Remedial Workshop

MBA REMEDIAL ASSESSMENT

Module Team: Dr Kamal EL-Dik

Semester: Spring 2019

Assignment Number: 1 of 1
Assignment Title: Report

Word Count: 1909 excluding references and table of content

Date of Submission: 07 June, 2019

Student Name: Bassim Aridi

Student ID: 30190002

By submitting this assignment, I confirm that the work is all my own, and that I have not plagiarised the work of others in
any form whatsoever. I also confirm that I am aware of the University’s Plagiarism rules. I also confirm that the work has
not been previously submitted to The British Academy in Lebanon for assessment in any other module.
Table of Contents
Lehman Brothers – A look back at the history.........................................................................................................................3
From Growth to Freefall...........................................................................................................................................................3
The Growth...........................................................................................................................................................................3
The Worrying Signs..............................................................................................................................................................4
Rock-Bottom.........................................................................................................................................................................4
The Impact................................................................................................................................................................................5
Conclusions and Role of Social Responsibility.......................................................................................................................5
References.................................................................................................................................................................................5
Lehman Brothers – A look back at the history
The story of Lehman Brothers had a humble start, with Henry Lehman, a German immigrant, who started
a shop in Alabama and shortly he was joined by his brothers Henry and Emmanuel which had an impact
on the name to become Lehman Brothers. Despite starting a general trading company, Lehman Brothers
turned to be a closed investment firm in 1929, and in 1984 American Express acquired Lehman Brothers
before offering the company on public stock in 1994; Lehman Brothers continued with the policy of
acquisitions in its strategy to grow in investment banking, asset management, and real estate. This trend
of growth reached its peak in 2007 with record high net revenues, net income, and earnings per common
share [ CITATION Jas08 \l 1033 ].

This growth was hiding a series of miscalculated risk decisions that aimed for high profitability without
weighing the consequences of investing in “toxic” assets and lending money with high interests to
unreliable parties – individuals or companies. The bubble of profits was busted in 2008 with vast losses in
asset valuation and lack of liquidity which led to the devastating decision to declare Lehman Brothers
bankrupt and selling made by bankruptcy judge James Peck who described his decision: “I have to
approve this transaction because it is the only available transaction” [ CITATION Hal08 \l 1033 ].

From Growth to Freefall

The Growth
The decision of American Express to offer Lehman brothers for public stock was accompanied by
appointing Richard (Dick) Fuld as CEO, who was long servant employee at Lehman Brothers [ CITATION
Wig14 \l 1033 ], which under his direction the company began growing its portfolio thanks to the
aftermath of the 1999 repeal of the Glass-Steagall Act barring affiliations between commercial banks and
investment banks and their activities. This deregulated market dragged Lehman Brothers to be involved
in proprietary trading which prioritized the company’s making profit trading with its resources rather
than focusing on generating profit for its clients, securities, financial derivatives, asset management, and
real estate [ CITATION Wig14 \l 1033 ].
With housing market booming in mid-early 2000s, Lehman Brothers and other companies got heavily
involved in mortgage-backed securities – MBSs, and collateral debt obligations – CDOs, and between
2003 and 2004 Lehman Brother acquired five mortgage creditor companies which gave increased the
revenues for the real estate division of Lehman Brothers by 56% between 2004 and 2006 to reach 146
billion dollars of value generating 19.3 billion dollars of revenue of which 4.2 billion dollars are net
income[ CITATION NIC19 \l 1033 ]. Instead of sticking with buying mortgages to integrate it with the MBS,
Lehman Brothers expanded its business to originate loans using the acquisitions between 2003 and 2004
mentioned earlier due to the increasing profitability of securitization [ CITATION Wig14 \l 1033 ].
Between 2006 and 2008 Lehman Brothers adopted a more aggressive strategy, rather than just acquiring
assets to sell them to 3rd parties benefitting from securitization, the company fell into the trap of
acquiring assets and keep them as investments in the quest of higher market share and profits, but this
retained the risk and ROI of those investments [ CITATION Wig14 \l 1033 ]. One of the key areas of growth
Lehman Brothers targeted was leveraged loans for highly leveraged and/ or speculative firms in
exchange of higher return, but at the same time putting capital at an increasing risk, combined with the
other pillars of growth which were commercial real estate and proprietary business which are by nature
illiquid compared to the initial business of Lehman Brothers. The result was that by mid-2007 Lehman
Brothers held significant assets in real state, which resulted in difficulty to raise cash, hedge risk, and the
ability to sell assets which affected its ability of reduce leverage in the balance sheet [ CITATION Wig14 \l
1033 ].
The Worrying Signs
In mid-2006, prices of US housing began to decline, and despite that factor Lehman Brothers continued
in its strategy to originate subprime mortgages and increase its assets of real estate [ CITATION Wig14 \l
1033 ], and by the end of 2007, the value of Lehman Brothers commercial or residential real estate
reached 111 billion dollars, and securities doubled compared to 2006.
The aggressive strategy adopted by Lehman Brothers proved costly in terms of increasing leverage,
figure 1 shows the leverage ratio and how it increased in 2007 compared to the steady pattern between
2003 and 2006.
Figure 1: Lehman Brothers Reported Gross Leverage Ratios, 2003-2007

* Leverage Ratio = Total Assets / Stakeholder’s Equity

Source: [ CITATION Leh07 \l 1033 ]
The first half of 2007 brought signs weakness in the real estate market, which made investment banks
and especially Lehman Brothers under greater scrutiny regarding their liquidity and value of real estate
assets acquired; hence, rating agencies and financial analysts demanded the reduction of the leverage
ratio, to achieve this objective, companies had to two option: sell assets or increase equity. Despite
raising 6 billion dollars in terms of capital [ CITATION Wig14 \l 1033 ], Lehman brothers opted to sell
assets, this decision by CEO Richard Fuld proved to be a challenging step that had unsuccessful results,
the urge for selling assets forced Lehman Brothers to sell at discounted prices, risking to record loss for
their assets and moreover raising doubts about their value of their remaining assets [ CITATION Wig14 \l
1033 ], and [ CITATION NIC19 \l 1033 ] highlighted that Lehman Brothers “did not take the opportunity to
trim its massive mortgage portfolio, which in retrospect, would turn out to be its last chance”.

Rock-Bottom
The high leverage ratio combined with the massive portfolio of mortgage securities have made Lehman
Brothers vulnerable to deteriorating market fluctuations, and as a result of the near collapse of the
second-largest guarantor of mortgage-backed securities - Bear Stearns on March 17 2008, the stock
value of Lehman Brothers fell by 48% [ CITATION NIC19 \l 1033 ].
As an attempt to buy time, Lehman Brothers adopted the “Repo 105” transactions, which aims to get
loans for financing in which the collateral delivered equalled at least 105% of the loan [ CITATION
Wig14 \l 1033 ]. The company relied heavily on Repo 105, removing assets that are worth 50 billion
dollars; however, the bankruptcy examiner – Anton Valukas recorded that those “transactions should
have been disclosed in its SEC reporting— which they were not” [ CITATION Wig14 \l 1033 ]. The
accumulation of liquidity scarcity and the risk associated with Lehman Brothers mortgage and assets, and
the losses recorded by Lehman Brother especially the statement on September 10, 2008 that announced
that it expected $5.6 billion dollars in write-downs on its toxic assets this is also associated with an
expected loss of $3.93 billion for quarter three made Moody’s to threaten in lowering the credit rating of
Lehman Brothers, and with desperate attempts to secure a partner to purchase and wipe out the toxic
assets, the result was a 42% drop in the stock value on September 11, 2008 [ CITATION NIC19 \l 1033 ].
Last ditch efforts to secure a deal with Barclays and Bank of America failed, and on September 15, 1008,
Lehman Brothers filed for Chapter 11 bankruptcy, resulting in a 93% stock loss compared to September
12.
The Impact
The aftermath of Lehman Brothers shook the global markets for weeks given the status that the
company held globally and because of the investments and assets it had on the books. Several analysts
questioned the decision of the United States government not to bail out Lehman Brothers where its
bankruptcy wiped out 46 billion dollars of its market value [ CITATION NIC19 \l 1033 ].
The model that Lehman Brothers used along with other investment banks is borrowing short term
money on low interest rates with maturities as short as one day, and used these funds for lending and
investing hoping in higher interest rates and returns [ CITATION Rob18 \l 1033 ] as per Goldman Sachs. As
of Aug. 31, 2008 which is two weeks before Lehman Brothers bankruptcy the company had around 600
billion dollars of bonds, stocks, and asset investments along with 572 billion dollars of borrowings,
whereas shareholder equity was 28 billion dollars and that’s why Lehman Brothers was vulnerable.
Since that bankruptcy, a total of 690 interest rate cuts by the top 50 central banks were recorded
[ CITATION Spi16 \l 1033 ], Alex Dryden - global market strategist at JP Morgan Asset Management, told
CNBC that “these rate cuts came into effect to try and stimulate economic growth and to prop up
economies post the financial crisis” [ CITATION Spi16 \l 1033 ]. And the direction now is that movements
instead will use interest rates as a mean to manage inflation risks, providing assurance to nervous
markets and consumers.
Another area impacted by the Lehman Brothers collapse is the exchange rate in global currencies,
[ CITATION Ant09 \l 1033 ] studied the correlation between the fluctuations of exchange rates. The
observation made was the clear relationship between higher interest rates before the Lehman shock the
more fall of exchange rate followed, this is a direct consequence of a sharp increase in risk aversion by
investors [ CITATION Ant09 \l 1033 ] concluded.

Conclusions and Role of Social Responsibility

The repeal of Glass-Steagall act in 2009, is seen by many the beginning of the Lehman collapse, this
repeal of the act triggered investment companies to invest in the housing sector, and Lehman Brothers
had a significant role in the US housing sector boom that took place in the early 2000s. The causes of this
collapse are not limited to accounting and financial reasons only, many ethical causes were highlighted
by several researchers, [ CITATION ASH \l 1033 ] is one of those who examined the ethical side of this
collapse highlighting three main wrong doings:
- The CEO Richard Fuld, was stubborn and did not assume responsibility, although he had the
opportunity to highlight his concerns back in 2007 about the short term health of Lehman
Brothers due to the fact that the company was dragged to risky loans instead, he “squandered it
in favor of communicating to investors and Wall Street that no foreseeable concerns existed”
[ CITATION ASH \l 1033 ] Had Fuld taken the other way around, other options would have been
available to extract competitive solutions and probably Lehman Brothers would have had time to
minimize the financial collapse, where large capital investors would have appreciated
transparency and the general public along with governmental agencies would have had did effort
to save Lehman Brothers as was the case with other financial institutions. But instead, Fuld had
always reluctant to draw an optimistic view of the Lehman Brothers financial health which
hindered the company’s credibility to find suitors for wiping its assets and bailing it.
- The second ethical wrongly decision was that of Chief Financial Officer Erin Callan, who approved
drawing off assets away from Lehman Brothers accounts and into Hudson Castle, the phantom
subsidiary created for the benefit of its parent company’s balance sheet [ CITATION ASH \l 1033 ].
This is linked to the Repo 105 transactions that were discussed earlier, where Lehman had errors
in filing the balances which was then highlighted when the bankruptcy was filed. So in addition to
the continuous lies regarding the financial health by its CEO, Lehman Brothers would have been
 better helped by accurate disclosure of financial details, which could have been resulted in higher
chances of receiving much-needed financial aid.
- The final wrong ethical behaviour in this case was that of Ernest and Young - EY, the only third
party privy to the activities at Lehman Brothers, where EY was accused for gross negligence and
lack of corporate responsibility because failed to reveal the extensive steps taken by executive
leadership to conceal financial problems.

References
Brender, A., Gagna, E. & Pisani, F., 2009. Can we understand the recent moves of the euro-dollar exchange rate?.
[Online]
Available at: https://voxeu.org/article/euro-dollar-exchange-rate-during-crisis

Hall, J., Orr, B. & Daga, A., 2008. Judge approves Lehman, Barclays pact. [Online]
Available at: https://www.reuters.com/article/us-lehman-barclays/judge-approves-lehman-barclays-pact-
idUSN1932554220080920

Lehman Brothers, 2007. Lehman Brothers Holdings Inc. Form 10-K for fiscal year ended November 30, 2007, s.l.: s.n.

LIOUDIS, N. K., 2019. The Collapse of Lehman Brothers: a Case Study. [Online]
Available at: https://www.investopedia.com/articles/economics/09/lehman-brothers-collapse.asp

MONTGOMERY, A., n.d. The Dearth of Ethics and the Death of Lehman Brothers. [Online]
Available at: https://sevenpillarsinstitute.org/case-studies/the-dearth-of-ethics-and-the-death-of-lehman-brothers/

Neely, J., 2008. TIMELINE: A brief history of Lehman Brothers. [Online]

Available at: https://www.reuters.com/article/us-lehman-timeline/timeline-a-brief-history-of-lehman-brothers-
idUSLC64449320080912

Samuelson, R. J., 2018. Lehman Brothers collapsed 10 years ago. Whose fault was it?. [Online]
Available at: https://www.washingtonpost.com/opinions/lehman-brothers-collapsed-10-years-ago-whose-fault-was-
it/2018/08/26/79137b2e-a7dd-11e8-a656-943eefab5daf_story.html?noredirect=on&utm_term=.0db33f1e105f
[Accessed August].

Srivastava, S., 2016. central banks have cut interest rates 690 times since lehman brothers, is there a way out?. [Online]
Available at: https://www.cnbc.com/2016/12/22/central-banks-have-cut-interest-rates-690-times-since-lehman-brothers-
is-there-a-way-out.html

Wiggins, R. Z., Piontek, T. & Metrick, A., 2014. LEHMAN BROTHERS BANKRUPTCY A: OVERVIEW. [Online]
Available at: http://som.yale.edu/sites/default/files/files/001-2014-3A-V1-LehmanBrothers-A-REVA.pdf