Well It has been One Year since the Demise of the 158 yr. old Investment Banking Firm Lehman Brothers(U.S.).The Bank had filed for BANKRUPTCY on September 15, 2008. The bankruptcy of Lehman Brothers is the largest bankruptcy filing in U.S. history It went under holding assets of $639 billion against debts of $613 billion
Primary Reason for its shutdown was "The SUB PRIME CRISIS".
Now I have some facts and figures that will explain the Collapse of Lehman from Financial Management Point of View like the Balance Sheet.
Lehman's Two Biggest Mistakes
1)Too much leverage
2)Risky debt-to-equity ratios
Too much leverage
The basic concept of financial leverage is taking the proceeds of a loan and investing that money to receive a higher rate of return. The difference in the rates (the interest rate of the loan and interest rate earned on the investment) is called the spread.
Lehman Brothers was overleveraged.
They borrowed money in order to invest in mortgage-backed securities (MBS) .
In the case of the MBSs, when it was revealed that the assets used as collateral for those mortgage-backed securities were worth a lot less than they thought, the MBSs became worthless and Lehman Brothers' spread went from positive to negative.
In balance sheet terms, they started with a balance sheet in which they owned more than they owed. They ended up with a balance sheet in which they owed more than they owned
Risky debt-to-equity ratios
Debt-to-equity ratios tells us how much debt a company has for every dollar of equity. Divide total liabilities by total equity.
In the case of commercial banks, debt-to-equity ratio of about 10 to 1, meaning for every dollar of equity, the bank has $10 of debt.
Lehman Brothers at various times had debt-to-equity ratios of >30 to 1. If a firm is running at $30 of debt for every $1 of equity, their cushion is dangerously small.
Any drop in the value of the assets underlying their investments, or in their spread, pushes the firm to bankruptcy.
Why AIG and not Lehman?????
Size – Same as the Lehman.
Fear -- Whereas Lehman’s collapse was long expected, AIG have the same affect to the Fed and market participants alike. The business is so complex and mysterious, and its reach so broad, that no one was sure what its failure would mean.
AIG’s troubles arose because it sold too many credit default swaps, essentially insurance against loan failures.
It’s the largest insurance company in the world, AIG insures millions not just of individuals but of institutions as well.
It was thought that 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(prob. Calc by Fed).
Lehman’s financial troubles have been plaguing the company for more than a year prior to bankruptcy filing.
In August 2007, it closed one of its subprime lenders and recorded a one-time after-tax charge of $25 million.
The company reported a $2.8 billion loss during the second quarter. From January to June 2008 alone, the company’s stock lost more than 75% in value. In short, investors had an idea what was going on in the company.
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.
Barclays and Bank of America had been in talks to rescue the bank, but negotiations faltered when it became clear that the US Treasury was opposed to using government money to help seal a deal.
What was the Actual Reason we all do not Know some say that The CEO of Lehman had bad relations with the US Govt,Some say that Lehman's CEO was Over ambitious,Some say that US TREASURY SECY. called Richard Fuld(CEO Lehman Brothers) on 10th Sept and offered him some amount to sell of his bank but Richard Fuld refused to do so as the amount cited was too low for Lehman Brothers because its value was 3 times more.
Whatever the reason was Folks,I cannot say but what was Bad was that the US Govt. didn't help Lehman Brothers and thats why we landed up in the so called CRISIS
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