MANACC

Background and History

1844 - 23-year-old Henry Lehman comes from Bavaria to Birmingham, Alabama. He opened
a dry goods store, “H. Lehman”

1850 – Mayer Lehman arrives. The company is renamed once more, to the “Lehman
Brothers”. Lehman Brothers began accepting cotton as payment and reselling. This became
the most important part of their business.

In 1862 -- facing difficulties as a result of the Civil War, the firm teamed up with a cotton
merchant named John Durr to form Lehman, Durr & Co.[20][21] Following the war the
company helped finance Alabama's reconstruction. The firm's headquarters were eventually
moved to New York City, where it helped found the New York Cotton Exchange in 1870

The Lehman Brothers began to trade bonds the same way they had begun to do with cotton
in the 1850’s. The trading of these bonds and securities led the Lehman Brothers to join the
New York Stock Exchange and give up commodities trading for the sake of merchant-banking
and financial advisory.

1930s-1970s

The Lehman Brothers, over the years, began to help finance things such as television and oil,
as well as many new technologies, even early computers. Robert Lehman died in 1969, and
the company has been led by non-Lehman’s ever since.
The company began to fail, and Bell and Howell CEO Pete Peterson was appointed to help
save the company.

In 1984, Lehman Brothers was acquired by American Express and merged with its retail
brokerage Shearson to form Shearson Lehman Brothers. American Express began to divest
its financial services by business lines in 1992 and eventually, in 1993, the firm was spun off
and once again became known solely as Lehman Brothers. In 2000, Lehman celebrated its
150th anniversary.

Beginning of the end

In 2003 and 2004, with the U.S. housing boom well under way, Lehman acquired five
mortgage lenders, including subprime lender BNC Mortgage and Aurora Loan
Services, which specialized in loans.

Lehman's acquisitions at first seemed prescient; record revenues from Lehman's real
estate businesses enabled revenues in the capital markets unit to surge 56% from 2004
to 2006, a faster rate of growth than other businesses in investment banking or asset
management.
The firm securitized $146 billion of mortgages in 2006, a 10% increase from 2005.
Lehman reported record profits every year from 2005 to 2007. In 2007, the firm
reported net income of a record $4.2 billion on revenue of $19.3 billion.

In February 2007, the stock reached a record $86.18, giving Lehman a market
capitalization of close to $60 billion.

On March 14, 2007, a day after the stock had its biggest one-day drop in five years on
concerns that rising defaults would affect Lehman's profitability, the firm reported
record revenues and profit for its fiscal first quarter.

In the post-earnings conference call, Lehman's chief financial officer (CFO) said that
the risks posed by rising home delinquencies were well contained and would have
little impact on the firm's earnings. He also said that he did not foresee problems in
the subprime market spreading to the rest of the housing market or hurting the U.S.
economy.

As the credit crisis erupted in August 2007 with the failure of two Bear Stearns hedge
funds, Lehman's stock fell sharply. During that month, the company eliminated 2,500
mortgage-related jobs and shut down its BNC unit. In addition, it also closed offices
of lender Aurora in three states.

On March 17, 2008, following the near-collapse of Bear Stearns – the second-largest
underwriter of mortgage-backed securities – Lehman shares fell as much as 48% on
concern it would be the next Wall Street firm to fail.

Subprime loans were loans issued to borrowers with poor or no credit history
(Gramlich; Jansen el at 2008). The implication of these loans was an increase in risk
associated with high probability of default and as a result subprime borrowers paid
high interest rates and fees compared to their A-Credited counterparties (Gramlich
2007; Jansen el at 2008). This increase in high interest rates and fees made it
impossible for majority of low income US citizens to own a home.

To promote home ownership for all citizens, the US government sought to change the
subprime market which was primary dominated by non-conventional lenders by
engaging the banks to make subprime loans available to the poor

To that effect the Home Mortgage Disclosure Act of 1975(HMDA) required banks in
metropolitan areas to disclose their mortgage loans classification and geographic
location to exposure and discourage the redlining practice in which banks
concentrated their lending in wealthier neighborhoods

High liquidity in the market and coupled with a high demand for financial products also
contributed to a lax of regulation. The borrowers were offered mortgage loans at adjusted
interest rate which initially started with low “teaser” interest rates that were affordable
and adjusted to higher interest rates in later stages essentially requiring the borrower to
refinance the mortgage

In the period between 2004 and 2006, the Federal Reserve with the aim to constrict
inflationary pressure, slowly increased the interest rates resulting in contraction of the
money supply (Besley and Brigham 2012, 2011; Bianco 2008). With a low money supply
and higher

interest rates resulted to a slight decline in housing demand. At the same time the adjusted
mortgage rates began to reset to their new higher interest rates. This created a new
situation given the background of the subprime borrowers. With difficulty to meet their
obligation to pay the high mortgage interest rates, their only option was to sell their
homes. However, with no possibility to lower prices in the face of lower demand and
coupled with no resources to pay realtor fees, it was impossible to sell their homes
resulting to an increase in foreclosures and mortgage loans defaults (

Increased foreclosures and defaults led to decline in housing values. This declined also
began to have an indirect effect on securitized financial products. The reason for this is
because like other securities, mortgage-backed financial products usually received risk
valuations using historical mortgage data. In addition, each mortgage-backed security had
an underlying cashflow that was generated by interest payments of mortgage related
loans. Since mortgage loans were usually bundled together and repackaged as riskless or
high yield securities, it was therefore difficult for market participants to differentiate
between the securities that were highly exposed to risk associated with default and
foreclosures and those that were not. Hence inability to distinguish between these
securities assets resulted to a panic in the financial markets and loss of investors’
confidence in these products.

Lehman major investments were tied to the mortgage business and about 64% of its
revenue was generated through the fixed income and equities business operations. In
addition, Lehman relied on the repo markets to finance its daily operations and
consequently, used security inventory on its balance sheet as collateral.

The credit rating was important to Lehman because low credit rating would adversely
affect its liquidity and competitive position. Consequently, increasing the cost of
borrowing and the likelihood of high exposure to risk associated with financial distress
and bankruptcy

Faced with these two dilemmas, Lehman had incentives to find a solution that would both
lower its leverage and provide the necessary finances to repay its repo loans. This would
enable Lehman to maintain good relationship with its counterparties hence securing the
source of funding for smooth running of the firm business operations.

Lehman had only two of these options at its disposal to help manage its balance sheet
hence lower its leverage ratio. However, generating internal finances or raising capital
through issuance of new equity had negative impact on the overall value of the firm
consequently lowering its stock prices.

For one, to generate internal finances, Lehman would have to sell some of its security
inventories. Most of these securities were directly or indirectly linked to mortgage
business. However, because of the increase in foreclosure and default, investors had lost
confidence in these assets hence making it difficult to find a ready market to sell them. In
addition, more investors and financial institutions also had the incentives to sell off their
mortgage related securities. An increase in supply and a decline in demand for these
securities resulted to the financial markets flooded with devalued securities. Furthermore
even if Lehman was successful in selling some of its security inventories, it would have to
sell them at a discount which would have negative implications on the firm’s overall
performance. Second, through issuance of new equity, Lehman had the opportunity to
raise need capital to pay off some of its debts. This would enable Lehman to rebalance its
balance sheet, hence lower its leverage ratio. However, issuance of new equity would not
only lower stock prices

To avoid the negative implications on stock prices as well as maintain its counterparties’
confidence, Lehman opted to significantly reduce its leverage ratio by manipulating its
accounts through repurchase agreements (

Repo 105. These transactions were similar to Lehman’s normal financing repurchase
agreements both in structure and magnitude. This means that the transactions were
conducted using the same type of collateral, had similar counterparties and Lehman
received coupon payments from the transferred securities. Given the similarity, Lehman
executed the Repo 105 transactions in the same way as the normal financing repurchase
transactions with the exception of the accounting treatment (i.e. the Repo 105 transactions
were classified as sales)

Most of Lehman’s repurchase transactions classified for as “sales” were true financing
repurchase agreements and therefore the transferred securities should have remained on
Lehman’ balance sheet during the repo term The incoming borrowed cash would have
increased its total assets and total liabilities simultaneously as Lehman would have
recorded a corresponding liability representing its obligation to repay the borrowed cash.
The leverage ratio and the balance sheet figures would have increased as well due to the
changes recorded.

4 Reasons Why Lehman Failed

There Was No Buyer

The first, and probably most major, problem was the lack of a buyer. Think about the
situations of other troubled institutions like Bear Sterns, Merrill Lynch, Washington
Mutual, and Wachovia. None of those declared bankruptcy, because they all found
buyers. Lehman didn't. Bank of America was interested until it realized it could get
Merrill Lynch instead. Barclays wanted Lehman, but British regulators balked.

This is an important point, because all along U.S. regulators believed a deal could get
done. They never really wanted to simply save a firm -- acquisition was the
acceptable alternative to failure. Finalizing one with Barclays looked particularly
promising. But then, as former Treasury Secretary Hank Paulson recounts in his book,
"The British screwed us." Had British regulators allowed the acquisition to proceed,
then there would be nothing to debate today.
Its Balance Sheet Was a Disaster

Since there wasn't a buyer, the next option was for the Federal Reserve to come
through with an emergency loan. It decided not to, because it did not believe that
Lehman had strong enough collateral to back up the loan. And here's where the
subjectivity comes in. Although the Fed could have technically provided such a loan,
its calculations required that it not do so, because they showed that the central bank
would sustain a significant loss by trying to revive an institution that would likely fail
ultimately anyway.

There Was No Political Palatability for Bailouts

And that wasn't a politically desirable option. The public was already becoming
impatient with the financial industry. The idea that the Fed or Treasury might step in
to bail out a firm like Lehman, and stick taxpayers with billions of dollars in losses,
just didn't fly politically. With other acquisitions, the losses were calculated to be less
significant, and a willing acquirer was on board. That way, it didn't seem like the
institution was simply saved, but that it still sort of failed, and was purchased by
another bank.

Its Failure Wouldn't Directly Affect Average Americans

Of course, when it came to AIG, none of those reasons mattered. It was bailed out the
day after Lehman failed to the tune of $85 billion. It also had no acquirer; its balance
sheet was also a mess; and its losses could also be quite significant. What changed? In
part, the politics were completely different. A failure of Lehman would indirectly
affect all Americans. But its direct losses would mostly fall on the shoulders of
institutional investors and current and former Lehman investment bankers who held
the firm's stock. A failure of AIG, however, would directly affect a huge number of
average Americans. This wasn't just a problem for Wall Street: its insurance products
were intertwined throughout Main Street.

Once the world realized how bad of an idea it was to allow Lehman to fail, everything
changed. That's why the widespread bank bailouts occurred. While the U.S. might be
able to get away with one major investment bank defaulting, it couldn't possibly allow
two or three more big institutions to fail. So the calculus above became irrelevant. But
at the time, during the weekend of September 13-14, 2008, the logic above explains
why Lehman wasn't revived

1. Leverage
During the good times, the best way to enhance your returns is to 'gear up' by
borrowing money to invest in assets which are rising in value. This enables you to
'leverage' (magnify) your returns, which is particularly useful when interest rates are
low. However, leverage cuts both ways, as it also magnifies your losses when asset
prices fall. (Witness the recent return of negative equity to the UK property market.)

A sensibly run retail bank would have leverage of, say, 12 times. In other words, for
every £1 of cash and other readily available capital, it would lend £12. In 2004,
Lehman's leverage was running at 20. Later, it rose past the twenties and thirties
before peaking at an incredible 44 in 2007.

Thus, Lehman was leveraged 44 to 1 when asset prices began heading south. Think of
it this way: it's a bit like someone on a wage of £10,000 buying a house using a
£440,000 mortgage. If property prices started to slide, or interest rates moved up, then
this borrower would be doomed. Thanks to its sky-high leverage, Lehman was in a
similar pickle.

2. Liquidity
Most businesses fail not because of lack of profits but because of cash-flow problems.
Like all banks, Lehman was an upturned pyramid balanced on a small sliver of cash.
Although it had a massive asset base (and equally impressive liabilities), Lehman
didn't have enough in the way of liquidity. In other words, it lacked ready cash and
other easily sold assets.

As markets fell, other banks started to worry about Lehman's shaky finances, so they
moved to protect their own interests by pulling Lehman's lines of credit. This meant
that Lehman was losing liquidity fast, which is a dangerous state for any bank. Only
six months earlier, in March 2008, Lehman rival Bear Stearns faced a similar loss of
liquidity before JPMorgan Chase rode to its rescue.

Believing that Lehman did not have enough liquidity at hand, other banks refused to
trade with it. Once a bank loses market confidence, it loses everything. Being unable
to trade meant that Lehman and its business ceased to exist in other banks' eyes.

3. Losses
After the terrorist attacks of 11 September 2001, US interest rates plummeted, causing
a five-year boom in domestic and commercial property prices. This boom ended in
2006 and US housing prices have since fallen for three years in a row.

Lehman was heavily exposed to the US real-estate market, having been the largest
underwriter of property loans in 2007. By the end of that year, Lehman had over $60
billion invested in commercial real estate (CRE) and was very big in subprime
mortgages (loans to risky homebuyers). Also, it had huge exposure to innovative yet
arcane investments such as collateralised debt obligations (CDO) and credit default
swaps (CDS).

As property prices crashed and repossessions and arrears sky-rocketed, Lehman was
caught in a perfect storm. In its third-quarter results, Lehman announced a $2.5 billion
write-down due to its exposure to commercial real estate. Lehman's total announced
losses in 2008 came to $6.5 billion, but there was far more 'toxic waste' waiting to be
unearthed.
First, the fragility. Allowing Lehman to fail — cited often as the government's biggest
boo-boo — started a chain reaction. There was a run on money-market funds after one
big money-market fund revealed that it owned a lot of suddenly worthless Lehman
debt. London-based hedge funds that relied on Lehman for day-to-day financing
found themselves unable to do business because their accounts with Lehman's U.K.
subsidiary were frozen. Similar dislocations played out around the world. Before long,
financial institutions were paralyzed by fear. They simply didn't trust each other
anymore, and didn't want to lend to each other. The financial system proved too
fragile to handle the stress.

Secondly, consensus among the policymakers who mattered, in the U.S. and overseas,
was that the panic had to be stopped at any cost.The cost was a bailout that placed
trillions of taxpayer dollars at risk. It was expensive, it was messy, it was unfair. It
struck many people as downright un-American. But it worked. "I've abandoned free-
market principles to save the free-market system," is how President George W. Bush
described it last December.

Three Wrongs

1.         When the housing marketing began faltering in 2007, Fuld was entrenched in
a highly aggressive and leveraged business model, not unlike many other Wall Street
players at the time. Unlike the competitors, a few of whom had the foresight to
identify the pending collapse and evaluate possible consequences of mortgage
defaults, Fuld did not rethink his strategy. Instead he proceeded into mortgage-backed
security investments, continuously increasing Lehman Brothers’ asset portfolio to one
of unreasonably high risk given market conditions. In short, he was obstinate, but
when the time came to recognize his error, he did not assume responsibility or admit
wrongdoing. Fuld had an opportunity in 2007 to voice concerns about his bank’s
short-term financial health and its heavy involvement in risky loans, and he
squandered it in favor of communicating to investors and Wall Street that no
foreseeable concerns existed. Had he been truthful, more competitive solutions —
along with the benefit of time — would have been available, likely helping prevent or
minimize the financial hemorrhage that loomed on the horizon. For example,
commercial banks, such as Barclays and Bank of America, which were approached
for a snap acquisition decision, would have had more time to evaluate whether the
move would complement their long-term strategies. They also would have had more
time and opportunity to resuscitate Lehman Brothers than they did a few quarters
down the road.

Additionally, while the immediate effects of admitting a shaky outlook would have
been negative, two repercussions must be considered. First, large capital investors
would have been appreciative of the transparency, and after getting past the initial
shock, they would have taken action to get the bank back on track. Second, had the
general public — including the federal government — been aware of the situation and
the actionable measures being taken to rectify it, more intellectual and financial aid
would have been available to minimize losses and potentially avoid total collapse.
This was not the case, however, and by choosing to paint an unrealistically optimistic
picture of Lehman Brothers’ financial situation, Fuld forfeited the opportunity to take
advantage of various solutions that would have cut the company’s losses. Had he
acted more prudently, Lehman Brothers’ story may have ended differently.

2.         The second ethical lapse, which was perhaps the most premeditated and
fundamentally wrong, was Callan’s approval of siphoning assets away from Lehman
Brothers accounts and into Hudson Castle, the phantom subsidiary created for the
benefit of its parent company’s balance sheet. This blatant misrepresentation of
financial health, perpetrated through the employment of Repo 105, was an attempt to
grossly manipulate the bank’s many stakeholders and also clearly indicative of a
much bigger problem. Even more telling is the fact that this technique was used in
two consecutive quarters.

Various documents examining the collapse of Lehman Brothers, including

congressional testimonies and investigative reports, confirm that the purpose of Repo
105 was not to diminish earnings for tax benefits or similar effects. Instead, moving
assets away from the balance sheet was intended to create the illusion of a company
that was stable and secure. Had Lehman Brothers’ executive team been capable of
managing the issue, this tactic would have been a temporary stay until
reorganizational measures were taken and accurate statement releases could be
resumed. Instead, for six consecutive months, the bank’s leverage was so dangerously
high that it had no choice but to intentionally mislead its shareholders if it hoped to
maintain any semblance of confidence in its operation. As with Fuld’s decision to lie
about the company’s state of affairs, Lehman Brothers would have been better served
by fully and accurately disclosing the details of its finances. With the benefit of
credibility and time to strategize, the likelihood of receiving much-needed aid would
have been far greater.

3.         Finally, Ernst & Young, the only third party privy to the happenings at
Lehman Brothers, failed to reveal the extensive steps taken by executive leadership to
conceal financial problems. As a firm of certified public accountants expected to
honor and uphold an industry-wide code of ethics, Ernst & Young may be accused of 
being responsible for gross negligence and lack of corporate responsibility. Why
would such a highly respected organization risk its own reputation and turn a blind
eye on behavior that is clearly unethical? Obviously Lehman Brothers was a sizeable
(and presumably lucrative) client of the firm. But past scandals involving questionable
accounting observances, such as Enron, have demonstrated firsthand that inaction is
as equally reprehensible as direct involvement in the scheme itself. More than just a
paycheck was at risk, and failure to act successfully discredited Ernst & Young on the
basis of ethical and industry standards.

Analysis of facts and issues

A ferocious cycle resulted where risk was compensated. The accounts published in
2009 produced a culture of boldness and risk, which was excessively rewarded when
the firm and its executives generated profits. This promoted hubris that allowed
certain managers to believe that it was different and normal rules did not apply to
them. Conversely, for Lehman, competing with commercial banks would be a
gigantic task by utilizing high amounts of leverage.

Together, Lehman and E&Y supposedly approved the borrowing under agreements to
later repurchase the notes as a sale of an asset instead of short-term borrowing
arrangement [11]. The attorney general complained that E&Y “substantially assisted
Lehman to engage in a massive accounting fraud, involving the surreptitious removal
of $10 billions of securities from its balance sheet”, through Repo 105 transactions
[11]. The firm speedily amplified its use of Repo 105 as the financial crisis grew and
Lehman was facing demands to reduce its leverage [11].

While not referenced or incorporated into Lehman’s internal Repo 105 Accounting
Policy, senior management of Lehman set limits on the total amount by which the
firm could reduce its balance sheet on any given day using Repo 105 transactions [9].
The former Lehman employees described Repo 105 dealings as an accounting trick
and a sluggish way of managing the balance sheet [9]. The management formed 2
rules loosely known within Lehman as (1) the “80/20” or “continual use” rule and (2)
the “120%” rule, prescribing a minimal level of continual application of Repo 105
dealings throughout the quarter and a maximum volume of Repo 105 transactions at
quarterend [9].

None could consistently judge the interconnections in the financial system due lack of
transparency [8]. It was unclear what the bankruptcy of Lehman Brothers in New
York would mean for its subsidiaries in London and Frankfurt [8]. There was no
international regulation on the decree of systemically important banks [8]. The
problem of imprecise incentives, no transparency, lack of capital, liquidity buffers,
and the lack of mechanisms are few highlights for the systemic failure of important
banks [8].

The power within the board of Lehman Brothers was centralized in CEO and
Chairman, Fuld, who seized more than 50% of the beneficial ownership owned by
directors and officers [10]. The one-year term diminished the impact any director
could have on board decisions or the board decision-making processes [10]. Fuld was
involved in significant financial decisions and understood the importance of reducing
leverage to maintain credit ratings and the effect reporting losses would have on the
company’s survival. Fuld failed to inform other board members of the impact of Repo
105 transactions on financial statements and firm operations, if single transaction
limits were to be removed [10].

The stock options in 2008 were exercisable in installments of 1/3 on the anniversary
of the grant dates over the coming three years, with ten-year terms and were not
forfeitable [10]. Once allegations of Repo 105 usage were made known, the audit
committee acted appropriately as needed. The audit committee was also responsible
for oversight of the Finance and Risk Committee (Final NYSE Corporate Governance
Rules, 303a 7 (b) (iii) (B)) [10]. The authors considered that many of the
shortcomings in board’s failure to notice could have been remedied by (1) reducing
the power of the CEO (2) increasing board member independence and (3) improving
the expertise of board members [10].

Lehman’s disintegration was associated with ethics and decisionmaking process [12].
The International Federation of Accountants 2014 stated, five essential doctrines of
professional ethics, known as Integrity, Objectivity, Professional Competence and
Due Care, Confidentiality, and Professional Behavior [12]. By manipulating their
balance sheet and illegal activities, Lehman Brothers broke integrity and professional
behavior. In this instance, consequential ethics can be linked to creative accounting.
By highlighting ethics and its role in the decision making process, we can see how led
to defective accounting practices [12]. The combination of bad ethics and flawed risk
management led Lehman Brothers to a remarkable collapse [12].

Yet, it would be wrong to say that contraction of credit market occurred suddenly.
Sufficient warning was given beforehand with warning signs such as the tightening of
the global credit market appeared about six months earlier with a gradual, yet distinct
slowing. However, any highly debt to equity entity holds a narrow window of
opportunity to respond to unfavorable market conditions. For Lehmans, this retention
of high proportion of non-liquid investments within the subprime crisis, the ability to
relieve of assets became near impossible without incurring significant losses. If such
action was taken, the company would be exposed on grounds of: a) the
acknowledgment of such losses would reduce equity, and b) the quality of the
remaining assets would be infected by prevailing market sensitivity.

Conclusions

The economic failure of Lehman Brothers was one of the largest and most complex in
history, surrounding 4 bodies of valid U.S. laws, and insolvency procedures that
consisted in excess of 80 international legal jurisdictions [6]. The payment ratio to
third-party creditors was initially estimated to be about 21 percent based on allowable
claims of $362 billion [6]. The actual distributions of payments have exceeded initial
estimates, some of which has gone to other Lehman entities of Lehman [6].
Customers of centrally cleared securities were generally made whole, and most
customers of Lehman’s broker-dealer were able to transfer their accounts to other
solvent broker-dealers [6]. On the contrary, many counterparts of Lehman’s OTC
derivatives suffered substantial losses [6]. The bankruptcy report conclusion was that
Fuld acted with gross negligence and breached the duty of care in filing misleading
financial statements. The poor planning of the bankruptcy process made it expensive
and delays in settling claims [6]. On the contrary, creditor losses were more
considerable without the ability of Lehman’s brokerage subsidiary in the USA, and
afterward, of Barclays, to finance positions through the Federal Reserve’s liquidity
services [6]. Finally, Lehman’s interlinks led to delays as per LBHI’s creditors
argument in court that, because the holding company guaranteed some of the
subsidiaries’ debt, they were permitted to recovery of a portion from subsidiary assets
[6]. The Chapter 11 procedures are based on the application of case law linking to the
Bankruptcy Court’s prior analysis of cases [6]. Despite the fact that existing case law
provided a useful starting point for Lehman’s resolution, the court provided new
interpretations of provisions in the Bankruptcy Code [6].

The bankruptcy court had to analyze complex financial securities for the first time. In
sum, the size and complexity of Lehman, the originality of its structure, and the rarity
with which such firms go bankrupt contributed to a prolonged and costly resolution
[6]. Because of the Dodd-Frank Act, regulators can resolve optionally large, complex
financial firms under the Authority of Orderly Liquidation, through the extended
reach of the FDIC [6]. Details of such a resolution to be implemented are still under
process, making it tough to evaluate the6 extent to which the resolution of large
nonbank financial firms will be more efficient going forward [6]. Regulators have to
ensure that new financial instruments do not pose systemic risks [8]. Currently, good
progress has been made with respect to transparency and securitization [8].

Recommendations

The downfall of Lehman evidently shows the relationship between regulations and
action management arrangement [12]. The letdown uncovered the deficit in the
regulatory system, thereby calling for the urgent need for severe supervision of
specific performance indicators such as a firm’s liquidity situation, solvency and
success [12].

Policy makers such as the International Financial Reporting Standards (IFRS),

Securities and Exchange Commission (SEC), the Basel Accord et al, must commence
tough policies to address the Lehman failure to prevent some future episode [12]. The
good news is that banks today are much better capitalized than they were five years
ago, in line with the new international regulatory principles [8]. Firms are required to
fuse with high-quality corporate governance practice to restore investors’ confidence
via ethical practices and standards [12]. Basel III requires banks to hold more capital
to raise the bank’s capacity to absorb losses and makes them more flexible against
sudden shocks [8]. In this regard, Basel III hangs on to the concept of risk-weighted
assets for sensible risk management [8].

There exists a hesitation whether the zero risk weight for government bonds is
sufficient [8]. For the first time ever, an international standard on liquidity has been
decided on, that can shield banks to a certain degree from liquidity constrict in the
money market [8]. If a too-big-tofail bank runs into trouble, the government enters to
prevent a systemic crisis [8]. We have to ensure that large and interconnected banks
can fail without causing a systemic crisis [8]. A new international principle on
recovery and resolution of systemically important banks has been developed, which is
a major step forward [8]. However, the willingness to let an institution go bankrupt is
a political rather than an economic decision [8].

The IT and tech spending by the big banks has fallen since 2007. Big Data and
increasingly urbane analytics offer huge opportunities to better understand and serve
worldwide markets [13]. These could offer regulators with efficient tools, enabling
them to detect potential danger and intervene in time to prevent another crisis [13].

By promising liberty, easing long-term planning, and closing the resource crack
between the agency and the entities it controls, selfgoverning funding will permit the
SEC to protect millions of investors, by identifying and addressing all types of risks
[2]. Tough actions will be taken to prevent future risky activities under its supervision
and new responsibilities assigned to it under any future legislation [2].

The FDIC’s report states that if Dodd-Frank was in place; Lehman would not have
gone bankrupt, as it would have received help from the government to settle its debt
[14]. On the other hand, this report was based on numerous suppositions and only
time can tell if regulations are beyond doubt efficient since testing has not been done
[14,15].
The Bottom Line

The collapse of Lehman Brothers was not the result of a single lapse in ethical
judgment committed by one misguided employee. It would have been nearly
impossible for an isolated incident to bring the Wall Street giant to its knees,
especially after it successfully withstood so many historical trials.

Instead its demise was the cumulative effect of a number of missteps perpetrated by
several individuals and parties. These offenses can be categorized into three acts: Lies
told by Chief Executive Officer Richard Fuld; concealment endorsed by Chief
Financial Officer Erin Callan; and negligence on behalf of Ernst & Young.

Lehman's collapse roiled global financial markets for weeks, given the size of the
company and its status as a major player in the U.S. and internationally. Many
questioned the U.S. government's decision to let Lehman fail, as compared to its tacit
support for Bear Stearns, which was acquired by JPMorgan Chase & Co. in March
2008. Lehman's bankruptcy led to more than $46 billion of its market value being
wiped out. Its collapse also served as the catalyst for the purchase of Merrill Lynch by
Bank of America in an emergency deal that was also announced on September 15. In
short, Lehman Brothers -- a company with a 158-year history, including 14 years as
an NYSE-listed giant -- failed simply because it took on too much risk in a booming
market. In the end, its move from the safety of corporate finance and M&A (mergers
and acquisitions) income into the risky world of proprietary trading proved to be its
downfall.

The lesson here is that any firm, no matter how big and powerful, can be dashed to
pieces on the rocks of leverage, liquidity and losses!