lehman brother crash

Presented By:

Hitesh Dutt - 20

Kuntal Datta - 25

Poorva Bhardwaj - 32

Sameer Kalra - 40

Crash

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The Company History

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.

Years Events1844 Dry-goods store1850 Lehman brothers

Early 1850’s Started to accept payment in cotton for goods and also created a secondary market for trading in cotton

1858 Trading in coffee Exchange and also the New York Stock Exchange

1899 Underwrote a public offering for the International Steam Pump Company

1906 Started underwriting some bigger public offerings.

1930s focus of Lehman went toward venture capital

1975 Firm merged with Kuhn, Loeb and Company to form at the time the 4th largest investment bank 04/08/2023

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Operating Principles

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Demonstrating a Commitment to Excellence

Ensuring That Their Organization Is a True Meritocracy

Demonstrating Smart Risk Management

Preserving and Strengthening the Culture

Always Acting With an Ownership Mentality

Building and Protecting Their Brand

Maximizing Shareholder Value

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Product & Services

Financial Services Investment Banking

Equity Trading Research

Investment Management Private banking Private equity

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Subprime????.....

Prime Lending Subprime Lending

Issued to borrowers with highly rated credit histories.

Issued to borrowers with low incomes and assets, and with troubled credit histories.

Low interest rate High Interest rate

Called A-paper credit Called B-paper credits

Typically, it is the poor and the young who form the bulk of sub-prime borrowers

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Why loans were given Real Estate Boom would allow even

people with dodgy credit backgrounds to repay on the loans they were taking to buy or build homes. As in 1997 prices of home were almost double.

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Contd. . .

Government encouraged to lend to sub-prime borrowers, arguing that this would help even the poor and young to buy houses.

Govt. want to increase the spending of people by increasing the availability of money

With stock markets booming and liquidity, many big fund investors saw sub-prime loan portfolios as attractive investment opportunities. Hence, they bought such portfolios from the original lenders.

This in turn meant the lenders had fresh funds to lend. The subprime loan market thus became a fast growing segment.

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Effect of interest rate on subprime:

Rate of lending to Sub prime was 2% higher than the prime lenders

Added to high risk of defaulting.

Higher interest rate meant substantially higher EMIs than for prime borrowers for same duration, further raising the risk of default.

Further, lenders devised new instruments to reach out to more sub-prime borrowers. Being flush with funds they were willing to compromise on prudential norms. The repayment of the principal portion was to start after two years.

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How did this turn into crisis:

The housing boom in the US started petering out in 2007.

The boom had led to a massive increase in the supply of housing. Thus house prices started falling.

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Contd. . .

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Supply of Home Increases more than Demand

Price of house decreases

Subprime Defaulters Increases

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Contd. . .

Default rate of sub prime borrowers increased as the housing value decreased, as well as banks were exposed to higher risk.

Adjustable Rate Mortgages:- Mortgages where interest rate is adjusted periodically

Slowdown in the US economy made matters worse.

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Roadmap to subprime:

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Impact of Subprime crisis

$512 billion in sub-prime losses were write off by Global Banks

High losses were borne by major banks like Citi, Merrill Lynch, JP Morgan chase, Freddie Mac a& Fannie Mae

Till July09 end #64 US banks collapsed.

FDIC said the number of "problem banks" in the US have risen to a 15-year-high of 305 in the first quarter of 2009 against 252 in December quarter04/08/2023

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Subprime on Lehman

Lehman adopted a very aggressive leverage policy in the context of a major financial crisis.

The roots of this crisis have to be found in bad regulation, lack of transparency, and market complacency brought about by several years of positive returns.

Lehman’s bankruptcy lead to a reassessment of the risk, in particular in the market for credit default swaps.

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Reason for failure

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Derivatives

Mortgages

Complex Products

High Risk- High ReturnAggressive Strategy Wrong Forecasting

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Reason for failure

End product purchased by Lehman brothers were embedded by these types of risk :-

Credit Risk Asset Price Risk Liquidity Risk

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Loss

positio

n

Risk

positio

n

Retu

rn

positio

nLow

High

Portfolio

AAA

Reason for failure

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Credit Risk and Return

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Reason for failure

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US credit upgrades and downgrades

US credit upgrades & downgrades

2007,Q1

2007,Q2

2007,Q3

2007,Q4

2008,Q1

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Reason for failure

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Market Crash

Dow Jones Industrial Average

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Reason for failure

Lehman Brothers had massive exposure to property derivatives.

Lehman had a ton of what is called "leveraged assets".

(D/E ratio of 30:1 where as industrial is 15:1)

Lehmann was exposed to a lot of Subprime Mortgage Backed Securities.

Lehman's Colossal Miscalculation.04/08/2023

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Why AIG not Lehman ???

Bailout was provided depending on financial markets. AIG insured millions not just of individuals but of

institutions as well.

It is also the insurer of million dollars worth of securities issued by institutional lenders and borrowers. The collapse of AIG would have surely brought down these companies too.

Federal Reserve had conducted assessments which showed, collapse of Lehman won’t bring much chaos to the markets as opposed to the collapse of AIG or Bear Stearns or Fannie Mae or Freddie Mac.

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Contd. . .

Lehman’s financial troubles have been plaguing the company for more than a year prior to bankruptcy filing. The Fed decided not to help these investors, probably

because it thought Lehman’s investors could have saved themselves by managing investment risks in a company already suffering from poor financial health.

The Fed may have wiped out what credibility it won resisting Lehman's rescue pleas and may have opened the door to countless other companies to come calling for help

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Filing bankruptcy

On September 15, 2008, the firm filed for Chapter 11 bankruptcy protection.

The filing marked the largest bankruptcy in U.S. history.

British bank 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.

On September 22, 2008, Nomura Holdings announced that it had agreed to acquire Lehman Brothers' franchise in the Asia Pacific region, including Japan, Hong Kong and Australia.

Lehman Brothers' Investment Management business, including Neuberger Berman, was sold to its management on December 3, 2008. Creditors of Lehman Brothers Holdings Inc. retain a 49% common equity interest in the firm, now known as Neuberger Investment Management.

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Impact of Lehman failure

Exposure to debt in (selective) default. LBHI had outstanding long-term debt of approximately $110

billion as of Aug. 30, 2008. Short-term commercial paper outstanding was around $8 billion at the end of May.

Money market funds managed by banks were holding some Lehman debt, leading to potential compensation to clients.

Counterparty exposure: More significant is counterparty exposure to the various

companies within the Lehman Bros. group. These exposures were largely confined to the biggest banks

and broker-dealers, but smaller institutions had some as well. Given the probable movements in the value of the collateral,

potential future exposure rose materially and were subjected to considerable volatility.

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Contd. . .

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Market price impact. Even entities active in the capital markets that have

negligible direct exposure to Lehman suffered, to a potentially greater extent.

This resulted in further downward pressure on a wide range of assets.

That in turn, forced highly leveraged institutions to liquidate to meet margin calls, putting further pressure on assets.

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Lessons Learnt

When a company attacks short-sellers, run. Good management teams embrace criticism, address it and

move on. Lehman attacked the messenger.

Lots of banks have downplayed their write downs by stressing net figures that include gains on so-called economic hedges, or as Lehman called them, "economic risk-mitigation strategies.”

  Gains on declining debt values mean something.

When the fair value of a company's debt slips, the market is telling you the company's assets must be deteriorating, too. If you had guessed from the ratio at Lehman that its asset values had further to fall, you wound up with the right answer.

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Conclusion

Some companies are indeed not too big to fail  While the availability of liquidity can provide some

form of short-term life support to an institution under severe stress, it is either real or perceived capital inadequacy that can precipitate a company's failure

  The impact from a regulatory action or inaction can

have unintended consequences through indirect exposures and linkages that sometimes are only known to direct market participants.

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Questions

THANK YOU !