Joke and some video clips

I found this joke online and thought I should share it!

 Lehman Brothers and George Bush:

U.S. (Former) President George W. Bush: I am saddened to hear about the demise of Lehman Brothers. My thoughts go out to their mother as losing one son is hard but losing two is no doubt a tragedy

Below I have included a couple of interesting videos. The first shows Sky News reporting on when news of the bankruptcy first broke and the second shows a recruitment video for Lehman Brothers from 1999. This video gives us an insight into the culture at Lehman.

(Sky News as bankruptcy broke, 2008)

(Recruitment video – Lehman Brothers, 1999)

Conclusion

In my blog I have explored how Lehman Brothers moved through Kindelberger’s (1989) stages of financial crisis as well as the reasons behind the failure of Lehman Brothers. These reasons include, but are definitely not limited to, risk management, irrational exuberance/arrogant culture at Lehman, financial innovation (including repo 105 transactions) and finally regulation. Lehman had a number of firm specific variables that contributed to its failure, these variables led to Lehman’s business model being inherently flawed and unsustainable. In addition to these firm specific variables there were economy wide factors that played a role in Lehman’s downfall. These economy-wide variables include the rise of financial innovation and the role of regulation in the economy. The impact of Lehman’s failure on the global economy was vast; it set off a chain of events that led to the world experiencing a deep global recession the worst since the Great Depression. The great crisis of 2007 saw U.S. foreclosures spike (see graph below) and it is estimated that in the U.K around 3.7 million people have been made redundant since the beginning of the recession, that represents a huge one in seven of all employees (Sky News, 2013). Without a doubt Lehman has left a scar on the global financial landscape.

(Graph showing spike in foreclosures, The Economist, 2007)

I feel in order to protect the world from another global crisis we need to introduce a comprehensive regulatory framework that governs all financial institutions whose well-being has an impact on the financial stability of the economy. Only time will tell whether the new measures implemented will be enough to prevent another Great Crash.

I hope you have found my blog as useful and interesting as I have found researching Lehman Brothers. In this blog it has not been possible to explore every detail of Lehman’s bankruptcy but if you ever want to find out more I recommend reading the report of Anton R. Valukas who was the examiner in the bankruptcy proceedings of Lehman Brothers Holdings Inc. The link to his nine volume report is shown below.

• http://jenner.com/lehman

Bibliography

1.  Kindleberger, C.P. Manias, Panics and Crashes: A History of Financial Crises, rev. ed. Basic Books, New York, 1989.
2. Sky News (2013) Financial Crisis Led To 3.7 Million Job Losses. [online] Available at: http://news.sky.com/story/1054212/financial-crisis-led-to-3-7-million-job-losses [Accessed: 24 Feb 2013].
3. The Economist (2007) The hammer drops. [online] Available at: http://www.economist.com/node/9905451 [Accessed: 24 Feb 2013].
4.  Valukas, A. (2010) LEHMAN BROTHERS HOLDINGS INC. CHAPTER 11 PROCEEDINGS EXAMINER REPORT. Jenner & Block, Volumes: 1-9.

Part 2: Regulation pre- and post-Lehman’s collapse

Regulatory reform in the post Lehman world: Have there been moves towards a safer financial system?

Under intense public pressure governments around the world have sought to introduce regulation to prevent a large scale financial crisis occurring again. On July 10^th 2010 the U.S. government introduced the Dodd-Frank Wall Street Reform and Consumer Protection Act. This law, which stretches to 2,319 pages, is wide-ranging in its scope. It creates a new Consumer Financial Protection Agency which has the role of monitoring the complex financial instruments within the financial system and educating investors on these instruments (Hallman, 2012). To try and regulate financial institutions deemed ‘too big to fail’ Dodd-Frank created the Financial Stability Oversight Council which has the power to take control of failing banks and unwind them. In addition, Dodd-Frank provided shareholders with a “say-on-pay” vote and restricted remuneration in financial institutions that received government funds.

(Obama signing Dodd-Frank: Google Images, 2013)

The Dodd-Frank reform sounds impressive with such a wide scope of reform but little has been done to implement Dodd-Frank which implies the regulators might have bitten off more than they can chew. The reform has also (as expected) come up against huge opposition from Wall Street for example in quarters one and two of 2012 the American Banker Association spent $4.6m to lobby on topics including Dodd-Frank (Hallman, 2012). In the UK the Bank of England established a Financial Policy Committee in 2011 and there are calls for extra taxes on bank bonuses (FT, 2013). The EU has introduced the European Systemic Risk Board.

At an international level the Financial Stability Board has introduced principles for sound compensation practices (Financial Stability Forum, 2009) and there has been the creation of Basel III. Basel III stresses the importance of capital including building up counter- cyclical capital buffers and maintaining higher levels of capital within the financial institutions  The Basel Committee has also increased the number of principles for good bank corporate governance from 8 to 14 (Basel Committee, 2010).

The question remains whether these regulations will be fully enforced, will they be held in place in times of rapid growth and whether they are really enough to protect the stability of the global financial system.

Bibliography

1.       Hallman, B. (2012) Four Years After Lehman, U.S. Banks Fight Reform. [online] Available at: http://www.huffingtonpost.com/2012/09/15/lehman-brothers-collapse_n_1885489.html [Accessed: 23 Feb 2013].

2.      Bis.org (2013) Basel Committee - BIS. [online] Available at: http://www.bis.org/list/bcbs/index.htm [Accessed: 23 Feb 2013].

3.      Financial Times (2013) Labour demands extra tax on bank bonuses - FT.com. [online] Available at: http://www.ft.com/cms/s/0/14e7f0c8-6a42-11e2-a3db-00144feab49a.html#axzz2LuGscvlW [Accessed: 25 Feb 2013].

4.         Financialstabilityboard.org (2013) Financial Stability Board. [online] Available at: http://www.financialstabilityboard.org/ [Accessed: 23 Feb 2013].

Part 1: Regulation pre- and post-Lehman’s collapse

Pre- collapse: lack of regulation

Prior to the collapse of Lehman the government failed to regulate several key areas of the financial system.  The government did not introduce measures that would have curbed risk taking, reined in the use of derivatives and increased disclosure within the system. These failures helped contribute to the collapse of Lehman and the wider financial crisis. As well as failing as chief regulator of Lehman the SEC (Securities and Exchange Commission) discovered that Lehman had excluded many important risk factors from their risk tests but failed to act (Valukas, 2010).Lehman was also allowed to operate repo 105 transactions without disclosing the true nature of the repos and was able to exceed many of its risk limits without disclosing this fact.

Why was pre-collapse regulation so weak?

(Google Images, 2013: Fat cat banker having his shoes polished by a member of the senate)

One view why regulation was so weak is regulatory capture. Regulatory capture can be defined as “The process by which regulatory agencies eventually come to be dominated by the very industries they were charged with regulating” (Investopedia, 2013)

One method of regulatory capture is lobbying which aims to influence decision makers. Wall Street spends an extortionate amount on lobbying government for example it is estimated that $3.28bn was spent lobbying in 2012 (Lobbying Database, 2012). Stigler (1971) found that regulated institutions frequently pressurised regulators to modify regulations. An example of regulatory capture occurred when politicians blocked attempts to reform the government sponsored enterprises such as Fannie Mae and Freddie Mac (Dowd, 2009) even though many admitted that the enterprises were major players in the financial crisis. In addition, financial institutions can exert pressure through political campaign contributions which also allows them to exert considerable influence.

So what could the government do?

Stricter governmental disclosure rules could have curbed excessive risk taking at Lehman. In addition, compensation packages in place in the financial sector have been accused of encouraging risk taking and short termism e.g. at Lehman compensation was often based solely on revenue (Valukas, 2010) . The government could introduce measures to regulate executive compensation, insisting it be based on a number of risk factors that are in line with the health of the financial system. Another piece of legislation could be introduced to regulate the creation and trading of complex financial instruments.

Bibliography

1.   Dowd, K (2009) ‘Moral Hazard and the Financial Crisis’, Cato Journal 29(1): 142-6
2.  Investopedia.com (2012) Regulatory Capture Definition | Investopedia. [online] Available at: http://www.investopedia.com/terms/r/regulatory-capture.asp#axzz2LeTwzYVa [Accessed: 23 Feb 2013] Opensecrets.org (2012) Lobbying Database | Open Secrets. [online] Available at: http://www.opensecrets.org/lobby/index.php [Accessed: 23 Feb 2013].
3. Stigler, G.J. 1971. "Theory of Economic Regulation." Bell Journal of Economics and Management Science 2 (Spring): 3-21
4. Valukas, A. (2010) LEHMAN BROTHERS HOLDINGS INC. CHAPTER 11 PROCEEDINGS EXAMINER REPORT. Jenner & Block, Volumes: 1-9.

The aftermath/aftershock

After the collapse of Lehman what has become known as the great panic of 2008 ensued (Clark, 2009). Kindleberger (1989) describes this panic as the final stage of a financial crisis. On the day Lehman filed for bankruptcy a record number of 8bn share were exchanged (Clark, 2009). Lehman had been considered by many as too big to fail so its collapse triggered a crisis of confidence in the economy. The fall of Lehman has been described as an “earthquake” and as a “heart attack” in the financial markets, some also postulated that after Lehman the economy was just one financial institution away from a global financial meltdown (FT, 2009). Not long after the announcement of Lehman’s bankruptcy, Bernake (Chairman of the Federal Reserve) made his famous statement “we may not have an economy on Monday” (Thomas & Hirsh, 2009).

(Google Images, 2013 : Lehman employs lining up to hear the news of their future)

After Lehman’s demise the world's economy spiraled, global trade froze and panic came with the announcement that some money market funds were heavily invested in Lehman bonds. This led to investors rushing to withdraw their money from money market funds (CNN, 2008). In order to prevent the panic causing further damage Bernake assured investors that all their money would be guaranteed. In the following days the Treasury and Federal Reserve pumped trillions of dollars in to try to support the ailing financial system (NY Times, 2012).

Many had assumed that the government would intervene and stabilize Lehman to avoid it collapsing. Executives at Lehman claim they warned key government figures such as the Treasury Secretary Henry Paulson and the chairman of the Federal Reserve Ben Bernake of the contagion effect Lehman could have on world markets. They claimed that letting Lehman fail would be to “unleash the forces of evil on the global markets” (Clark, 2009).

Leaders in government maintained that they could do nothing to prevent the failure of Lehman but it has been argued that the U.S. government could have intervened in the interbank money markets, putting guarantees in place to allow short term funding for Lehman. In addition, the U.S. government could have provided guarantees against future losses to Barclays, who expressed interest in buying Lehman. Financial institutions who had run into difficulty before Lehman and many that ran into difficultly after Lehman were bailed out for example Bear Sterns in March 2008. This inconsistency in bailout policy further introduced uncertainty into the economy.

 So why didn't the U.S. government bailout Lehman?

There are several possible explanations of why the government let Lehman fail, some of which point to conspiracy theories among government and senior figures in the financial services sector but here I will discuss what I believe are the most plausible theories. Number one is that the government wanted to stress to the financial sector that there existed consequences for risky actions. Cassidy (2010) states that “Many people suspect Paulson and Bernanke let Lehman go bankrupt to re-establish the principle that irresponsible behaviour would be punished”. Another possible reason behind the Federal Reserve’s refusal to bailout Lehman is public opinion. The U.S. government was under increasing pressure concerning the use of public funds to bail out large financial institutions. The public was angered that for many years the banks had privatised the gains but now the losses were being socialised. Henry Paulson, Secretary of the Treasury, said “I am being called Mr Bailout. I can’t do it again” (Nocera, 2009).

(Bailout Money: Google Images, 2013)

In the next post I will discuss the role of regulation in Lehman’s demise as well as looking at regulatory reforms post Lehman.

Bibliography

1.     CASSIDY, J. (2010). How markets fail: the logic of economic calamities. New York, Picador.

2.      Clark, A. (2009) How the collapse of Lehman Brothers pushed capitalism to the brink. Guardian, 4 Sept. Available at: http://www.guardian.co.uk/business/2009/sep/04/lehman-brothers-aftershocks-28-days

3.      Financial Times Video (2009) Sep 14: Part 2 - The Lehman aftershock - markets - FT.com. [online] Available at: http://video.ft.com/v/63078044001/Sep-14-Part-2-The-Lehman-aftershock [Accessed: 23 Feb 2013].

4.      Kindleberger, C.P. Manias, Panics and Crashes: A History of Financial Crises, rev. ed. Basic Books, New York, 1989.

5.      Money.cnn.com (2008) Monday Meltdown: How Lehman's fall created a global panic - Dec. 15, 2008. [online] Available at: http://money.cnn.com/2008/12/15/news/economy/monday.meltdown.fortune/index.htm [Accessed: 23 Feb 2013].

6.      Nocera, J (2009) The New York Times Lehman Had to Die So Global Finance Could Live. [online] Available at: http://www.nytimes.com/2009/09/12/business/12nocera.html?pagewanted=all [Accessed: 23 Feb 2013].

7.      Thomas, E., & Hirsh, M. (2009). Paulson's complaint. Newsweek, May 25. Available at http:// www.highbeam.com/doc/IGl-200187807.html. Retrieved on February 19,2013

8.      Topics.nytimes.com (2008) Lehman Brothers Holdings Inc. News - The New York Times. [online] Available at: http://topics.nytimes.com/top/news/business/companies/lehman_brothers_holdings_inc/index.html [Accessed: 23 Feb 2013].

Part 2: What went wrong?

Financial innovation can be defined as;

“the act of creating and then popularising new financial instruments as well as new financial technologies, institutions and markets. It includes institutional, product and process innovation” (FT, 2013)

Financial innovation represents both as an economy wide and firm specific factor in Lehman’s demise as the use of complex financial instruments destabilised Lehman’s business model. From the late 1990s/early 2000s onwards the use of financial innovative products such as CDOs and CDSs  (see end for definitions)  ballooned across the economy and Reuters estimates that the CDO market peaked at $534.2bn in 2006 which was almost an 800% increase on the 2000 figure (NY Times, 2011).

(Henry Paulson U.S. secretary of the treasury)

Lehman used these products excessively as financial innovation played a large part in Lehman’s aggressive growth strategy. An example of this excessive use occurred in 2006 when financial instruments made up 45% of total assets (Lehman Brother Inc, 2006). In particular Lehman was heavily invested in CDOs and CDSs and in 2008 held $614.6m equity securities in CDOs (Lehman Brother Inc., 2008). These CDOs lost a huge proportion of their value when confidence faltered in the market.

In addition to CDOs and CDSs Lehman used a financially innovative product to indulge in some very creative accounting practices to reduce their balance sheet. Lehman’s strategy had increased the risk and leverage of the firm substantially. In 2008, after the near collapse of Bear Sterns, the attention of the markets turned to Lehman and its future viability. Lehman needed market confidence to survive, especially to lend in the interbank markets, so management devised a strategy to reduce their assets and ,in turn, their leverage ratio. Much of Lehman's balance sheet was made up of illiquid assets that were difficult to sell so they turned to financial innovation and used what were termed ‘repo 105’ transactions.

Lehman used repo105 transactions to move assets off balance sheet and decrease the leverage ratio before the end of the quarter. Repo 105 transactions were similar to other repos used to gain short term financing but instead of being reported as a loan they were accounted for as a sale which allowed Lehman to move the assets off balance sheet (Valukas, 2010).  Lehman could count these repos as sales because “the value of the securities Lehman pledged in Repo 105 transactions were worth 105 per cent of the cash it received” (De la Merced and Werdigier, 2010). Repo 105 actions were a type of “window dressing” of Lehman’s reports.

This simple illustration shows how Lehman used repo 105:

The repo 105 transactions used were never publicly disclosed, the financial regulators didn't discover them and Lehman’s auditors Ernst & Young also failed to disclose them. Through repo 105 transactions Lehman was able to decrease its leverage; the decrease in leverage is shown in the graph below.

(Composed from Valukas Report, 2010)

CDO – “An investment-grade security backed by a pool of bonds, loans and other assets. CDOs do not specialise in one type of debt but are often non-mortgage loans or bonds” (Investopedia, 2013)

CDS – “A swap designed to transfer the credit exposure of fixed income products between parties” (Investopedia, 2013)

Bibliography

1.      De la Merced, M. and Werdigier, J. (2010) The Origins of Lehman’s ‘Repo 105’. The New York Times. Available at: http://dealbook.nytimes.com/2010/03/12/the-british-origins-of-lehmans-accounting-gimmick/.

2.      Financial Times. (2013). Financial Innovation. Available: http://lexicon.ft.com/Term?term=financial-innovation. Last accessed 17th February 2013.

3.      Investopedia. (2013). Collateralized Debt Obligations. Available: http://www.investopedia.com/terms/c/cdo.asp#axzz2LA9o5psS. Last accessed 17th February 2013.

4.      Investopedia. (2013). Credit Default Swaps. Available: http://www.investopedia.com/terms/c/creditdefaultswap.asp#axzz2LA9o5psS. Last accessed 17th February 2013.

5.      Lehman Brothers Holdings Inc., 2006. Annual Report 2006,New York: Lehman Brothers Inc

6.      Lehman Brothers Holdings Inc., 2008. Second Quarter 10-Q ending  May 31, 2008,New York: Lehman Brothers Inc.

7.      The New York Times. (2011). Collateralized Debt Obligations. Available: http://topics.nytimes.com/topics/reference/timestopics/subjects/c/collateralized-debt-obligations/index.html. Last accessed 17th February 2013.

8.      Valukas, A. (2010) LEHMAN BROTHERS HOLDINGS INC. CHAPTER 11 PROCEEDINGS EXAMINER REPORT. Jenner & Block, Volumes: 1-9.

So what went wrong at Lehman? (Part 1)

A wide variety of factors contributed to the downfall of Lehman, these include firm specific factors such as an inherently flawed and unsustainable business model as well as economy wide factors.

One central factor was risk and in particular risk management. When Lehman changed to an aggressive growth strategy the amount of risk skyrocketed but managers at Lehman disregarded nearly all risk controls. An employee at Lehman summed up Lehman’s view on risk with the following quote:

“the majority of the trading business’s focus is on revenues, with balance sheet, risk limit, capital or cost implications being a secondary concern” (Valukas, 2010:52)

An example of the complete disregard of risk limits at Lehman occurred in 2007 when Lehman increased their risk appetite limit several times throughout the year from $2.3bn to $4bn (Valukas, 2010). Lehman explained this rise as a change in calculation but it seems unlikely that such a large rise was down to a calculation change. As well as disregarding risk limits Lehman ignored the advice of some of their risk management team as well as external risk specialists. One of those who communicated their concerns was Lehman’s Chief Risk Officer Madelyn Antoncic who was subsequently reassigned (*FCIR, 2011).

Another factor that played a role was irrational exuberance (see post 1 for definition) and arrogance among Lehman’s employees. Senior staff at Lehman believed Lehman was infallible. This arrogance is displayed in emails from late 2007 between two top executives Fuld and Goldfarb when Fuld describes the firm’s position:

“I agree we need some help – but the Bros always wins!!” (Cohan, 2012)

This arrogant persona led to Fuld, once nicknamed the Gorilla of Wall Street, being demonised post Lehman’s collapse (see picture below). He was named on the '25 people to blame for the financial crisis' list by Times magazine (2009) and is described in press as greedy and a symbol of failure (Freeman, 2011). 

(The Demon Fuld: Google Images, 2013)

In my next post I will examine the role of financial innovation, balance sheet manipulation and disclosure in Lehman’s collapse.

*FCIR: Financial Crisis Inquiry Report

Bibliography

1.      Cohan, W. (2012). Lehman E-Mails Show Wall Street Arrogance Led to the Fall. Available: http://www.bloomberg.com/news/2012-05-06/lehman-e-mails-show-wall-street-arrogance-led-to-the-fall.html. Last accessed 3rd Feb 2013.

2.      Financial Crisis Inquiry Report (FCIR), 2011

3.      Freeman, J. (2009). Banking On a Rescue. Available: http://online.wsj.com/article/SB10001424052970204251404574342350506568022.html. Last accessed 12th Feb 2013.

4.      Sender, H et al. (2008). Broken brothers: How brinkmanship was not enough to save Lehman. Available: http://www.ft.com/cms/s/0/d9792572-8358-11dd-907e-000077b07658.html#axzz2KizR1ukN. Last accessed 12th Feb 2013.

5.      Time Lists. (2009). 25 People to Blame for the Financial Crisis. Available: http://www.time.com/time/specials/packages/article/0,28804,1877351_1878509_1878508,00.html. Last accessed 12th Feb 2013.

6.      Valukas, A. (2010) LEHMAN BROTHERS HOLDINGS INC. CHAPTER 11 PROCEEDINGS EXAMINER REPORT. Jenner & Block, Volumes: 1-9.

The end of Lehman Brothers

As stage four of the financial crisis (distress) progressed, Lehman’s management realised that the crisis was more severe than they had previously thought.  The counter cyclical strategy pursued had cost Lehman a huge share price decrease (shown in graph 1) and massive losses.

Many rumours circulated about Lehman’s financial health and the interbank market froze, reluctant to lend. This lack of confidence resulted in Lehman not securing the vital funds it needed for daily operations. On the 15^th of September 2008 Lehman Brothers filed for chapter 11 bankruptcy protection. This became the largest corporate bankruptcy in the U.S history with $639 billion in assets, the great ‘Wall Street Titan’ had fallen (Craig et al, 2008).

If you have an hour to spare and want to learn more about the end of Lehman Brothers the film below entitled “The Last Days of Lehman Brothers” provides a good overview of the run up to Lehman’s bankruptcy.

Graph 1 showing Lehman Brothers share price (May 2007 – August 2008)

(FT, 2008)

Bibliography

1.      Craig, S. et al. (2008) AIG, Lehman Shock Hits World Markets. The Wall Street Journal, 16 Sept. Available at: http://online.wsj.com/article/SB122152314746339697.html.

The rise of Lehman Brothers

Lehman Brothers was established in 1850 when Henry Lehman and his brothers started up a shop which sold to local farmers (Harvard, 2012) and from these humble beginnings Lehman rose to become America’s 4^th largest investment bank. Lehman’s rise in the 21^st century originated from a change in strategy. This was driven by the Federal Reserve slashing interest rates to 1% (Displacement: stage one of financial crisis). Following this Lehman moved through stage two (credit expansion) and stage three (bubble/mania) of financial crisis.

Lehman Brothers logo (Google Images, 2013)

Traditionally Lehman had pursued a low risk strategy which involved originating and purchasing assets to sell them on while not investing their own capital or holding assets on their balance sheet.  In the early 2000s the bank decided to change to an aggressive, higher risk strategy which involved using their own capital to buy assets and then storing these assets. Management at Lehman believed they were missing out on the advantages of the bullish market that many of their competitors were exploiting (Valukas, 2010). Although this high risk strategy was not uncommon among investment banks, it proved especially risky for Lehman as they had a small equity base and high leverage (Valukas, 2010).

As the boom (stage two of crisis) progressed Lehman invested heavily in property, leveraged loans and the mortgage market including the sub-prime market. The aim of this strategy was high revenue growth which was achieved by an increase in the bank’s balance sheet and risk. 

The crisis then progressed into stage three and a bubble began to form as the economy expanded. The market reacted positively to Lehman’s new aggressive growth strategy, with share price increasing steadily to peak in February 2007 at $85.80 (Bebchuk et al, 2009) and analysts at the major credit rating agencies such as Moody’s and Standard & Poor’s  giving Lehman positive investment grade ratings.

When the sub-prime crisis set in, Lehman believed that by pursuing a counter-cyclical strategy they could increase their advantage over competitors. At this time the economy had moved to stage four of the crisis: distress, but behaviour at Lehman still displayed signs of a stage three crisis for example mania and irrational exuberance*. Lehman had pursued this counter-cyclical strategy before during the downturn of 2001-2002 and it had proved successful, leading to an increased market share, so they continued their aggressive capital destructive strategy when many other banks were raising and hoarding capital (Cohan, 2012). This pursuit of market domination was what ultimately led to the downfall of Lehman.

Graphs illustrating the aggressive growth strategy at Lehman: First graph showing the increase in asset base and the second showing increasing net revenue

(Both graphs composed using data cited in Valukas, 2010)

Irrational Exuberance: “Unsustainable investor enthusiasm that drives asset prices up to levels that aren’t supported by fundamentals” (Investopedia, 2013)

Bibliography

1.      Bebchuk et al . (2009). The wages of failure: executive compensation at Bear Sterns and Lehman 2000-2008. Harvard Law School : Discussion Paper. 657 (1), 1-28. (Available at http://www.law.harvard.edu/programs/olin_center/papers/pdf/Bebchuk_657.pdf)

2.      Cohan, W. (2012) Lehman E-mails Show Wall Street Arrogance Led to the Fall. Available: http://www.bloomberg.com/news/2012-05-06/lehman-e-mails-show-wall-street-arrogance-led-to-the-fall.html. Last accessed 3rd Feb 2013

3.      Craig, S. et al (2008) AIG, Lehman Shock Hits World Markets. The Wall Street Journal, 16 Sept. Available at: http://online.wsj.com/article/SB122152314746339697.html

4.      Harvard Business School. (2012) History of Lehman Brothers.  .Available: http://www.library.hbs.edu/hc/lehman/history.html. Last accessed 3rd Feb 2013.

5.      Investopedia. (2012). Irrational Exuberance  Available: http://www.investopedia.com/terms/i/irrationalexuberance.asp#axzz2K9e2BRip. Last accessed 6th Feb 2013.

6.      Valukas, A. ( 2010) Lehman Brothers Holding Inc. Chapter 11 Proceedings Examiner Report. Jenner & Block, Volumes: 1-9    

Financial Crises: An Introduction

A financial crisis is “a disturbance to financial markets, associated typically with falling asset prices and insolvency among debtors and intermediaries, which spreads through the financial system, disrupting the market’s capacity to allocate capital”

 (Portes & Swoboda, 1987: p10)

Throughout history there have been numerous financial crises that vary in strength and location. The most notable financial crises include the great depression in the US (1929), the oil crisis in 1973, the Asian financial crisis (1997), the bursting of the dot com bubble (2001), the financial crisis of 2007-2010 and most recently the European debt crisis (2010).

In a financial crisis the economy goes through a series of stages, Kindleberger (1989) defined these stages as follows:

Stage 1: Displacement: Displacement occurs when there is an outside shock to the economic system which modifies the outlook of the economy

·       In the case of the 2007-2009 financial crisis the shock was the slashing  of short term interest rates to 1% by the Federal Reserve- aimed at stimulating growth in the sluggish economy

Stage 2: Boom/Credit Expansion: These low interest rates stimulated a boom in housing as mortgages were cheaper to attain. This boom increased house prices and construction rates raised to satisfy demand

Stage 3: Bubble/Mania:  A large proportion of the population became involved in the housing boom and segments of the population usually not included become involved, for example, sub-prime mortgage holders.       This led to speculation for profits and rationality gave way to irrationality and mania

Stage 4: Distress: In the US interest rates began to rise, leading to a fall in house prices and many sub-prime mortgage holders were unable to meet repayments. At this stage the bubble begins to unravel

Stage 5: Crash and Panic: System unstable and close to crashing. Panic was triggered by the failure of many financial institutions for example that of Lehman Brothers in 2008

The graph below illustrates the movement in the interest rate in the US between January 2000 and January 2010. The fall in interest rates as described in Stage 1 is evident as is the rise described in Stage 4.

(Source: www.tradingeconomics.com FEDERAL RESERVE)

In my blog I am going to explore the rise and fall of Lehman Brothers. I believe the rise and fall of Lehman mirrors the rise and fall of the global economy and illustrates the five stages of a financial crisis. I will research Lehman Brothers and aim to define:

·       How Lehman Brothers moves through the stages of the crisis

·       The reasons behind the failure of Lehman Brothers

·       How this failure is connected to the economy

·       The impact of Lehman’s failure on the economy

If you are interested in learning more about the causes of the most recent financial crisis (2007-2009) the video below provides a short summary of what went wrong.

Bibliography

1.      Kindleberger, C.P. Manias, Panics and Crashes: A History of Financial Crises, rev. ed. Basic Books, New York, 1989.

2.      Portes, R. and Swoboda, A. (1987) "Anatomy of Financial Crises." From Threats to International Financial Stability, pp. 10-58. New York: Cambridge University Press, 1987.

3.      Trading Economics. (2013). United States Interest Rates. Available: http://www.tradingeconomics.com/united-states/interest-rate. Last accessed 4th Feb 2013.