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bankruptcy of lehman
brothers
Lehman Brothers headquarters in New York CityFinancial
services firm Lehman Brothers filed for Chapter 11bankruptcy protection on September 15, 2008. The filing
remains the largest bankruptcy filing in U.S. history, with
Lehman holding over $600 billion in assets.[1]
Contents
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1 Background
1.1 Exposure to the mortgage market
1.2 Lehman's final months
2 Bankruptcy filing
2.1 Breakup process
3 Impact of bankruptcy filing
4 Neuberger Berman
5 Controversies
5.1 Controversy of executive pay during crisis
5.2 Accounting manipulation
5.3 Section 363 Sale
6 See also
7 References
8 External links
Background Main article: Subprime mortgage crisis
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Exposure to the mortgage market Lehman borrowedsignificant amounts to fund its investing in the years
leading to its bankruptcy in 2008, a process known as
leveraging or gearing. A significant portion of this
investing was in housing-related assets, making it
vulnerable to a downturn in that market. One measure ofthis risk-taking was its leverage ratio, a measure of the
ratio of assets to owners equity, which increased from
approximately 24:1 in 2003 to 31:1 by 2007.[2] While
generating tremendous profits during the boom, this
vulnerable position meant that just a 34% decline in the
value of its assets would entirely eliminate its book value
or equity.[3] Investment banks such as Lehman were not
subject to the same regulations applied to depository
banks to restrict their risk-taking.[4]
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In August 2007, Lehman closed its subprime lender, BNC
Mortgage, eliminating 1,200 positions in 23 locations,and took a $25-million after-tax charge and a $27-million
reduction in goodwill. The firm said that poor market
conditions in the mortgage space "necessitated a
substantial reduction in its resources and capacity in the
subprime space".[5]
Lehman's final months In 2008, Lehman faced an
unprecedented loss due to the continuing subprime
mortgage crisis. Lehman's loss was apparently a result of
having held on to large positions in subprime and otherlower-rated mortgage tranches when securitizing the
underlying mortgages. Whether Lehman did this because
it was simply unable to sell the lower-rated bonds, or
made a conscious decision to hold them, is unclear. In
any event, huge losses accrued in lower-rated mortgage-
backed securities throughout 2008. In the second fiscal
quarter, Lehman reported losses of $2.8 billion and was
forced to sell off $6 billion in assets.[6] In the first half of
2008 alone, Lehman stock lost 73% of its value as the
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credit market continued to tighten.[6] In August 2008,
Lehman reported that it intended to release 6% of its
work force, 1,500 people, just ahead of its third-quarter-
reporting deadline in September.[6]
On August 22, 2008, shares in Lehman closed up 5% (16%
for the week) on reports that the state-controlled Korea
Development Bank was considering buying Lehman.[7]Most of those gains were quickly eroded as news
emerged that Korea Development Bank was "facing
difficulties pleasing regulators and attracting partners for
the deal."[8] It culminated on September 9, 2008, when
Lehman's shares plunged 45% to $7.79, after it was
reported that the state-run South Korean firm had put
talks on hold.[9]
Investor confidence continued to erode as Lehman's
stock lost roughly half its value and pushed the S&P 500down 3.4% on September 9, 2008. The Dow Jones lost
nearly 300 points the same day on investors' concerns
about the security of the bank.[10] The U.S. government
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did not announce any plans to assist with any possible
financial crisis that emerged at Lehman.[11]
On September 10, 2008, Lehman announced a loss of
$3.9 billion and their intent to sell off a majority stake in
their investment-management business, which includes
Neuberger Berman.[12][13] The stock slid 7% that
day.[13][14]
On September 13, 2008, Timothy F. Geithner, then
president of the Federal Reserve Bank of New York called
a meeting on the future of Lehman, which included the
possibility of an emergency liquidation of its assets.[15]Lehman reported that it had been in talks with Bank of
America and Barclays for the company's possible
sale.[15] The New York Times reported on September 14,
2008, that Barclays had ended its bid to purchase all or
part of Lehman and a deal to rescue the bank fromliquidation collapsed.[16] It emerged subsequently that a
deal had been vetoed by the Bank of England and the
UK's Financial Services Authority.[17] Leaders of major
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Wall Street banks continued to meet late that day to
prevent the bank's rapid failure.[16] Bank of America's
rumored involvement also appeared to end as federal
regulators resisted its request for government
involvement in Lehman's sale.[16]
[edit] Bankruptcy filing
Barclays acquired the investment banking business ofLehman Brothers in September 2008Lehman Brothers
filed for Chapter 11 bankruptcy protection on September
15, 2008. According to Bloomberg, reports filed with the
U.S. Bankruptcy Court, Southern District of New York
(Manhattan) on September 16 indicated that JPMorganChase & Co. provided Lehman Brothers with a total of
$138 billion in "Federal Reserve-backed advances." The
cash-advances by JPMorgan Chase were repaid by the
Federal Reserve Bank of New York for $87 billion on
September 15 and $51 billion on September 16.[18]
[edit] Breakup process On September 22, 2008, a revised
proposal to sell the brokerage part of Lehman Brothers
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holdings of the deal, was put before the bankruptcy
court, with a $1.3666 billion (700 million) plan for
Barclays to acquire the core business of Lehman Brothers
(mainly Lehman's $960 million Midtown Manhattan
office skyscraper), was approved. Manhattan court
bankruptcy Judge James Peck, after a 7 hour hearing,
ruled: "I have to approve this transaction because it is
the only available transaction. Lehman Brothers became
a victim, in effect the only true icon to fall in a tsunamithat has befallen the credit markets. This is the most
momentous bankruptcy hearing I've ever sat through. It
can never be deemed precedent for future cases. It's
hard for me to imagine a similar emergency."[19]
Luc Despins, the creditors committee counsel, said: "The
reason we're not objecting is really based on the lack of a
viable alternative. We did not support the transaction
because there had not been enough time to properly
review it."[citation needed] In the amended agreement,Barclays would absorb $ 47.4 billion in securities and
assume $ 45.5 billion in trading liabilities. Lehman's
attorney Harvey R. Miller of Weil, Gotshal & Manges, said
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"the purchase price for the real estate components of
the deal would be $ 1.29 billion, including $960 million
for Lehman's New York headquarters and $ 330 million
for two New Jersey data centers. Lehman's original
estimate valued its headquarters at $ 1.02 billion but an
appraisal from CB Richard Ellis this week valued it at
$900 million."[citation needed] Further, Barclays will not
acquire Lehman's Eagle Energy unit, but will have entities
known as Lehman Brothers Canada Inc, Lehman BrothersSudamerica, Lehman Brothers Uruguay and its Private
Investment Management business for high net-worth
individuals. Finally, Lehman will retain $20 billion of
securities assets in Lehman Brothers Inc that are not
being transferred to Barclays.[20] Barclays had apotential liability of $2.5 billion to be paid as severance, if
it chooses not to retain some Lehman employees beyond
the guaranteed 90 days.[21][22]
On September 22, 2008, Nomura Holdings, Inc.announced it agreed to acquire Lehman Brothers'
franchise in the Asia Pacific region including Japan, Hong
Kong and Australia.[23] The following day, Nomura
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announced its intentions to acquire Lehman Brothers'
investment banking and equities businesses in Europe
and the Middle East. A few weeks later it was announced
that conditions to the deal had been met, and the deal
became legally effective on Monday, October 13.[24] In
2007, non-US subsidiaries of Lehman Brothers were
responsible for over 50% of global revenue
produced.[25]
Impact of bankruptcy filing The Dow Jones closed down
just over 500 points (4.4%) on September 15, 2008, at
the time the largest drop by points in a single day since
the days following the attacks on September 11,
2001.[26] (This drop was subsequently exceeded by an
even larger 7.0% plunge on September 29, 2008.)
Lehman's bankruptcy is expected to cause some
depreciation in the price of commercial real estate. Theprospect for Lehman's $4.3 billion in mortgage securities
getting liquidated sparked a selloff in the commercial
mortgage-backed securities (CMBS) market. Additional
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pressure to sell securities in commercial real estate is
feared as Lehman gets closer to liquidating its assets.
Apartment-building investors are also expected to feel
pressure to sell as Lehman unloads its debt and equity
pieces of the $22 billion purchase of Archstone, the third-
largest United States Real Estate Investment Trust (REIT).
Archstone's core business is the ownership and
management of residential apartment buildings in major
metropolitan areas of the United States. Jeffrey Spector,a real-estate analyst at UBS said that in markets with
apartment buildings that compete with Archstone,
"there is no question that if you need to sell assets, you
will try to get ahead" of the Lehman selloff, adding
"Every day that goes by there will be more pressure onpricing."[27]
Several money funds and institutional cash funds had
significant exposure to Lehman with the institutional
cash fund run by The Bank of New York Mellon and thePrimary Reserve Fund, a money-market fund, both falling
below $1 per share, called "breaking the buck", following
losses on their holdings of Lehman assets. In a statement
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The Bank of New York Mellon said its fund had isolated
the Lehman assets in a separate structure. It said the
assets accounted for 1.13% of its fund. The drop in the
Primary Reserve Fund was the first time since 1994 that a
money-market fund had dropped below the $1-per-share
level.
Putnam Investments, a unit of Canada's Great-WestLifeco, shut a $12.3 billion money-market fund as it faced
"significant redemption pressure" on September 17,
2008. Evergreen Investments said its parent Wachovia
Corporation would "support" three Evergreen money-
market funds to prevent their shares from falling.[28]
This move to cover $494 million of Lehman assets in the
funds also raised fears about Wachovia's ability to raise
capital.[29]
Close to 100 hedge funds used Lehman as their primebroker and relied largely on the firm for financing. In an
attempt to meet their own credit needs, Lehman
Brothers International routinely re-hypothecated[30] the
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assets of their hedge funds clients that utilized their
prime brokerage services. Lehman Brothers International
held close to 40 billion dollars of clients assets when it
filed for Chapter 11 Bankruptcy. Of this, 22 billion had
been re-hypothecated.[31] As administrators took charge
of the London business and the U.S. holding company
filed for bankruptcy, positions held by those hedge funds
at Lehman were frozen. As a result, the hedge funds are
being forced to de-lever and sit on large cash balancesinhibiting chances at further growth.[32] This in turn
created further market dislocation and overall systemic
risk, resulting in a 737 billion dollar decline in collateral
outstanding in the securities lending market.[33]
In Japan, banks and insurers announced a combined 249
billion yen ($2.4 billion) in potential losses tied to the
collapse of Lehman. Mizuho Trust & Banking Co. cut its
profit forecast by more than half, citing 11.8 billion yen in
losses on bonds and loans linked to Lehman. The Bank ofJapan Governor Masaaki Shirakawa said "Most lending to
Lehman Brothers was made by major Japanese banks,
and their possible losses seem to be within the levels
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that can be covered by their profits," adding "There is no
concern that the latest events will threaten the stability
of Japan's financial system."[34] During bankruptcy
proceedings a lawyer from The Royal Bank of Scotland
Group said the company is facing between $1.5 billion
and $1.8 billion in claims against Lehman partially based
on an unsecured guarantee from Lehman and connected
to trading losses with Lehman subsidiaries, Martin
Bienenstock.[35]
Lehman was a counter party to mortgage financier
Freddie Mac in unsecured lending transactions that
matured on September 15, 2008. Freddie said it had not
received principal payments of $1.2 billion plus accrued
interest. Freddie said it had further potential exposure to
Lehman of about $400 million related to the servicing of
single-family home loans, including repurchasing
obligations. Freddie also said it "does not know whether
and to what extent it will sustain a loss relating to thetransactions" and warned that "actual losses could
materially exceed current estimates." Freddie was still in
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the process of evaluating its exposure to Lehman and its
affiliates under other business relationships.[36]
After Constellation Energy was reported to have
exposure to Lehman, its stock went down 56% in the first
day of trading having started at $67.87. The massive drop
in stocks led to the New York Stock Exchange halting
trade of Constellation. The next day, as the stockplummeted as low as $13 per share, Constellation
announced it was hiring Morgan Stanley and UBS to
advise it on "strategic alternatives" suggesting a buyout.
While rumors suggested French power company
lectricit de France would buy the company or increase
its stake, Constellation ultimately agreed to a buyout by
MidAmerican Energy, part of Berkshire Hathaway
(headed by billionaire Warren Buffett).[37][38][39]
The Federal Agricultural Mortgage Corporation or FarmerMac said it would have to write off $48 million in Lehman
debt it owned as a result of the bankruptcy. Farmer Mac
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said it may not be in compliance with its minimum capital
requirements at the end of September.[40]
In Hong Kong more than 43,700 individuals in the city
have invested in HK$15.7 billion of "guaranteed mini-
bonds" () from Lehman.[41][42][43] Many
claim that banks and brokers mis-sold them as low-risk.
Conversely, bankers note that mini bonds are indeedlow-risk instruments since they were backed by Lehman
Brothers, which until just months before its collapse was
a venerable member of Wall Street with high credit and
investment ratings. The default of Lehman Brothers was
a low probability event, which was totally unexpected.
Indeed, many banks accepted mini bonds as collateral for
loans and credit facilities. Another HK$3 billion has been
invested in similar like derivatives. The Hong Kong
government proposed a plan to buy back the
investments at their current estimated value, which will
allow investors to partially recover some of their loss bythe end of the year.[44] HK chief executive Donald Tsang
insisted the local banks respond swiftly to the
government buy-back proposal as the Monetary
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Authority received more than 16,000
complaints.[41][43][44] On October 17 He Guangbe,
chairman of the Hong Kong Association of Banks, agreed
to buy back the bonds, which will be priced using an
agreed upon methodology based on its estimated
current value.[45] This episode has deep repercussions
on the banking industry, where misguided investor
sentiments have become hostile to both wealth
management products as well as the banking industry asa whole. Under intense pressure from the public, all
political parties have come out in support of the
investors, further fanning distrust towards the banking
industry.
[edit] Neuberger Berman Neuberger Berman Inc.,
through its subsidiaries, primarily Neuberger Berman,
LLC, is an investment-advisory firm founded in 1939 by
Roy R. Neuberger and Robert Berman, to manage money
for high-net-worth individuals. In the decades thatfollowed, the firm's growth mirrored that of the asset-
management industry as a whole. In 1950, it introduced
one of the first no-load mutual funds in the United
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States, the Guardian Fund, and also began to manage the
assets of pension plans and other institutions. Historically
known for its value-investing style, in the 1990s the firm
began to diversify its competencies to include additional
value and growth investing, across the entire
capitalization spectrum, as well as new investment
categories, such as international, real-estate investment
trusts and high-yield investments. In addition, with the
creation of a nationally and several state-chartered trustcompanies, the firm became able to offer trust and
fiduciary services. Today the firm has approximately $130
billion in assets under management.
Neuberger Berman's New York City headquarters on
Third Avenue. In October 1999, the firm conducted an
initial public offering of its shares and commenced
trading on the New York Stock Exchange, under the ticker
symbol "NEU". In July 2003, shortly after the retired Mr.
Neuberger's 100th birthday, the company announced
that it was in merger discussions with Lehman Brothers
Holdings Inc. These discussions ultimately resulted in the
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firm's acquisition by Lehman on October 31, 2003, for
approximately $2.63 billion in cash and securities.
On November 20, 2006, Lehman announced its
Neuberger Berman subsidiary would acquire H. A. Schupf
& Co., a money-management firm targeted at wealthy
individuals. Its $2.5 billion of assets would join
Neuberger's $50 billion in high-net-worth client assetsunder management.[46]
An article in The Wall Street Journal on September 15,
2008, announcing that Lehman Brothers Holdings filed
for Chapter 11 bankruptcy protection, quoted Lehmanofficials regarding Neuberger Berman: "Neuberger
Berman LLC and Lehman Brothers Asset Management
will continue to conduct business as usual and will not be
subject to the bankruptcy case of the parent company,
and its portfolio management, research and operatingfunctions remain intact. In addition, fully paid securities
of customers of Neuberger Berman are segregated from
the assets of Lehman Brothers and aren't subject to the
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claims of Lehman Brothers Holdings' creditors, Lehman
said."[47]
Just before the collapse of Lehman Brothers, executives
at Neuberger Berman sent e-mail memos suggesting,
among other things, that the Lehman Brothers' top
people forgo multi-million dollar bonuses to "send a
strong message to both employees and investors thatmanagement is not shirking accountability for recent
performance."
Lehman Brothers Investment Management Director
George Herbert Walker IV dismissed the proposal, goingso far as to actually apologize to other members of the
Lehman Brothers executive committee for the idea of
bonus reduction having been suggested. He wrote,
"Sorry team. I am not sure what's in the water at
Neuberger Berman. I'm embarrassed and Iapologize."[48]
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Controversies Controversy of executive pay during
crisisRichard Fuld, head of Lehman Brothers, faced
questioning from the U.S. House of Representatives'
Committee on Oversight and Government Reform. Rep.
Henry Waxman (D-CA) asked: "Your company is now
bankrupt, our economy is in crisis, but you get to keep
$480 million (276 million). I have a very basic question
for you, is this fair?"[49] Fuld said that he had in fact
taken about $300 million (173 million) in pay andbonuses over the past eight years.[49] Despite Fuld's
defense on his high pay, Lehman Brothers executive pay
was reported to have increased significantly before filing
for bankruptcy.[50] On October 17, 2008, CNBC reported
that several Lehman executives, including Richard Fuld,have been subpoenaed in a case relating to securities
fraud.[51]
[edit] Accounting manipulation In March 2010, the report
of Anton R. Valukas, the Bankruptcy Examiner, drewattention to the use of Repo 105 transactions to boost
the bank's apparent financial position around the date of
the year-end balance sheet. The attorney general later
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Andrew Cuomo filed charges against the bank's auditors
Ernst & Young in December 2010, alleging that the firm
"substantially assisted... a massive accounting fraud" by
approving the accounting treatment.[52]
On April 12, 2010, a New York Times story revealed that
Lehman had used a small company, Hudson Castle, to
move a number of transactions and assets off Lehman'sbooks as a means of manipulating accounting numbers of
Lehman's finances and risks. One Lehman executive
described Hudson Castle as an "alter ego" of Lehman.
According to the story, Lehman owned one quarter of
Hudson; Hudson's board was controlled by Lehman, most
Hudson staff members were former Lehman
employees.[53]
[edit] Section 363 Sale On February 22, 2011, Judge
James M. Peck of the U.S. Bankruptcy Court in theSouthern District of New York rejected claims by lawyers
for the Lehman estate that Barclays had improperly
reaped a windfall from the section 363 sale. "The sale
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process may have been imperfect, but it was still
adequate under the exceptional circumstances of
Lehman Week."