US Financial Crisis: The Fall of Lehman Brothers



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Code : ECC0019

Year :
2008

Industry : Banking, Insurance and Financial Services

Region : US

Teaching Note: Available

Structured Assignment : Available

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Company Background Lehman Brothers was founded as a small dry goods store in Montgomery, Alabama in 1844 (Annexure I) by a German immigrant Henry Lehman (Henry). It took up cotton trading as second business in 1850, but restricted itself to commodities trading and brokerage operations following Henry's death in 1855. After 3 years, Lehman opened its first branch in Manhattan Borough that became commodity trading centre of the country. The Civil War had forced the company to move to New York City in 1870, where it started capitalising on railroad bonds, securities underwriting and financial consultancy services. In the next decade, Lehman became a member of Coffee Exchange as well as the New York Stock Exchange...

Lehman's Involvement in Subprime Mortgage Lending Business Allured by high returns, Lehman Brothers tested its prospects by entering into the risky business of subprime home loan lending from mid-1990s. As an initial step in 1995, the firm started lending in the form of consumer-loansbacked securities to the California-based First Alliance Mortgage Co., which used to lend loans to the non-qualified (subprime) borrowers by virtue of their income levels, repayment capacity and defaulting credit history. In the beginning itself, FirstAlliance was denounced by the then Lehman's vice president Eric Hibbert for its unethical practices, describing it as a financial 'sweat shop' capitalising on weaknesses of people by dumping 'high pressure sales' on them through fraudulent practices.

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Deteriorating Market Conditions The purchase price in the mortgage market had fallen from $368,900 million inAugust 2007 to $347,700 million by the end of December 2007, as the mortgage purchasing transactions declined from $16,429 million to 12,796 million during the same period.4 This debacle continued to deepen due to holding up of large positions in the MBS market while the mortgages were originally rated very low when securitising them. The outstanding mortgage debt involving mortgage companies rose to $1,474,247million by the end of December 2007.5 In addition, large amount was invested in the modern financial instruments known as Credit Default Swaps6, which like insurance policies, provide a security envelop against third-party delinquency in the MBS market, while simultaneously facilitating the speculative business.

Final Struggle for Existence At the stock level, Lehman had its top five equity holdings in the stocks of non-blue chip companies only. They include KPIT Cummins Infosystems (7.3%), Mastek (5.15%), Fedders Lloyd (4.89%), Orbit Corp. (4.82%) and Spice Mobiles (4.41%). With the emerging symptoms like plunging of Lehman's shares and downgrading of its debt, which reflected pre-demise conditions of Bear Stearns, the investors began to worry over a possible default by Lehman.








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