group5.lehman brothers
TRANSCRIPT
Part 1
Triggered by a complex interplay of valuation and liquidity problems in the U.S banking system.
The bursting of the U.S. housing bubble caused the values of securities tied to U.S. real estate pricing to plummet.
Resulted in the collapse of large financial institutions, the bailout of banks by national governments and downturns in stock markets around the world.
Over 65 U.S. banks have become insolvent and have been taken over by the FDIC. These banks held over $55 billion in deposits, and the takeovers cost the federal government an estimated $17 billion
The victim of the U.S subprime financial crisis
Filed for bankruptcy on 15/9/2008
$639 billion in assets and $619 billion in debt The largest bankruptcy
ever
*Business Overview
• Ranked 47th among the America’s largest corporations, 4th largest investment bank in US in 2007
• Had long been considered one of the highest return, highest risk small investment banking firm in Wall Street
• Since the IPO in 1994 Lehman had steadily increased revenues. In 2007, Lehman net revenue was 19.2 billion dollars, total assets reached the level of USD 691 billion
• Doing business in investment banking, capital market and investment management
• During the 2000s, roughly 40% of Lehman's net revenues had come from fixed income sales and trading (including derivatives and swaps; mortgage-backed securities (MBS) and futures, leading to the heavy reliance of LB on capital markets
Net revenue by division of Lehman Brothers 2007
16%
64%20%Capital Markets
Investment Banking
Investment Management
In 2003 and 2004, the U.S. housing boom was well under way
Lehman acquired five mortgage lenders, including subprime lender BNC Mortgage and Aurora Loan Services
Due to the acquisitions, record revenues from Lehman's real estate businesses enabled revenues in the capital markets unit to surge 56% from 2004 to 2006
The firm securitized $146 billion of mortgages in 2006, a 10% increase from 2005
PART 2
Cause 1: Internal Reasons
*The victim of its own risky business decisions
*Lehman used securitization => risky bond package relating real estate* Involved the sub- prime debt crisis in America 2007-
2008.*Lehman also invested directly or indirectly in
commercial real estate. When the real estate market went down, property values also declined. * Its CEO, Dick Fuld’s decisions became riskier activities
and decisions* In 2005, Michael Gelband had to resign because of
opposing views on these risky strategies. In June 2008, he was reinvited to the director in charge
of global capital market to save it. this was too late action.
* The risky strategy of Lehman Brothers in the sub- prime mortgage is the internal reason for its closing day. The board of directors do not also have the same voice in management that led to the inconsistent development and risk management strategy.
* Lawrence G.McDonald regarded the closing of Lehman Brothers as “ a colosal failure of common sense”. This empire collapsed because Lehman Brothers had the "frivolous" and "dull" kings.
* Three Ls that killed Lehman:1.Leverage2.Liquidity3.Losses Sub-prime debt crisis in America 2007-2008 = lax management in sub-
prime credit lending + the greed of the market. Securitization is a smart financial tool but it was taken advantage for
the bad intention => it created the unpredictable consequences. Investors need to understand the risks before buying the complex
financial products in order to avoid heavy losses. These are big lessons to challenge for any country in the process of
integration and development.
• Legal • Sell securities that are not your
possesses but borrow them from other party net negative position
• Borrowing to sell at one price, but repurchasing to give back at lower price
Making profits by the declining stock price
• Often speculators are short sellers
•Critics : accused Lehman for being dishonest about their true losses-->Lehman lost investors ‘cause they believed in statement of critics
•Short sellers : spreading rumors to drive down the stock price to make benefits
• June 9, 2008: loss of $2.8 billion announced + lack of trust from investors
Can not raise capital franchising price = 0
45% plunging in stock price 66% spike in credit-default swaps
hedge fund clients began pulling out while its short-term creditors cut credit lines
Sep 9, 2008: Stock lost 50% its value
S&P 500 down 3.4% eroded investor confidence
The Dow Jones lost nearly 300 points the same day on investors’ concerns about the security of the bank
Lehman Brothers have base to believe that Fed would help it
Responses of Fed considered as Responses of Fed considered as direct and most significant cause of direct and most significant cause of Lehman bankruptcy.Lehman bankruptcy.
• are two government-sponsored enterprises (GSE)
• The corporations' purpose:- expanding the secondary
mortgage market by securitizing mortgages in the form of mortgage-backed securities (MBS)
- allowing lenders to reinvest their assets into more lending and in effect increasing the number of lenders in the mortgage market by reducing the reliance on thrifts
• Before the subprime mortgage crisis: - owned or guaranteed $1.4 trillion, or 40%, of
all U.S. mortgages. - only held $168 billion in subprime mortgages
- but it was enough to capsize the two• If they were to collapse, mortgages would be
harder to obtain and much more expensive. • If they went bankrupt, all the investments
would go to 0, and there would be mass upheaval on a global scale
• is an American multinational insurance corporation
• In the United States, AIG is the largest underwriter of commercial and industrial insurance
• AIG suffered from a liquidity crisis when its credit ratings were downgraded below "AA" levels in September 2008
• Main reasons why AIG was saved- AIG is too big (with assets of over $1 trillion),
it also covers too much and has an intimate relationship
- AIG’s insurance policies have accessed to many Americans (and customers around the world)
- the insurance business of AIG makes a lot of money
-> the collapse of AIG would have greater global impact than Lehman Brothers
• Grown significantly since the early 2000s• Top ten firms in terms of the number of MBS, ABS and commercial
mortgage backed securities originated each year• November 30, 2007: revenues of $16.1 billion
$13.40 trillion in derivative financial instruments$28 billion in level 3 assets on its books net equity position of only $11.1 billionleverage ratio of 35.5 to 1
• December 2007, Bear Stearns announced a loss of $854 million
2007 metrics Goldman Sachs Group (GS)
Morgan Stanley
Merrill Lynch
Lehman Brothers
Bear Stearns
Gross earnings ($B) 45.6 23.1 -6.1 19.3 2.2
Pre-tax income ($M) 17,604 3,441 -12,831 6,013 193
1-yr revenue growth (%) 23 -9.7 N/A 9.5 -52
Equity origination revenue ($B)
1,382 1,570 1,629 1,015 N/A
M&A advisory revenue ($B) 4,222 2,541 1,740 1,337 828
Debt underwriting revenue ($B)
1,951 1,427 1,550 1,551 N/A
Fixed Income Sales and Trading
Revenues as % of Total Revenues
(1998-2005)
Trading as % of Net Assets
Avg. Trading Efficiency
Lehman Brothers
40% 2.75% 60
Bear Stearns 35% 1.75% 50
Goldman Sachs
27% 2.00% 55
Morgan Stanley
20% 1.25% 35
Merrill Lynch 15% 1.9% 25
March: the system was not ready for Bear or “too big to fail” institutions to fail -> lead to a confidence crisis
September: better prepare to deal with the consequences of a failure
*Lehman missed its own opportunities to save Lehman, FED needs to break the law unpredictable consequences for the US legal and financial system.*Moreover, Lehman cannot prove
adequately guaranteed assets to receive support as other groups (eg. AIG)
• Moral hazard:If Government bailed out create “moral hazard” (company will take not less risky investments) - create an extremely bad precedent.- may cause a Domino effect in financial system.
*Political pressure:- Presidental election Debate: Is it
possible to use tax paid by people to save a for-profit firm?
- A sacrifice is essential for the market+ Cannot be AIG, Freddy Mac of Fannie Mae (why?)+The best option is Lehman
*Government was limited by Budget constraint, relationship between tax and bond.*If budget was spent rescuing Lehman
ineffective action lose people’s confidence in US Government.
*In our review, there may be a reasonable implication:
- FED stopped at rescuing Bear Stearns- Afterwards, giving out a program to
refinance for financial system, framework of punishment for collapsed firms.
BUT……
• 27 thousand people were unemployed during the financial market crisis, contributing to the extremely high rate of unemployment of this period.
• not simply just a financial crisis anymore but an economic recession that affects all other sectors in the economy.
• The lost of rescuing money insiders gave to Lehman made a caution and afraid of being empty-handed in investors so they never want or ready to help the other banks on the edge of bankruptcy again.
• So who will? FED again? the weight on FED shoulder might be even heavier.
PART 3
*Understand and monitor counterparty, market, and credit risks
*Measure, monitor and manage liquidity risk
*Increase the operational effectiveness of collateral management and accurately capture contractual terms
*Know their investments
*Hedge funds and other users of prime brokerage are seeking alternative custody models to separate the custodian and trade finance functions
*Stress the importance of transparency of internal controls
*Warran Buffet theory: Never bought derivative investment products That he did not understand=> If you can’t understand the prospectus, the offering
documents or an investment guide, it’s time to get nervous.
* Within days of Lehman’s collapse: * net asset value < traditional $1 share
price for a money-market fund*the fund had $785 million of Lehman debt
went to zero=> The fund was not quite the same as
everyone else.
* The Reserve Primary breaking the buck=> money rushed out of “prime money market funds”=> investors who panicked lost a whole lot more.
=> investors found themselves swamped and in the middle of the crisis=> needed to stay calm in order to make the right move.
*At the worst of the 2008 panic, a lot of investors desperately trying to win their money back => made a bad situation worse.
sticking with your original strategy is wiser than trying something more risky as a quick fix
* investors bailed out on the rumors. consumers find themselves in financial trouble for counting on troubled employers to keep paying them => Lehman Brothers failed
= > The financial crisis validated strategies that involve paying off debt and amassing a big emergency fund rarely seems to work in all market conditions.
* yield-hungry investors will go further up the risk scale without recognizing anything promising a higher yield coming with interest-rate risk and credit risk.
=> end up badly if you are letting greed drive your strategy during good times.
