in 1844 and played a precious role in the financial and commercial industry of United States for more than 15 decades? In 1844 Henry Lehman immigrated from Germany to Montgomery, Albania and set up a small dry goods shop and sold groceries to the nearby farmers, six years later he was joined by his two brothers Emanuel and Mayer and they later on named it Lehman Brothers. Soon after its founding the Lehman Brothers evolved from merchandising business to commodities brokers that trade cotton to farmers. In the year 1898 Lehman Brothers underwrote its first public offering for the international steam pump company in the 1900's the firm became a financer of many top retailers like R.H. Macy& Co, Sears, Roebuck and Company etc. In year 1906 Lehman Brothers shake hands with Goldman Sachs in order to bring the general cigar company to the market. In the year 1929 Lehman Corporation was created which was a closed end investment company. In the year 1975 Lehman brothers acquired Abraham &co and two years later in 1977 merged with Kuhn, Loeb &co to form Lehman Brothers Kuhn Loeb Inc. Later on in the year 1984 American Express acquired Lehman Brothers and merged it with Shearson but in 1994 Lehman Brothers became independent through public stock offerings and Lehman Brothers Holding Inc. In 2003 Lehman acquired Neuberger Berman for $2.6 billion and recently in 2007 Lehman Brothers recorded high revenues and income for the fourth consecutive year and the highest volume of trade on the London stock Exchange (Deal Book, 1928 Bakers library).
SWOT Analysis of Lehman Brothers
The Lehman Brothers provide a range of equity and fixed income services and apart from that they were a giant in investment banking services and underwriting services and thus serves the financial needs of various customer segments. They operate in very large magnitude and because of its large scale operations; they were able to have a deeper visibility, customer recall and enhanced market penetration. However because of the poor performance of residential mortgage origination and securitization business might need to restructure its business portfolio.
Revenues Coming From Diversified Operations:
On the London Stock Exchange the equity volume market share of the company increased to 14.5%whereas on the New York stock exchange reached 6.2% in the first half of 2007 as compare to 13.2% and 5.7% respectively in 2006. Lehman brothers had wide operations spread across Europe. In 2007 Lehman brothers American operations contributed 51% of the total revenues Europe and Middle East accounted for32.7% and revenues from operations in Asia pacific were 16.3%. The revenues from American operations decreased 12.7% whereas revenues from Europe and Middle East increased to 38.8% and73.9% from Europe and Asia pacific operations respectively.
Expertise fundamental and technical research:
Lehman Brothers provides expert fundamental, quantitative and strategic research in the field of fixed income and equity market as a result of this Lehman Brother was ranked no 1 ahead of Bear Sterns and Citigroup in the institutional investors US equity research poll of 2007. Equity research of Lehman Brothers is spread in 1500 companies and over 100 sectors.
The complaint was filed against Lehman Brothers on behalf of those clients who paid certain amount of minimum borrowing rate fees to broker dealers in connection with borrowing securities also in June 2006 40 shareholders of Nova star financials filed an allegation against Lehman brothers that its broker dealers were involved in illegal stock market manipulation. As a result of all these legal issues and allegations Lehman Brothers might face huge damages and also an impact on their brand image.
Heavy Investment in Subprime market:
In 2007 Lehman Brothers reportedly wrote down $830 million in real asset backed securities. The fixed income net revenues of Lehman Brothers declined to $6.0 billion. In 2007 from $8.4 billion in 2006. The deterioration of US residential mortgage sector also had a adverse affect on Lehman Brothers real estate investment. Lehman Brother had a portfolio of $5276 million in US subprime mortgage market.
The year 2007 was very favourable year for Lehman Brothers, in June 2007 they completed the acquisition of EAGLE ENERGY PARTNERS and in October 2007 they announced the acquisition of a Turkey based equity security brokerage firm MNG securities. Lehman Brothers also expanded its business in different geographical locations where new growth opportunities were emerging.
Rapid Growth in asset management industry:
Asset management industry grew by 7.8% in 2006 to represent a compound annual growth rate of 11.3% for the time period 2002-2006. The portfolio of Lehman brothers asset management business grew by 25.3% in 2007 to take its asset under management to$282 billion and this growth is expected to drive the sector to a value of $71.6 trillion by 2011
New Investment opportunities:
The investment Banking industry is globally benefitting from the day by day increasing mergers and acquisitions and corporate reforms and Lehman Brothers is one of the main players in the investment banking sector and the expected outcome for 2011 are forecasted at$8.8billion by the end of 2011.
New Trading opportunities in Foreign exchange indices:
In august Lehman brothers announced the foreign exchange indices (LBFX) which are a set of rules that keeps a track on the performance of g10 currencies against US dollars. Index returns are published on the Lehman live client website and the Lehman brothers global family on Bloomberg and they can be used to track the currency performance in total returns.
Residential Mortgage Business Taking a Dip: According to the data of US Mortgage Bankers Association Housing starts continuously declined continuously from 2.1 million in the first quarter in the year c2006 to 1.5 million in the first quarter of 2007 and in return this dip affected the business of Lehman brothers to a certain extent.
Due to the mergers a number of companies had now came up with a offering of wide range of products at very competitive prices, this exposed Lehman brothers to completion in the financial markets at both the international and local level, apart from this the ever growing technology and introduction of e-commerce have paved a way for non depository institutions to offer those products which were traditionally banking products.
The Finance Function of Lehman Brothers
Lehman Brothers had a portfolio consisting of a bulky share of loan connected to the purchasing real estate's (Guardian, 15 September 2008). Its core business includes buying and selling shares and fixed income assets, trading and research, investment banking, investment management and private equity. Out of the different activities performed by them the core business of the global Lehman Brothers Group was investment banking and also provides financial services to corporations, government institutional clients and high net worth individuals. Deeds of the company was structured into three categories first the capital market, investment banking and venture management. These three diverse fragments comprise of business in equity and fixed income sale, trading and research, asset management and private management and equity (price water house coopers report, 28 October 2008). Lehman Brothers was the worldwide creator in certain equity and fixed income products and its distribution aptitude in equity and fixed income products was based on client flow business model which mainly focus on the transaction of the client in the global capital markets across the world by advising on specified need of the client, serving as the intermediary in the market place and allow the client to adjust according to their portfolio by acting as an underwriter to them. Early in 2007 there was the decline in the prices of property market (about 16 to 20 percent) which made the value of the property lesser than the loan value outstanding which was the shattering for Lehman brothers.
The beginning of the end?
IS AGENCY PROBLEM A REASON?
The chief executive of Lehman Brothers Dick Fuld ran the company as if he is in a war. Despite several warnings he ignored the signs of the coming collapse. Fuld made loads of money and made some of his shareholders and employees splendidly rich. In the best eight years of the company he took home$300 million. According to him Lehman was at war in the market, the employees were the soldiers and everyday was a battle. Even when Merrill Lynch and ContiGroup went down Dick Fluid and his colleagues were satisfied those there clever hedging strategies worked. In other words we can say that Dick Fluid was a command and control CEO. Even when Lehman Brothers profits started coming down even then he was celebrating the fact that 2007 was a record year for them. Lawrence McDonald, a former trader with Lehman Brothers once said that” Other than six or seven people, no one really knew him. In my four years there, he never came down to the trading floor. Not once.”. This clearly shows the fact he was confined to himself and wanted that everyone should follow his decision word to word, he never discussed his problems with the employees, command and control was his policy, this affected the company as there was no internal communication within the company and as result he failed to predict that Lehman is on the verge of bankruptcy. Some steps would have been taken if he had paid some attention towards the warnings which were issued and Lehman could have been saved.
RISK MANAGEMENT SYSTEM
Because of the stubborn nature of Fuld he decided to invest in the subprime markets with the assumption of increase in the market by 20% but the plan backfired because of that the leverage ratio rose to 44:1 From 30.7:1 and they were completely under a huge debt as there was a poor risk management. There were no far-reaching reforms in respect of capital cover regimes; Lehman did not saved capital buffers in good times for the forthcoming losses. Later on they appealed Barclays and Bank of America for help but they simply refused.
The American Banking regulation system was divided into two parts but Lehman Brothers being an investment bank did not had such hard regulations as commercial banks which was regulated by US Federal Government. Apart from that there were very less regulations to reduce the risk taking in the company but they did not had sufficient amount of incentives to avoid system risks because the government takes a large portion of the company which is going bankrupt and this could be said as one of the reasons as to why the American government did not saved Lehman Brothers. The American government had not much idea about the network of Lehman and other financial institutes and thus refused to help it in the end.
Impact on financial markets and global markets (consequences)
The collapse of the Lehman brothers was one of the biggest calamity for the financial markets which blow the markets like a waves of Tsunami in US but its effected markets worldwide which disturbed the world economy by 21% overnight. A press conference released that annual rate of GDP dropped in the first quarter of 2008 by 18% and which effected the net worth as it was decreased by more than a quarter. Same declining effects can be seen on the New York stock exchange which faced the steep decline of 45% of its stock index S&P 500 by the early November 2008. US and European banks lost more than 1 trillion dollar on toxic assets from January 2007 to 2009. According to reports, banks of US by the time lost 60% of our economy. The highly leveraged nature of Lehman led the bank to request security from the Bank of England. This in turn led to investor panic and a bank run in mid-September 2007(journals of bankers, 1 quarterly report, 2008). Over 100 of mortgage lenders went bankrupt during 2007-2008. The crisis hit its peak in September and October 2008. As the result of that many lost their job which was evaluated 2.6 million and 129,000 jobs lost in Canada and 17033 approximate in Australia between Septembers to December 2008. Several major institutions failed, were acquired under duress, or were subject to government takeover. UBS stated on October 6 2007 that 2008 would see a clear global recession, with recovery unlikely for at least two years. The economist of the UBS announced that its beginning of the end has begun. The daily telegraph wrote in their article that ''The troubles in front of Britain is unexpectedly accurate similar to the 1930s, since prices of many assets - from shares to house prices - are falling at record rates [in Britain], but the value of the debt against which they are held remains unchanged'' (The daily telegraph January press release, journals 2009 the banker). The darkest day in the history of England which wiped off more than £50 billion London's blue-chip shares when it dropped by 215.5 points or can say that more than 4% in the stock market. More than 5000 Lehman staff in Britain was clearing their desks in the country's largest single loss of jobs. The effect of collapse was also seen on the worlds giant insurance company AIG as it was running out of the cash in order to cover its loses they asked the government to help them out of it reportedly to tune of $40 billion. The problem was that if the AIG would have directly affected countless of consumers and companies worldwide as a result the whole financial system would be affected as it was the web of complex financial deals.
Subprime mortgage means in finance those making loans that are in the riskiest category of consumer's mortgage. As it was associated to the subprime mortgage in which they offered an opportunity for borrowers to pay minus than the normal credit records for the home mortgage.