Introduction
The 2008 financial crisis was a complicated situation that culminated from a variety of circumstances. However, many economists acknowledge the bankruptcy of the Lehman Brothers investment bank as the trigger that turned a problematic financial situation into a worldwide depression. In his book, In Fed We Trust: Ben Bernanke’s War on the Great Panic, David Wessel claims that the principal financial actors involved in the event knew that it would have a significant impact but underestimated its severity.
As a result, when the management of the bank expected assistance from other firms and the Bank of America, it did not receive the help it needed. With no backup plan, the firm collapsed, taking a significant portion of the American economy with it and creating a chain reaction that was felt worldwide. Overall, Lehman’s failure was a result of the combination of market tendencies to drift towards risky loans and rely on the government for safety and the firm’s unethical internal practices.
Lehman’s Part in the Crisis
The 2008 financial crisis began with the bankruptcy of Lehman Brothers, a financial services firm that primarily dealt with investment banking. The situation was indicative of the market as a whole, with many different organizations accruing significant losses as a result of bad housing market loans. As Wessel (2010) states, “what was unusual was the size: in just six months, it had taken $6.7 billion in losses on its commercial real estate portfolio” (p. 8).
As a result, the firm became unattractive to investors, and its shares dropped to a level that indicated severe economic distress. Nevertheless, it remained one of the United States’ largest banks and held considerable assets, thus constituting a significant part of the economy. Aware of the potential impact on many other companies in case the company collapsed, the leaders of the Fed began considering the situation.
There were two options on the table if Lehman was to be preserved: a government bailout or an acquisition by a competitor. Having taken over the fate of the bank, representatives of the Fed began weighing them against each other, favoring the latter option. The use of taxpayer money to save a private institution would be the last resort due to popular criticisms of bailouts for failing large businesses.
As such, when the British bank Barclays expressed an interest in acquiring Lehman Brothers, the leaders of the Fed and the Treasury focused on closing a deal as soon as possible, given the urgency of Lehman’s problem. According to Wessel (2010), the buyer ran into an issue on Sunday, as the British government decided it did not want its economy to take on such liability. As a result, Lehman would be unable to open its doors for business on Monday and had to file for bankruptcy, which served as the beginning of the crisis.
Moral Hazards and Lehman Brothers
While the Fed caused the financial crisis by taking control of the bank’s situation and then failing to find a solution in time, Lehman Brothers were responsible for the creation of its dire financial state. In particular, the Fed representatives who handled the crisis were initially unaware of the severity of the problem. Nguyen (2016) describes an accounting method that Lehman used to misrepresent its financial position and classifies the actions as fraud.
While not necessarily criminal in terms of the law, the company’s actions were immoral. Its executives inflated the firm’s performance to maintain its attractiveness to investors even as it failed. As a result, Lehman accrued large amounts of debt that it could not resolve, which led to its state at the time of the crisis. However, the leaders were not overly concerned because they expected that their bank was too important and would have to be saved by other players unless they wanted to be harmed as well.
When banks take on large amounts of risky loans, their efforts can backfire, with them incurring significant losses as a result. The government then steps in to bail them out, using taxpayer money to subsidize the losses. Wachter and Tracy (2016) describe such conduct as unethical and refer to it as “privatization of gain and socialization of loss” (pp. 119-120). Lehman expected the people of America to pay for its reckless risk-taking, as they did for firms such as Bear Stearns.
However, the government officials, Henry Paulson in particular, did not want to continue the bailout practice because of their public unpopularity. As a result, Lehman’s moral misconduct led it to bankruptcy at a critical moment for the nation.
The Impact of the Crisis on Lehman Brothers
Lehman Brothers technically did not exist during the financial crisis, as the company’s liquidation was the starting point of the depression. However, the reputation its assets acquired as a result of being the trigger and the overall financial troubles of the period contributed to a significant depreciation of its value. Wessel (2010) notes that “Barclays later bought Lehman’s core U.S. business from the bankruptcy court, including a $1 billion Manhattan skyscraper, for $1.75 billion” (p. 12). After some time had passed, the company became a much smaller liability, and the British bank did not encounter any obstructions in continuing with its purchase.
While Lehman Brothers as a financial entity functionally ceased to exist and thus was unaffected by the events following its bankruptcy, it is still possible to talk about its employees. Dell’Atti and Trotta (2016) estimate that by 2007, the company employed 28,600 people as part of a continued and significant growth trend. All of these people lost their jobs with the bankruptcy, and most of the company’s value was lost. Against the backdrop of the overall losses that have resulted from the 2008 financial crisis, those figures are small. However, the event still affected large numbers of people adversely and is noteworthy in that regard.
Handling Analysis and Recommendations
Lehman Brothers did not manage its financial situation responsibly and ultimately caused the crisis through its reliance on a government bailout that did not happen. It is unlikely that the company could have prevented the recession, as many other investment banks were using similar practices. If Lehman was more transparent, it could have avoided its collapse by moving off of its trajectory before the situation became unmanageable. With that said, it would also likely grow at a considerably slower rate because investors would stop coming to the company once they saw its situation. Against the backdrop of other companies that were purchasing risky loans and growing rapidly, Lehman would look unattractive. Moreover, nobody knew at the time that the Fed would fail to fulfill its role as a last resort.
As such, the appropriate strategy for Lehman would be to begin purchasing housing loans alongside other businesses that did so. Unethical behaviors such as the use of creative accounting to conceal losses should not have been tolerated. However, after failures began occurring, the company’s executives should have started considering whether bailouts would continue.
As Wessel (2010) claims, Henry Paulson, the Secretary of the Treasury, “was hardly getting encouragement from the White House or Republicans in Congress to bail out another big financial house” (p. 13). Lehman should have analyzed the political climate of the country and realized that there might not have been a bailout instead of relying on it blindly. Then, it could have explored other options without excessive urgency and possibly been able to save itself without requiring the financial assistance of the Fed.
Conclusion
Lehman Brothers followed along with the trend of purchasing high-risk loans in large quantities and relying on the government to shoulder any losses. It also conducted unethical accounting that concealed its issues until they culminated in catastrophic damage and impending bankruptcy. This mistake coincided with the government’s decision to stop providing bailouts, and there was not enough time for a private acquisition once the only potential buyer encountered an issue that would require some time to be resolved. In the end, Lehman had to be liquidated, causing the 2008 financial crisis and incurring massive damage to the world’s economy.
Through increased transparency about its actions, the company may not have been able to avert the recession, but it could have saved itself from bankruptcy. It should have also been more aware of the positions of its critical stakeholders, such as the Fed. There were indications that it was reluctant to spend government money to save another company beforehand, which Lehman should have taken into account.
References
Dell’Atti, S., & Trotta, A. (eds.). (2016). Managing reputation in the banking industry: Theory and practice. Cham, Switzerland: Springer.
Nguyen, T. N. (2016). Preventing corporate fiascos: A systemic approach. London, United Kingdom: Palgrave Macmillan.
Wachter, S. M., & Tracy, J. (eds.). (2016). Principles of housing finance reform. Philadelphia, PA: University of Pennsylvania Press.
Wessel, D. (2010). In Fed we trust: Ben Bernanke’s war on the Great Panic. New York, NY: Crown Business.