This action might not be possible to undo. Are you sure you want to continue?
1.0 Introduction On 15 th September 2008, when the investment bank Lehman Brother fell was the largest bankruptcy ever in the history. The bank had assets nearly $639 billion, the Lehman bank business areas before the collapse was investments banking, equities, capital markets and investment management (Lehman Brothers, 2007, annual report; 2008). Due to competition from other investment banks, Lehman Brothers decided to change from lower risk brokerage to higher risk, they focused on making long ±term investment. They were also in volved in different types of Subprime loans and Mortgages, these loans were issued to people who had little security and this led to higher interest rates. The government also encouraged banks to issue loans so that even financially weak people could buy houses. However, things changed when cheap loans and real estate prices burst in 2006. Interest rates started to become very high and led to default which meant then a lot of loss in revenue and severe increase in Liquidity risk. Prices of real estate also fell and assets lost value (Bankruptcyreport, 2008). In the beginning of 2008, Lehman Brothers started losing millions of money with their high debts and their balance sheet filled with weak, illiquid assets.Lenders and other parties lost confidence in the bank increasing capital costs and made it hard for the bank to get short-term funding to maintain Liquidity (Lehman Brothers second quarterly report, 2008). They tried to negotiate with other banks for sale but no settlements were made, therefore due to t heir disregard of risk awareness, the US government had lost confidence in the bank and chose not to intervene in the inevitable end of Lehman Brothers. There are things that need to be considered when a major financial firm assumes to be ³too big to fail´ the government needs to nationalise the company in order to limit its effects on other firms and also to protect the system. This has been the debate over whether the US government action to let the Lehman Brothers fail was justified or it was the best th ing to do to avoid financial institutions creating a problem called ³moral hazard´. Many financial institutions, investment banks in particular, issued large amounts of debt during 2004 ±2007, and invested the proceeds in mortgage -backed securities (MBS), essentially betting that house prices would continue to rise, and those households would continue to make their mortgage payments. Borrowing at a lower interest rate and investing the proceeds at a higher interest rate is a form of financial leverage . During 2008, three of the largest U.S. investment banks either went bankrupt like Lehman Brothers or were sold at fire sale prices
From a lay man¶s point of view. Lehmann Brothers is nowhere near as significant an institution. 2 . Also. namely. Fannie Mae and F reddie Mac is believed to have had collateral and showed great promise of paying back the Federal Reserve in the future that¶s why they received bailout while they were not very sure about the Lehman Brothers. it is very easy to say that the government¶s decision was biased in some way. 2010). As with Leh man. after reading the case study. The government also expected companies such as Bank of America and Barclays to buy parts of Lehman Brothers company therefore they did not step in. The government should have forced the industry to address the financial pressures that were simmering for over a year before the Lehman Brothers crisis. In the case of Lehmann brothers. H. when the stock markets in Russia had dropped a lot because of their problem.S..Companies like AIG.. AIG's collapse would be the beginning of the entire worl d's economic system unravelling. government treated some financial institutions differently during the crisis? Was that appropriate? The US government¶s decision could have been based on many past factors and their financial policies which are not disclosed t o common man. 2. M. and Moffett. K. These failures augmented the instability in the global financial system. Rath. government is largely via short -term means. D. the funding of the U. I. short-term securities and current cash flows from taxes. through legal and taxation pressures if necessary. Daly. I do not think they were biased or acted differently with different institutions. K. S Stonehill. as the Federal Reserve had bailed out two groups before Lehmann and then AIG two days after. Lehman Brothers were also known to take larger risks which led the company to fail (Eiteman. But. By the time of the Lehman Brothers crisis the industry participants were concerned exclusively in safeguarding the future of their own businesses.to other banks Bear Stearns and Merrill Lynch . The government had to look into the interests of the country and to keep the economy going rather than help one or two companies.0 Do you believe that the U. Lehmann brothers approached the government at a very late stage. the government is exposed to a potential cash flow squeeze in several ways.S. The United States government was right in principle not to save Lehman Brothers from bankruptcy as they acted too late. A. Hence. Analysts view the Lehman Brother¶s fall as a good way to show the government how to deal with issues of financial crisis.
which received $182 billion in taxpayer aid. (AIG). We presume that the government may have let the Lehman brothers to fall in order for other institutions to learn the lesson and to avoid the same mistakes in future. especially since the 1998 case of long term capital management. it actually has an incentive to take on more risk. The problem was that it merely showed that moral hazard had already grown too great. 3 . Federal Reserve Chairman Ben Bernanke countered that charge. But with Lehman Brothers down fall was a way to dr aw the line. Normally moral hazard clean ses itself during a crisis. By the time Lehman¶s turn came. Fannie Mae and Freddie Mac being allowed to set up as private ± sector profit seeking co mpanies that benefited from implicit guarantee caused moral hazard. Within days. it was too late. Letting Lehman go down was a well -intentioned attempt to draw the line under moral hazard. saying it was impossible for the Fed to rescue Lehman Brothers from bankruptcy in 2008 because the Wall Street firm lacked sufficient collateral to secure a loan. not less. moral hazard is even greater coming out that it was going in.0 Many experts argue that when the government bails out a private financial institution it creates a problem called ³moral hazard. Bernanke said there was a fundamental difference. by making it clear to the other systemically important big banks that they would not be allowed to fail. Asked how the Lehman case differed from that of American International Group Inc. because investors lose a lot of money and know to behave differently in future. What do you think? ³Moral hazard´ applies to the fact that Lehman Brothers decided to push the limits by taking higher risks.2008 global credit crisis. despite such a damaging crisis. and so there was no alternative but to re -inject yet more moral hazard into the system. ³Moral hazard was the central of the problems of 2007 .´ meaning that if the institution knows it will be saved.3. Bailout had most definitely heightened over the years. it was obvious that the financial system was on the brink of total collapse. This time. Avoiding bailouts earlier in the process might have stopped moral hazard growing too great.
M..S mark et but all over the world markets. On the other hand.S. then the government should have allowed the giant corporation to fail. It was an uncontrolled bankruptcy of an investment bank in the world where the official line was still th at everything was under control. which also led to 1. after AIG¶s discretionary spending of the government loan. government had assisted Lehman.500 employees becoming unemployed. government should have allowed Lehman Brothers to fail? Lehman Brother was allowed to collapse because Lehman bank ruptcy was an economic disaster. (Eiteman. H. 2010) 4 . Daly. It was believed that Lehman Brothers was hardly to fail because it was big investment bank with long history. Therefore. and Moffett. unfortunately. K. investor confidence diminished causing the S&P 500 and the Dow Jones drop sharply in September 2008. Rath. some individual in A IG¶s upper management awarding themselves with bonuses and vacations after the bailout.0. the problem that followed from Lehman did not just stem from the fact that the government was not honouring Lehman¶s debts. that US taxpayers must honour in full all the debts of all the banks. it was like a massive domino effect on not only U. Do you think that the U. the decis ion to allow Lehman Brothers to fail is a double-edged sword. during the first six months of 2008. If Lehman Brothers did not have such a consequential impact on the global economy.S. who would pay the cost for such a massive bailout if the government had assisted Lehman? AIG has received $85 billion from U. I.S. As a result of a steadily declining market val ue. If the U.S.4. A. Lehman¶s stock value decreased approximately by 73%. K. According to the statistics. government as federal assistance. S Stonehill. The collapse of Lehman was good to the exten t it signalled very clearly to market participants the magnitude of losses throughout the financial sector. however. U. D.. the government was trying to make a signal for out of Lehman Brothers by letting it collapse. Making such signal out of a large company will make other large corporations to operate responsibly and ethically. investors¶ confidence across the world may not have faltered as it did which in turn would not have n egatively impacted the world markets.
It caused $60 billion loss in bad real estate loans for Lehman Brothers. They refused to do business with Lehman due to over -confidence of its CEO over the Lehman financial assets. it consumed significantly more capital than before. whilst the staff only loses its future payments and gets to keep old bonuses. when Lehman asked Barclays and Bank of America for acquisition. In the case of Lehman Brothers. If the firm¶s results are negative. This led to huge losses for Lehman. And after big debt of $639 billion. they may take excessive risk in order to get bigger bonuses. it loses its accumulated capital. 5 . As a result. 2008) . This creates a situation where the bankers act without any feeling of risk. This created a vicious cycle that in return made it much more difficult for the ba nk to borrow capital and to hedge risks(Bankruptcy Report.0 Conclusion: There were several strategic mistakes that eventually led the Lehman bank into bankruptcy. This situation creates the risk of moral hazard. the staff and management made a fortune during the good years when the firm made record profits. housing loans made by the bank to people with little support made these loans very risk y. and when interest rates were raised by these banks. these borrowers could no more repay Lehman. When Lehman started to focus more on long -term investments instead of brokerage.Lehman¶s management exceeded their own risk limits.5. they simply rejected the offer. Investments are a trade -off between risk and potential profit. Considering Lehman Brother¶s small equity base this meant a drastically increase in liquidity risk. since bankers at most can lose their job.These days there is mortgage crisis in United States due to decline in prices of real -estates. However. profits that were possible due to high risk taking with high leverage and exposure to then profitable loaning and real estate affairs . One of the main reasons for its downfall was its poor relations with top banks of United States.
investopedia. Historical Recources (2010).. and Moffett. Justin. K. Academic OneFile. Lehman Brothers 2007 Ann ual Report Lehman Brothers First Quarter Report. S Stonehill. 2009: 44. Daly..huffingtonpost.html 6 . 2008 Lehman Brothers Second Quarter Report. Pearson Education Australia Fox. K.com/2009/05/11/glass -steagall-act-the-se_n_201557. I. Rath.library.com/articles/economics/09/lehman -brothers-collapse. Web. History of Lehman Brothers.hbs.edu/hc/lehman/history.0 Reference Eiteman.asp http://www. D. 2008 http://www. http://www. A. 6 Mar.html Lehman Brothers (2008). H.6. 2011. "The Bailout's Biggest Flaw." Time 28 Sept. M. 2010 Multinational Business Finance.