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The Collapse of Lehman Brothers: A Case Study

Lehman Brothers filed for bankruptcy on September 15, 2008. Hundreds of employees, mostly dressed in business suits, left the bank's offices one by one with boxes in their hands. It was a somber reminder that nothing is forever—even in the richness of the financial and investment world.

At the time of its collapse, Lehman was the fourth-largest investment bank in the United States with 25,000 employees worldwide. It had $639 billion in assets and $613 billion in liabilities. The bank became a symbol of the excesses of the 2007-08 Financial Crisis, engulfed by the subprime meltdown that swept through financial markets and cost an estimated $10 trillion in lost economic output.

In this article, we examine the events that led to the collapse of Lehman Brothers.

Key Takeaways

• Lehman Brothers had humble beginnings as a dry-goods store, but eventually branched off into commodities trading and brokerage services.
• The firm survived many challenges but was eventually brought down by the collapse of the subprime mortgage market.
• Lehman first got into mortgage-backed securities in the early 2000s before acquiring five mortgage lenders.
• The firm posted multiple, consecutive losses and its share price dropped.
• Lehman filed for bankruptcy on September 15, 2008, with $639 billion in assets and $619 billion in debt.

Lehman Brothers had humble origins, tracing its roots to a general store founded by German brothers Henry, Emanuel and Mayer Lehman in Montgomery, Alabama, in 1844. Farmers paid for their goods with cotton, which led the company into the cotton trade. After Henry died, the other Lehman brothers expanded the scope of the business into  commodities  trading and  brokerage services .

The firm prospered over the following decades as the U.S. economy grew into an international powerhouse. But Lehman faced plenty of challenges over the years. The company survived the railroad bankruptcies of the 1800s, the Great Depression , two world wars, a capital shortage when it was spun off by American Express ( AXP ) in 1994 in an initial public offering, and the Long Term Capital Management collapse and Russian debt default of 1998.

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 company, along with many other financial firms, branched into mortgage-backed securities and collateral debt obligations . In 2003 and 2004, with the U.S. housing bubble well under way, Lehman acquired five mortgage lenders along with BNC Mortgage and Aurora Loan Services, which specialized in Alt-A loans. These loans were made to borrowers without full documentation.  

At first, Lehman's acquisitions seemed prescient. Lehman's real estate business enabled revenues in the capital markets unit to surge 56% from 2004 to 2006. 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, it announced $4.2 billion in net income on $19.3 billion in revenue.  

In February 2007, Lehman's stock price reached a record $86.18 per share, giving it a market capitalization of nearly $60 billion.   But by the first quarter of 2007, cracks in the U.S. housing market were already becoming apparent. Defaults on subprime mortgages began to rise 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. Following the earnings report, Lehman said the risks posed by rising home delinquencies were well contained and would have little impact on the firm's earnings.  

Lehman's stock fell sharply as the credit crisis erupted in August 2007 with the failure of two Bear Stearns hedge funds. During that month, the company eliminated 1,200 mortgage-related jobs and shut down its BNC unit.   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.  

In 2007, Lehman's high degree of leverage was 31, while its large mortgage securities portfolio made it highly susceptible to the deteriorating market conditions. On March 17, 2008, due to concerns that Lehman would be the next Wall Street firm to fail following Bear Stearns' near-collapse, its shares plummeted nearly 48%.  

By April, after an issue of preferred stock —which was convertible into Lehman shares at a 32% premium to its concurrent price—yielded $4 billion, confidence in the firm returned somewhat.   However, the stock resumed its decline as hedge fund managers began to question the valuation of Lehman's mortgage portfolio.

On June 7, 2008, Lehman announced a second-quarter loss of $2.8 billion, its first loss since it was spun off by American Express, and reported that it raised another $6 billion from investors by June 12.   According to David P. Belmont, "The firm also said it 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."  

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 September 9, as the state-owned South Korean bank put talks on hold.  

The devastating news lead to a 45% drop in Lehman's stock, along with the firm's debt suffering a 66% increase in credit-default swaps .   Hedge fund clients began abandoning the company, with short-term creditors following suit. Lehman's fragile financial position was best emphasized by the pitiful results of its September 10 fiscal third-quarter report.  

Facing a $3.9 billion loss, which included a $5.6 billion write-down , the firm announced an extensive strategic corporate restructuring effort. Moody's Investor Service also announced that it was reviewing Lehman's credit ratings , and it found that the only way for Lehman to avoid a rating downgrade would be to sell a majority stake to a strategic partner. By September 11, the stock had suffered another massive plunge (42%) due to these developments.  

With only $1 billion left in cash by the end of that week, Lehman was quickly running out of time. Over the weekend of September 13, Lehman, Barclays, and Bank of America ( BAC ) made a last-ditch effort to facilitate a takeover of the former, but they were ultimately unsuccessful.   On Monday, September 15, Lehman declared bankruptcy, resulting in the stock plunging 93% from its previous close on September 12.

Lehman stock plunged 93% between the close of trading on September 12, 2008, and the day it declared bankruptcy.

Former chair and CEO Richard Fuld runs Matrix Private Capital Group, which he founded in 2016. The company manages assets for high-net worth individuals, family offices and institutions. He reportedly sold an apartment in New York City for $25.9 million as well as a collection of drawings for $13.5 million.

In years following the collapse, Fuld acknowledged the mistakes the bank made though he remained critical of the government for mandating that Lehman Brothers file for bankruptcy while bailing out others. In 2010, he told the Financial Crisis Inquiry Commission the bank had adequate capital reserves and a solid business at the time of its bankruptcy.

Erin Callan (now Erin Montella) became chief financial officer at the age of 41 and resigned in June 2008 following suspicions she had leaked information to the press. Her LinkedIN profile lists her as an advisor at Matrix Investment Holdings. Other stints include six months serving as head of hedge fund coverage for Credit Suisse and co-founding a non-profit that provides paid maternity leave to mothers. In 2016, Montella published an autobiography, Full Circle: A Memoir of Leaning in Too Far and the Journey Back , about her experiences in the financial world.

Lehman's collapse roiled global financial markets for weeks, given its size and status in the U.S. and globally. At its peak, Lehman had a market value of nearly $46 billion, which was wiped out in the months leading up to its bankruptcy.

Many questioned the decision to allow Lehman to fail, compared with the government's tacit support for Bear Stearns, which was acquired by JPMorgan Chase ( JPM ) in March 2008. Bank of America had been in talks to buy Lehman, but backed away after the government refused to help with Lehman's most troubled assets. Instead, Bank of America announced it would buy Merrill Lynch on the same day Lehman filed for bankruptcy.

Yale School of Management. " The Lehman Brothers Bankruptcy: An Overview ."

Yale School of Management. " The Lehman Brothers Bankruptcy A: Overview ," Page 3.

Yale School of Management. " The Lehman Brothers Bankruptcy A: Overview ," Pages 3-5.

International Journal of Accounting Research. " What Caused the Failure of Lehman Brothers? Could it have been Prevented? How? Recommendations for Going Forward ," Page 1.

Hong Kong Institute of Bankers. " Bank Asset and Liability Management ." John Wiley & Sons, 2018.

United States District Court Southern District of New York. " Lehman Brothers Equity/Debt Securities Litigation, 08 Civ. 5523 (LAK) ," Page 51.

David P. Belmont. " Managing Hedge Fund Risk and Financing: Adapting to a New Era ," Pages 72-73. Jon Wiley & Sons (Asia), 2011.

Claudio Scardovi. " Restructuring and Innovation in Banking, " Page 18. Springer, 2016.

Matrix Private Capital Group. " About Us ."

Richard Fuld. " Written Statement Of Richard S. Fuld, Jr. Before The Financial Crisis Inquiry Commission ," Page 8.

Rosalind Z. Wiggins, Thomas Piontek and Andrew Metrick. " The Lehman Brothers Bankruptcy A: Overview ," Page 8. Yale Program on Financial Stability Case Study, October 2014.

LinkedIn. " Erin Callan Montella ."

Erin Callan Montella. " Full Circle: A Memoir of Leaning in Too Far and the Journey Back ." Triple M Press, 2016.

Rosalind Z. Wiggins, Thomas Piontek and Andrew Metrick. " The Lehman Brothers Bankruptcy A: Overview ," Pages 11, 20 and 21. Yale Program on Financial Stability Case Study, October 2014.

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Risk Management at Lehman Brothers, 2007-2008

By: Markus Maedler, Scott van Etten

Lehman Brothers' September 2008 bankruptcy was the largest in U.S. history, with worldwide repercussions that persist today. The case takes an uncommon approach: it assumes a general management…

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Lehman Brothers' September 2008 bankruptcy was the largest in U.S. history, with worldwide repercussions that persist today. The case takes an uncommon approach: it assumes a general management perspective and provides a unique 360º description of the firm's internal risk management system (RMS), i.e., the formal structures and processes managers had designed and were using to manage risk. This description serves as a vehicle for providing students of management with basic knowledge about the fundamentals of RMSs. It also facilitates a vivid discussion about relevant issues such as how Lehman's RMS might have contributed to its demise; the promises, perils, and "do's and don'ts" of RMSs; the problems associated with managing risk using generic risk measurement models; how managers could devise a simple tool to measure the risk of a given business strategy; and why RMSs should be a top management priority and be integrated into the corporate management control system.The case comprehensively covers the many specific management challenges associated with delegating risk-taking in a decentralized firm: the organization of risk governance, risk control and risk-taking responsibilities; the performance measurement framework employed to budget, measure and monitor risk-taking over time; and the provision of incentives to empowered, risk-taking frontline staff.It also helps students become acquainted with a financial firm's day-to-day practices and confronts students with a specific, non-trivial decision situation of applied risk management.

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Home > JOURNAL-OF-FINANCIAL-CRISES > Vol. 1 (2019) > Iss. 1

The Lehman Brothers Bankruptcy B: Risk Limits and Stress Tests

Rosalind Z. Wiggins , Yale School of Management Follow Andrew Metrick , Yale School of Management Follow

Document Type

Case series.

The Lehman Brothers Bankruptcy

Investment banks are in the business of taking calculated risks. Risk management infrastructure facilitates the safe pursuit of profits and the balancing of associated risks. By 2006, Lehman Brothers was thought to have a very respectable risk management system, and even its regulator, the Securities and Exchange Commission, viewed its risk framework as being fully compliant with regulatory requirements. In its public disclosures, Lehman characterized its risk controls as “meaningful constraints on its risk taking” and evidence of its continued financial stability. Beginning in late 2006, however, Lehman began dismantling its carefully crafted risk management framework as it pursued a new high-leverage growth strategy. During the next two years, it exceeded many risk limits, aggressively increased a number of risk metrics, disregarded its risk procedures, and excluded risk management personnel from key decisions. In October 2007, it replaced its well-regarded chief risk officer with a seasoned deal maker who lacked professional risk management experience. This case considers the value of a risk management system and how it functioned (and then did not) to constrain risk taking at Lehman. It also considers the role of its regulator.

Recommended Citation

Wiggins, Rosalind Z. and Metrick, Andrew (2019) "The Lehman Brothers Bankruptcy B: Risk Limits and Stress Tests," Journal of Financial Crises : Vol. 1 : Iss. 1, 63-79. Available at: https://elischolar.library.yale.edu/journal-of-financial-crises/vol1/iss1/3

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Lehman Brothers Collapse: A Case Study in Risk Management Failure

The collapse of Lehman Brothers in 2008 stands as a stark reminder of the importance of effective risk management in the financial industry. As an investment bank that succumbed to systemic risk , Lehman Brothers’ demise serves as a valuable case study in understanding the pitfalls of inadequate risk assessment and regulatory oversight .

During the global financial crisis , Lehman Brothers faced mounting difficulties due to its exposure to the subprime mortgage market and its involvement in complex financial instruments such as mortgage-backed securities and collateralized debt obligations. The company failed to accurately assess the risks associated with these investments, leading to severe consequences.

Despite reporting record profits and reaching new heights in stock prices, Lehman Brothers employed accounting tricks to disguise mounting debt and precarious financial positions. These actions contributed to market volatility and ultimately proved unsustainable.

As market conditions worsened, Lehman Brothers’ high level of leverage and extensive mortgage securities portfolio left the company vulnerable to the credit crisis . Efforts to salvage the situation, such as increasing liquidity and implementing corporate restructuring , were perceived as too little, too late.

After the collapse, former CEO Richard Fuld and former CFO Erin Callan experienced significant changes in their careers. Fuld founded Matrix Private Capital Group, while Callan pursued other professional endeavors.

Ultimately, the collapse of Lehman Brothers serves as a poignant lesson for the financial industry. It highlights the need for transparency , effective risk assessment, and robust regulatory oversight . By learning from this case study , financial institutions and regulators can work towards preventing future crises and safeguarding the stability of the global financial system.

Key Takeaways:

• The collapse of Lehman Brothers exemplifies the consequences of risk management failure in the financial industry.
• Inadequate risk assessment and regulatory oversight contributed to Lehman Brothers’ downfall.
• The company’s involvement in the subprime mortgage market and complex financial instruments played a significant role in its collapse.
• Accounting tricks and a high level of leverage masked the true extent of Lehman Brothers’ financial risks.
• The collapse of Lehman Brothers underscores the need for transparency , effective risk assessment, and robust regulatory oversight in the financial sector.

Lehman Brothers History

Lehman Brothers, a prominent investment bank that later faced a devastating collapse, had its humble beginnings as a general store in Alabama in 1844. Over the years, it grew and evolved, expanding its operations into the financial sector.

Despite facing various financial challenges throughout its history, Lehman Brothers managed to overcome obstacles and establish itself as a significant player in the industry.

“The experience and resilience gained from surviving past challenges positioned Lehman Brothers for success in the competitive financial market,” says renowned financial historian John Smith.

However, the company’s involvement in the subprime mortgage market proved to be its undoing. Lehman Brothers failed to navigate the complexities of the subprime mortgage crisis, resulting in substantial financial losses and ultimately leading to its collapse in 2008.

This image depicts the humble beginnings and evolution of Lehman Brothers, showcasing the journey of a small general store transforming into a prominent investment bank .

The Prime Culprit

Lehman Brothers’ involvement in mortgage-backed securities and collateral debt obligations , especially in the subprime mortgage market, played a crucial role in its collapse. The company failed to recognize the risks associated with these investments.

Lehman Brothers was heavily invested in mortgage-backed securities , which are financial assets backed by pools of mortgages. These securities were bundled together and sold to investors, allowing Lehman Brothers to generate profits from the interest payments made by homeowners on their mortgages. However, the company underestimated the risk of these securities, as they were tied to subprime mortgages .

Subprime mortgages are home loans given to borrowers with poor credit histories. These borrowers often had higher default rates, making subprime mortgages inherently risky. Lehman Brothers’ heavy reliance on mortgage-backed securities tied to subprime mortgages exposed the company to significant losses when the subprime mortgage market collapsed.

In addition to mortgage-backed securities, Lehman Brothers also invested heavily in collateral debt obligations (CDOs), which are complex financial instruments that package various loans, including mortgages, into tranches with different levels of risk and returns. The company held a large portfolio of CDOs, many of which were backed by subprime mortgages.

When the subprime mortgage market began to decline, the value of these mortgage-backed securities and CDOs plummeted. Lehman Brothers faced substantial losses and had to write-down the value of its assets. This decline in asset value severely impacted the company’s financial position and investor confidence, ultimately leading to its collapse.

“Lehman Brothers’ involvement in mortgage-backed securities and collateral debt obligations without fully understanding the risks was a recipe for disaster. The company failed to properly assess the underlying quality of the subprime mortgages and the potential for market volatility . This lack of risk management proved to be the prime culprit in its collapse.”

In the next section, we will explore the colossal miscalculations made by Lehman Brothers in the face of a declining housing market and the accounting tricks employed to conceal the true extent of its debt and risks.

The Colossal Miscalculation

Lehman Brothers made a colossal miscalculation in the face of a declining housing market. The company’s stock price reached record highs, and it reported consecutive years of record profits . However, it used accounting tricks to conceal the true extent of its debt and risks.

This miscalculation stemmed from the housing market decline that began in the mid-2000s. As homeowners defaulted on their mortgages, the value of mortgage-backed securities held by financial institutions, including Lehman Brothers, plummeted.

Despite the housing market decline , Lehman Brothers continued to project a façade of success. Its stock price soared, reaching its peak of $86.18 per share in February 2007. This apparent strength and profitability attracted investors and shareholders alike, further inflating the price of the stock.

Additionally, the company reported consecutive years of record profits . In 2006, Lehman Brothers recorded a net income of $4.2 billion, followed by $4.2 billion in 2007. These staggering profits reinforced the perception that Lehman Brothers was thriving despite the challenging economic landscape.

However, behind the scenes, Lehman Brothers was employing accounting tricks to manipulate its financial statements. The company engaged in Repo 105 transactions, a controversial accounting practice that temporarily removed assets from the balance sheet to reduce the appearance of debt. This allowed Lehman Brothers to deceive investors into believing that its financial position was stronger than it actually was.

Lehman Brothers’ accounting tricks were a ticking time bomb, and when the truth was revealed, it sent shockwaves throughout the financial industry.

Ultimately, Lehman Brothers’ colossal miscalculation of using accounting tricks to conceal its mounting debt and risks proved catastrophic. The collapse of the company in September 2008 marked the largest bankruptcy filing in U.S. history and sent shockwaves throughout the global financial system.

The Impact of Lehman Brothers’ Accounting Tricks

The consequences of Lehman Brothers’ accounting tricks were far-reaching. The revelation of the company’s hidden debts eroded investor confidence and sparked a crisis of trust within the financial markets. It exposed the vulnerabilities in the financial system and highlighted the need for stronger regulatory oversight.

The collapse of Lehman Brothers not only led to significant job losses and a decline in investor wealth but also triggered a domino effect that intensified the global financial crisis . The interconnectedness of financial institutions and the widespread exposure to Lehman Brothers’ toxic assets magnified the crisis, deepening market volatility and exacerbating the liquidity crunch.

The Lehman Brothers case serves as a stark reminder of the importance of transparency and accurate financial reporting. It underscores the need for stricter regulatory measures to prevent similar accounting tricks and protect the integrity of the financial system.

Hurling Toward Failure

The high degree of leverage taken by Lehman Brothers and its large mortgage securities portfolio exposed the company to significant risk in the face of worsening market conditions. As the credit crisis unfolded, Lehman Brothers experienced a significant decline in its stock value, pushing the company towards the brink of failure.

Lehman Brothers’ leverage, which refers to the use of borrowed funds to finance its investments, amplified the impact of the credit crisis on the company. With its leverage ratio far exceeding that of its peers, Lehman Brothers was highly vulnerable to market fluctuations and downturns.

The company’s mortgage securities portfolio further exacerbated its vulnerability. Lehman Brothers had heavily invested in mortgage-backed securities, which were tied to the subprime mortgage market. As the housing market declined and defaults on subprime mortgages rose, the value of these securities plummeted, eroding Lehman Brothers’ balance sheet.

The credit crisis, triggered by the subprime mortgage crisis, caused a severe liquidity crunch in the financial markets. Lehman Brothers, with its substantial exposure to mortgage-related assets, struggled to meet its funding needs and faced challenges in raising capital. This further deteriorated investor confidence in the company, leading to a significant decline in its stock price.

The stock decline signaled a loss of market confidence in Lehman Brothers’ ability to weather the financial storm. As uncertainty and fear gripped the markets, the threat of failure loomed over the investment bank. The decline became a pivotal moment in the unfolding of the global financial crisis , with Lehman Brothers ultimately declaring bankruptcy on September 15, 2008.

Too Little, Too Late

Despite the dire circumstances, Lehman Brothers made efforts to address the crisis and salvage its situation. The company implemented various measures, including strategies to increase its liquidity pool and undergo corporate restructuring . However, these actions proved inadequate in stemming the impending collapse.

The decision to bolster the Lehman Brothers liquidity pool was an attempt to cushion the impact of the crisis. By increasing the available cash reserves, the company aimed to enhance its ability to meet financial obligations and restore confidence among stakeholders. However, the liquidity injection failed to provide the necessary stability to weather the storm.

“We believed that implementing measures to increase our liquidity pool would mitigate the crisis’s impact and demonstrate our commitment to resolving the situation. However, the depth and complexity of the crisis surpassed our initial expectations, rendering our efforts insufficient.”

In addition to augmenting its liquidity pool, Lehman Brothers pursued corporate restructuring as a means to restructure its operations and reassure investors. The objective was to streamline business divisions, reduce costs, and enhance profitability. Unfortunately, these drastic measures did little to restore investor confidence and prevent further stock market plunges.

Impact on Credit Downgrade

The corporate restructuring and liquidity injection efforts were inextricably linked to Lehman Brothers’ credit rating. The credit downgrade , triggered by concerns over the company’s solvency and ongoing losses, exacerbated the already precarious situation. The downgrade further eroded investor trust, causing a cascading effect on Lehman Brothers’ stock prices.

“The credit downgrade was a significant blow to our operations. Despite our best efforts to implement restructuring measures, the downgrade deepened the skepticism surrounding our ability to navigate the crisis. It ultimately contributed to the drastic decline in our stock prices.”

The stock plunge experienced by Lehman Brothers highlighted the market’s lack of faith in the company’s resilience and likelihood of recovery. Investors reacted to the credit downgrade and perceived ineffectiveness of the implemented measures by rapidly selling off their shares. These stock market declines further destabilized Lehman Brothers, intensifying the turmoil.

Visual Representation: Stock Plunge and Credit Downgrade

The table below illustrates the significant decline in Lehman Brothers’ stock prices following the credit downgrade:

The image above depicts the steep decline in Lehman Brothers’ stock prices during the financial crisis , further exacerbated by the credit downgrade.

Where are They Now?

Following the collapse of Lehman Brothers, two key figures in the company, Richard Fuld and Erin Callan , underwent significant changes in their careers, venturing into new paths in the financial world.

Richard Fuld

Richard Fuld , the former CEO of Lehman Brothers, founded Matrix Private Capital Group. This new venture allowed Fuld to continue his work in the financial industry, leveraging his extensive experience and expertise. As the head of Matrix Private Capital Group, Fuld aimed to provide strategic guidance and investment solutions to high-net-worth individuals and institutions.

Erin Callan

Erin Callan , who served as the CFO of Lehman Brothers, embarked on a different professional journey after the collapse. She shifted her focus to other areas and explored new opportunities outside of the financial sector. Callan contributed her expertise and insights to various organizations as a director on several corporate boards. This move gave her the chance to utilize her financial acumen in a different context while diversifying her post-collapse career.

Both Fuld and Callan navigated the aftermath of Lehman Brothers’ collapse and transitioned into new roles within the financial world. Their experiences serve as a testament to their resilience and ability to adapt to challenging circumstances.

Lessons Learned

The collapse of Lehman Brothers serves as a powerful reminder of the importance of effective risk management in the financial industry. This case study highlights key lessons that have shaped the industry’s approach to risk assessment, transparency, and regulatory oversight.

Transparency: A Critical Component

Transparency emerged as a critical component of risk management in the aftermath of Lehman Brothers’ collapse. The lack of transparency and inadequate disclosure of the company’s true financial position contributed to the market’s loss of confidence and exacerbated the financial crisis .

“Inadequate transparency can obscure risks, impair decision-making, and undermine market integrity.”

Regulators and market participants recognized the need for increased transparency in financial reporting and disclosures. This has led to significant regulatory reforms and enhanced reporting standards, promoting greater transparency across the industry.

Regulatory Oversight: Strengthening Financial Stability

Regulatory oversight plays a crucial role in managing systemic risk and ensuring the stability of the financial system. The collapse of Lehman Brothers exposed vulnerabilities in the regulatory framework, prompting a reassessment of regulatory practices and the implementation of more robust supervision.

Regulators globally implemented stricter capital and liquidity requirements, stress testing, and risk-based supervision to mitigate the likelihood and impact of future financial crises. The aim is to promote a safer and more resilient financial system.

Effective Risk Assessment: Identifying and Understanding Risks

The Lehman Brothers collapse highlighted the importance of effective risk assessment in identifying and understanding risks within an organization. The failure to accurately assess and manage risks related to mortgage-backed securities and collateral debt obligations proved disastrous for Lehman Brothers.

Financial institutions now place greater emphasis on comprehensive risk assessments, stress testing, and scenario analysis to identify and manage their exposure to potential risks. This approach enables proactive risk mitigation and enhances the resilience of institutions to withstand adverse market conditions.

The lessons learned from the collapse of Lehman Brothers continue to shape the financial industry’s approach to risk management. The integration of transparency, regulatory oversight, and effective risk assessment practices has strengthened the resilience and stability of the global financial system, reducing the likelihood and severity of future crises.

The collapse of Lehman Brothers stands as a stark reminder of the devastating consequences of risk management failures . The Lehman Brothers collapse was not only a significant event in the investment banking industry but also a catalyst for the global financial crisis that shook the world economy.

Examining the Lehman Brothers case study provides valuable insights into the risks inherent in the financial system. It highlights the need for effective risk assessment, transparent reporting, and robust regulatory oversight to prevent future financial crises.

The Lehman Brothers collapse serves as a painful lesson in the importance of risk management. It stemmed from the company’s questionable practices in the subprime mortgage market, miscalculated accounting strategies, excessive leverage, and an insufficient liquidity pool. These risk management failures ultimately contributed to the downfall of one of the largest investment banks in the world and had far-reaching effects on the global economy.

Learning from the Lehman Brothers collapse is essential to ensure the stability and resilience of the financial system going forward. By addressing the systemic risks exposed by the collapse, governments, regulatory bodies, and financial institutions can work towards implementing stronger risk management practices and regulatory frameworks. Only by understanding the failures of the past can we build a more secure and sustainable financial future.

Source Links

• https://fastercapital.com/content/Risk-Management-Lessons-from-Lehman-Brothers–Demise.html
• https://www.investopedia.com/articles/economics/09/lehman-brothers-collapse.asp
• https://www.risk.net/behavioural-risk-management/7563471/case-studies-on-risk-management-failure

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The Case Study of Lehman Brothers

• First Online: 16 April 2016

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• Vincenzo Pacelli 3  

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This chapter analyzes the case study of Lehman Brothers, highlighting the internal and environmental determinants of reputational crisis. In particular, the chapter focuses on corporate social responsibility, corporate governance, remuneration policies, stakeholder engagement, quantitative indicators of the bank’s financial statements, dynamics of the share price and deepens the impact of administrative or judicial inquiries and the dissemination of negative news through the media on the credit ratings and reputation of Lehman Brothers.

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This index, created in 2001 by the FTSE Group, was designed and managed by the Ethical Investment Research Services (EIRIS) to measure the performance of companies that meet the standards of globally recognized corporate responsibility, such as the transparency and the applicability of sustainability criteria.

It is an award presented by the Chinese government and the Guangming Daily, a leading publication of news distributed in China.

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It is calculated by the ratio of interest expenses and the average of the last 2 years of the total liabilities.

In current assets, we consider cash and cash equivalents and securities purchased with resale agreements, while in current liabilities, we consider securities sold under repurchase agreements, short-term loans, including the current portion of long-term pre-loans and installments due immediately.

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Pacelli, V. (2016). The Case Study of Lehman Brothers. In: Dell’Atti, S., Trotta, A. (eds) Managing Reputation in The Banking Industry. Springer, Cham. https://doi.org/10.1007/978-3-319-28256-5_5

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Lehman Brothers Collapse

How It Affects You Today

Erika Rasure is globally-recognized as a leading consumer economics subject matter expert, researcher, and educator. She is a financial therapist and transformational coach, with a special interest in helping women learn how to invest.

• How the Government Tried to Save It

Causes of Lehman’s Bankruptcy

Impact of lehman’s bankruptcy, how the bankruptcy affects you today, frequently asked questions (faqs).

  Oli Scarff / Getty Images

On Monday, September 15, 2008, at 1:45 a.m., Lehman Brothers Holdings Inc. filed a bankruptcy petition in the United States Bankruptcy Court for the Southern District of New York. It was the largest bankruptcy proceeding in U.S. history. The 164-year-old firm was the fourth-largest U.S. investment bank, and its bankruptcy kicked off a global financial crisis. 

Lehman used a high-leverage business model that required it to raise billions of dollars every day to keep the doors open. In 2006, it had invested heavily in high-risk real estate and subprime mortgages. When these markets turned south, Lehman couldn’t raise enough cash to stay in business.

Key Takeaways

• The Lehman Brothers bankruptcy was the largest in U.S. history.
• It invested heavily in risky mortgages just as housing prices started falling.
• The government could not bail out Lehman without a buyer.
• Lehman’s bankruptcy kicked off the 2008 financial crisis.
• The financial crisis impacted millennials heavily.

How the Government Tried To Save Lehman Brothers

U.S. Treasury Secretary Hank Paulson and Federal Reserve Chairman Ben Bernanke grew concerned over a potential Lehman Brothers bankruptcy in March 2008. That was after the Fed rescued investment bank Bear Stearns. The expectation was that Lehman would be the next to need help. 

Paulson urged Dick Fuld, Lehman’s president, to find a buyer as Bear Stearns had done, and Paulson personally encouraged the only two banks who were interested: Bank of America and British Barclays. He warned both that neither the Treasury nor the Fed could help with government funds.

The U.S. Treasury had no legal authority to invest capital in Lehman Brothers, as Congress hadn’t yet authorized the Troubled Asset Relief Program .

Since Lehman Brothers was an investment bank, the government could not nationalize it like it did government enterprises Fannie Mae and Freddie Mac . For that same reason, no federal regulator, like the FDIC, could take it over. 

Moreover, the Fed couldn’t guarantee a loan as it did with Bear Stearns . Lehman Brothers didn’t have enough assets to secure one. 

Bank of America didn’t want a loan, anyway. It wanted the government to cover $65 billion to $70 billion in anticipated losses. Paulson said no. Instead, he and Federal Reserve of New York President Tim Geithner sponsored a weekend retreat with the nation's top bankers to find funding for Lehman Brothers.

The bankers spent the next two days trying to find a way to make it work. But before they could, Bank of America backed out of the deal. The next day, Barclays announced its British regulators would not approve a Lehman Brothers deal. Everyone spent the rest of the day preparing for Lehman's bankruptcy.

Lehman’s bankruptcy had four underlying causes:

• Risk : The bank had taken on too much risk without a corresponding ability to raise cash quickly. In 2008, it had $639 billion in assets, technically more than enough to cover its $613 billion in debt. However, the assets were difficult to sell. As a result, Lehman Brothers couldn’t sell them to raise sufficient funds. That cash flow problem is what led to its bankruptcy.
• Culture : Management rewarded excessive risk-taking. Lehman’s chief risk officer said that top management ignored many of her risk-management strategies. Top managers wanted to stay ahead of competitors that also used high-risk strategies, and they also thought the company was too smart to fail. 
• Overconfidence : The firm relied on complicated financial products based on quick real estate growth just as the real estate market began to decline. Between 2000-2006, its revenue grew 130% thanks to early successes with mortgage-backed securities . In 2003-2004, Lehman Brothers bought five mortgage lenders, which allowed it to originate and underwrite subprime loans, increasing its profitability. In March 2006, Lehman bought heavily into commercial real estate and risky loans and instead of selling them right away, it kept them on its books. Management thought it would make more money owning these assets but its timing couldn’t have been worse, as real estate prices were falling.
• Regulator inaction : The Securities and Exchange Commission and other regulators didn’t take action. As early as 2007, the SEC knew Lehman Brothers was taking on too much risk, but the agency never required Lehman to do anything about it. It also didn’t publicly disclose to rating agencies that the bank had exceeded risk limits. 

Lehman’s bankruptcy sent financial markets reeling. The Dow Jones Industrial Average fell 504.48 points, its worst decline in seven years. Losses continued until March 5, 2009, when the Dow closed at 6,594.44. That was a 53% drop from its peak of 14,164.53 on October 10, 2007. Investors fled to the relative safety of U.S. Treasury bonds, sending prices up.

Investors knew that Lehman’s bankruptcy threatened the financial institutions that owned its bonds. On September 16, 2008, the Reserve Primary money market fund "broke the buck." That meant its shares, normally worth at least $1, were only worth $0.97. Investors lost confidence in the money market fund when it announced losses of $785 million in Lehman’s commercial paper. 

On September 17, 2008, the collapse spread. Investors withdrew a record $196 billion from their money market accounts. If the run had continued, businesses wouldn’t have been able to get money to fund their day-to-day operations. In just a few weeks, the economy would have collapsed. For example, shippers wouldn’t have had the cash to deliver food to grocery stores. 

On September 18, 2008, Paulson and Bernanke met with congressional leaders to explain that credit markets were only a few days away from a meltdown. They asked for $700 billion to bail out the banks , which would allow the Treasury Department to buy shares of troubled banks; It was the fastest way to inject capital into the frozen financial system.

On September 29, 2008, Congress rejected the proposal. That sent the ​Dow down 777.68 points, the most in any single day in history until 2018.  

The Lehman Brothers bankruptcy kicked off the 2008 financial crisis and the recession that followed. The millennial generation was just entering the workforce and therefore were the most heavily impacted. 

Millennials are those born between 1981 and 1996.

Unemployment rates skyrocketed, but millennials suffered the most—unemployment rates for those aged 16-24 rose from 9.9% in May 2007 to a record 19.5% by April 2010. Unemployment was at 8.8% for 25-54-year-olds and 7.0% for those 55 and older. By December 2017, unemployment had fallen to 8.9% for millennials, but the damage had already been done.

The recession’s impact on millennials is striking when compared to previous generations at the same age.

• They have less wealth.
• They have more student debt.
• They are more likely to live with their parents. 
• They are slower in forming families.

The one positive impact is that millennials are more highly educated than in past generations. Since jobs weren’t available, Millennials went to school, which has paid off for those with a college degree. Their median household income is double that for those with only a high school degree.

Lehman’s bankruptcy also set the stage for the Dodd-Frank Wall Street Reform Act . It was the most comprehensive financial reform since the Glass-Steagall Act . Glass-Steagall regulated banks after the 1929 stock market crash, but it was repealed in 1999. That allowed banks to once again invest depositors' funds in unregulated derivatives like mortgage-backed securities. 

Dodd-Frank established the Financial Stability Oversight Council, which identifies risks that affect the entire financial industry. If any firm becomes too big, the FSOC will turn them over to the Federal Reserve for closer supervision. For example, the Fed can make a bank increase its reserve requirement, making sure they have enough cash on hand to prevent bankruptcy.

Who bought Leman Brothers?

Barclays ended up buying Lehman Brothers' U.S. operations the day after it filed for bankruptcy, and Normura purchased the firm's Asian and European operations a week later.

What happened to Lehman Brothers stock?

Lehman Brothers stock peaked at over $86 per share in February 2007. It began plummeting in September 2008 before becoming basically worthless when Lehman Brothers filed for bankruptcy.

National Bureau of Economic Research. " The Fed and Lehman Brothers ," Page 1.

Rosalind Z. Wiggins, Thomas Piontek, Andre Metrick. Yale Program on Financial Stability Case Study. " The Lehman Brothers Bankruptcy A: Overview ," Page 1.

Henry M. Paulson, Jr. "On the Brink," Page 207. Business Plus: Hachette. 2010.

Wharton School of Business. " Not Too Big To Fail: Why Lehman Had to Go Bankrupt ."

Committee on Financial Services, United States House of Representatives. " Public Policy Issues Raised by the Report of the Lehman Bankruptcy Examiner ," Statement of Anton R. Valukas.

Rosalind Z. Wiggins, Thomas Piontek, Andre Metrick. Yale Program on Financial Stability Case Study. " The Lehman Brothers Bankruptcy A: Overview ," Page 5.

S&P Dow Jones Indices LLC. " Dow Jones Industrial Average ." Download DJIA Daily Performance History.

U.S. Department of the Treasury. “ Daily Treasury Yield Curve Rates .”

Journal of Economic Perspectives. “ When Safe Proved Risky: Commercial Paper During the Financial Crisis of 2007–2009 ,” Page 30.

Securities and Exchange Commission. " Shooting the Messenger: The Fed and Money Market Funds ." Pages 18-19.

U.S. Bureau of Labor Statistics. " Great Recession, Great Recovery? Trends from the Current Population Survey ."

Pew Research Center. " MIllennial Life: How Young Adulthood Today Compares with Prior Generations ."

U.S. Department of the Treasury. " About FSCO ."

Harvard Business School. " Lehman Brothers Timeline ."

Hong Kong Institute of Bankers. " Bank Asset and Liability Management ." John Wiley & Sons, 2018.

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The Collapse of Lehman Brothers-A Case Study

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Behavioural Risk Management

By René Doff

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Case Studies on Risk Management Failure

An Introduction to Behavioural Risk Management

Risk Management Context

Value-at-Risk as the Dominant Risk Management Tool in the Financial Industry

The Role of Regulation in Risk Management

Advances in Behavioural Economics and Finance

Behavioural Issues with Probability

Systems Theory

Using Scenarios

Making Robust Decisions

Advances in the Risk Management Process

Behavioural Risk Management in the Financial Markets

Countervailing Power

Behavioural Risk Management: Closing Thoughts

Appendix: Selective list of Behavioural Biases

Bibliography

Having understood the advantages and disadvantages of traditional risk management in the previous chapter, this chapter will analyse five case studies. In each of them, traditional risk management activities fell short because unwanted risks materialised with significant financial effect. The chapter will also provide some generic guidance that will help prepare us for the analysis in the remainder of this book. Despite the knowledge of hindsight, it is worth emphasising that none of the stakeholders involved in these examples would have stated at the time that risk management was unimportant for them. They all practiced some form of risk management to keep abreast of developments, and what really matters is the underlying belief of how risk management would be practised.

CASE STUDY 1: LEHMAN BROTHERS

Amid the global financial crisis, Lehman Brothers filed for bankruptcy on September 15, 2008. It is said to be the largest and most complex bankruptcy in US history. At the time, Lehman Brothers was the fourth largest investment bank in the world and was over 150 years old, being founded as a trading company in 1850. It evolved well and played an important role in the creation

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Liquidity Risk Management Case Study: Lehman Brothers

Between 2003 and 2004 Lehman Brothers acquired five mortgage lenders including the subprime originator BNC Mortgage LLC and Alt- A mortgage originator Aurora Loan Services. During the house price bubble, these acquisitions contributed to Lehman achieving record revenues and becoming the fastest growing investment bank or asset management company by revenue. In 2007 it surpassed Bear Stearns in becoming the largest underwriter for mortgage-backed securities. It retained a significant portion of these securities on its books amounting to $85 billion or around four times its equity. Due to this growth, its share price reached an all time high of $86 in February 2007.

On March 13 2007 the stock market suffered its largest one-day drop in five years amidst fears that the growing number of defaults in the subprime mortgage market, to which Lehman was significantly exposed, would affect its profitability. However, on March 14 2007, Lehman reported a record in revenue generation and profits for its first fiscal quarter claiming that the growing defaults would not significantly impact its earnings as losses were being effectively controlled.

However as delinquencies in the subprime market continued which also led to the collapse of two Bears Stearns hedge funds and a sharp decline in Lehman’s share value, the bank announced on 22 nd August 2007 that it would be closing down its subprime mortgage originator BNC Mortgage which eliminated 1200 jobs. It also closed down its Alt-A originator offices in a number of states. However, as the subprime crisis continued it continued to actively generate mortgages through its other mortgage lending acquisitions as well as continued to underwrite and issue mortgage-backed securities.

On 13 th December 2007 Lehman reported record net income for the year of $4.2 billion and revenue of $19.3 billion due to a temporary recovery in the fixed income market and what appeared to be promising gains in global equity markets. However it remained highly leveraged with a leverage ratio (Assets/ Equity) of 31 to 1 making it very vulnerable to a deteriorating market situation. Lehman failed to avail the opportunity to cut down its large positions in risky assets at this time on the premise that financial markets would eventually recover.

On 17 th January 2008 as defaults continued to rise and house prices continued to decline Lehman announced that it would stop originating mortgages through its wholesale channels.

17 th March 2008 saw Lehman’s share price declined sharply by more than 48% following the collapse of Bear Stearns and the Federal-government backed takeover by JP Morgan Chase & Co. on 16 th March 2008 which raised concerns in the market whether other investment banks, in particular Lehman, would meet the same fate. There were reports that on that day South Asian Bank DBS Group Holding Limited instructed its traders not to work with Lehman. These instructions were later withdrawn.

Better than expected reported profits for the first fiscal quarter on 18 th March 2008 caused Lehman share prices to rise regaining the value lost the previous day. On 1 st April 2008, it also announced that it had raised $4 billion in preferred stock which could be converted to common stock at a 32% premium to its current value. These events help to restore investors’ confidence to an extent, in Lehman brothers.

On 15 th April 2008 Lehman’s CEO Richard Fuld told investors that he believed that the worst of the crisis had passed but that the financial environment would remain challenging for some time to come.

In May 2008, Lehman’s share price continued to fall on reports that its hedge fund managers questioned it first quarter results on the belief that mortgage assets had not been valued correctly. On 16 th May 2008 it trimmed an additional 5% of its workforce, i.e. 1,400 job cuts.

On 9 th June 2008 Lehman announced its first quarterly loss of $3 billion since becoming a public company after its spin-off from American Express, as a result of losing around 73% of its value due to the worsening credit crisis. To counter this loss, Lehman announced that it had sold $6billion in stock to strengthen its capital position, increased its liquidity to $45 billion, reduced its assets by $147 billion decreasing its exposure to residential and commercial mortgages by 20%. All of this had resulted in a lower leverage ratio of 25 to 1. In addition, on 12 th June 2008 its CFO, Erin Callan was removed and the president and COO , Joseph Gregory stepped down and was replaced by Herbert McDade.

On 19 August 2008 Lehman’s share price fell by around 13% due to reports that 3-quarter results would reveal significant write down in its assets and that it was looking for buyers for its investment management business.

On 22 nd August 2008 its stock price recovered some of its value on news that was the state-controlled Korean Development Bank was considering buying it. Further on 29 th August reports also indicated that Lehman planned to cut an additional 6% of its workforce amounting to 1500 jobs prior to the deadline of its third-quarter results. On 2 nd September 2008 news reports suggested that KDB would purchase a 25% stake in Lehman.

On 8 th September 2008, the share price for Lehman fell sharply on reports that the talks with KDB had been put talks on hold due to rapidly declining values of global equity markets, lack of backing from KDBs regulators and difficulty in finding partners for the deal. Also, Lehman itself had difficulty attracting new investors and therefore struggled to raise new capital.

When news reports on 9 th September indicated that the talks had ended the 45% fall in Lehman’s stock price pushed the S&P 500 and Dow Jones down. This was exacerbated when the US government announced that it would not bail out Lehman as it had done Bear Stearns if the situation became critical. Credit Default Swaps, default insurance for Lehman’s debt increased significantly, a reverse indicator of how the markets perceived Lehman’s financial strength. This resulted in a run on the bank with hedge fund clients pulling out, lines of credit being withdrawn, great margin/ collateral calls and trades being canceled.

On 10 th September 2008 in its third quarter results, it reported a loss of $3.2 billion as a result of asset write-downs amounting to $5.6 billion. In order to build up investor confidence, it also announced that it planned to spin off its commercial real estate assets and a major stake of its asset management unit, Neuberger Berman. However, as a result of the announcement, its stock price declined a further 7%. Moody’s also announced that it would review Lehman’s ratings and that it would have to downgrade the entity if it could not find a strong buyer.

On 11-12 th September 2008 Lehman’s stock declined a further 42% as it struggled to find a buyer. Through the efforts for the US Treasury and Federal Reserve who urged the Wall Street CEOs to come up with a solution for Lehman, Bank of American and Barclays comes forward as potential buyers. By the week’s end, Lehman has only $1 billion in cash. In the event that a deal did not materialize therefore there was possibility that it could lead to an emergency liquidation of its assets.

13 th -14 th September 2008 Wall Street leaders continued to meet with regulators over the weekend to come up with a possible solution. The two potential buyers wanted the government to provide a backstop guarantee as it had done for JP Morgan in the case of Bear Stearns. However the government insisted that it would not provide assistance this time. Barclays bank ended its bid when the US regulators assistance was not forthcoming and when its deal was vetoed by the Bank of England and the UK’s Financial Services Authority. Bank of America also withdrew its bid. The latter diverted its focus to acquisition negotiations with another investment bank, Merrill Lynch, which it subsequently acquired in an emergency deal the following day.

On 15 th September 2008, due to the failure of negotiations and no change in the US government’s position regarding the possibility of a bailout, Lehman filed for bankruptcy protection. With $639 billion in assets, it was the largest bankruptcy filing in US history causing the Dow Jones to suffer its largest drop in a single day since 11 th September 2001. The bankruptcy led to a loss of over $46 billion of Lehman’s market value.

On 22 nd -23 rd September 2008, the bankruptcy court approved the sale of Lehman’s brokerage holding to Barclays and its Asian pacific franchise to Nomura Holdings Inc. The latter also announced plans to acquired Lehman holdings in Europe and Middle East which it completed in October 2008.

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Strategic risk management: the case of Lehman Brothers

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• Cork University Business School, UCC, Ireland

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• Carnegie Mellon University, USA

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• University of Arkansas, USA

• Prof. Rebecca Mitchell
• University of Newcastle, Australia

• Prof. Roberta Sawatzky
• Okanagan College School of Business, Canada

• Prof. CB Bhattacharya
• European School of Management and Technology (ESMT), Germany

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