Introduction
In over a decade since Lehman Brothers declared bankruptcy, controversy has raged over many facets of the collapse, including whether authorities could have bailed out the financial institution. The collapse was significant considering that the failure to rescue Lehman was the definitive moment that triggered the 2008 financial crisis. This research paper attempts to investigate what happened to make Lehman go under evaluating the role of the government in the final days of Lehman’s demise. The later sections highlight a personal view of how the government handled the outcome of the subsequent financial crisis under President Obama. The personal opinions are based on the appreciation of the primary triggers in the collapse and the impact of government action in managing the situation.
Main Triggers in the Collapse of Lehman Brothers
The collapse of Lehman Brothers could be traced to two major determining factors, including the firm’s overconfidence and government inaction. The history of the collapse reveals that on September 13, 2008, Barclays and Bank of America (BAC) attempted one last rescue of the Lehman Brothers, but the efforts were utterly futile (Shenai 156). Between the closing of trade on September 12, 2008, and the day the company went into bankruptcy, Lehman shares fell 93 per cent (Shenai 156). The fall would have been mitigated with proper financial analysis and government regulation of the mortgage-based investments (Shenai 157). The company was a victim of overconfidence in the markets just before the subprime mortgage crisis.
Overconfidence
Financial records have revealed that Lehman Brothers depended on complex financial instruments based on rapid real estate expansion precisely as the market started to decline. Its income increased by 130 per cent between 2000 and 2006 due to early achievements with mortgage-backed assets as security (Tuch 315). Lehman Brothers purchased five mortgage companies in 2003-2004, allowing it to originate and underwrite subprime mortgages, improving its profitability (Fligstein 147). In March 2006, Lehman also invested extensively in real estate development and questionable loans, but instead of immediately selling them, it retained them on its ledger (Marthinsen 671). However, the timing was wrong since real estate values plummeted, triggering the subprime mortgage crisis often referred to as the colossal investment miscalculation.
The Colossal Miscalculation
The overconfidence in mortgage-backed securities and collateral debt obligations meant that Lehman Brothers was unprepared for the subprime mortgage crisis. In early 2007, Lehman’s share value rose to a record $86.18, giving it a market valuation of roughly $60 billion (Dan 7). However, by the first quarter of 2007, the miscalculations in the US home market trends were becoming apparent. Subprime mortgage foreclosures increased, exposing the company to instability (Marthinsen 673). Despite clear signs of a declining market, Lehman stated that the risks posed by growing home loan defaults were adequately managed (Fligstein 149). However, the overconfidence and government inaction exposed the company to a financial shock that led to the collapse.
The Role of Government in Lehman’s Demise
An analysis of the sequence of events shows that the government regulatory institutions’ inaction contributed to the fall of Lehman Brothers. A review of the events that caused the collapse shows that the financial crisis’s primary cause was deregulation in the banking industry (Shenai 157). The government allowed banks to participate in hedge fund trading using derivatives. The government failed to intervene when necessary to regulate the firm (Marthinsen 673). The nature of investment and the magnitude of risks Lehman Brothers took with mortgage-backed securities and collateral debt obligations were out of proportion.
Regulator Inaction
Such government negligence is analyzed as catastrophic regulator inaction. The United States government agencies did not act promptly to protect the public. The Securities and Exchange Commission (SEC) and other government agencies took no action to correct the risk mistakes made as a result of overconfidence within the company (Karim 33). The SEC was aware that Lehman Brothers was acting recklessly as early as 2007, yet the agency never ordered Lehman to course correct (Karim 37). SEC also failed to report publicly that the financial institution had breached risk restrictions. Such mistakes exposed other companies to sudden economic disruptions. The negligence resulted in the financial crisis, which precipitated the Great Recession.
Personal Perspective of Government Response
However, despite government agencies’ failure to avert the crisis, the timely intervention from President Obama’s administration seems to have mitigated further catastrophe. Under President Obama, Congress enacted the Troubled Asset Relief Program (TARP) to authorize the US Treasury to implement an extensive rescue program for struggling banks (Bedoyan 17). The goal was to avoid a global and domestic economic collapse (Bedoyan 19). The American Recovery and Reinvestment Act (ARRA) and the Economic Stimulus Plan were also approved in 2009 to end the recession (Mallett 27). From a personal perspective, the interventions effectively addressed the liquidity crisis that was threatening to crush the economy. Although the move was controversial, the bank bailout gave the global economy the necessary boost to keep afloat.
Conclusion
Even after more than a decade since the fall of Lehman Brothers, memories of 2008 remain fresh. In response, regulatory authorities seem to be working hard and extensively to improve the effectiveness of risk assessment in investments. As recollections of the crisis fade, the impact of the Lehman Brothers collapse still proves the importance of keeping financial institutions in check. The need for government agencies to be proactive in regulating investment is also made apparent. Considering the sequence of events that resulted in Lehman Brothers collapsing, the most effective remedy would be reforming policies in bankruptcy for financial institutions.
Works Cited
Bedoyan, Christian. Government Intervention Injustice and The Troubled Asset Relief Program. Diss. California State University, Northridge, 2020.
Dan, Anish Kumar. “Creative accounting—A creation for destruction: With reference to some global instances.” BESC J. Com. Manag 3 (2017): 1-14.
Fligstein, Neil. “5 The Subprime Moment, 2001–2008. The Banks Did It.” Harvard University Press, 2021. 142-169.
Karim, Mahmoud Mofid Abdul. “Failure of Lehman Brothers.” Journal of Finance and Investment Analysis 10.4 (2021).
Mallett, William J. “Transportation Infrastructure Investment as Economic Stimulus: Lessons from the American Recovery and Reinvestment Act of 2009.” Congressional Research Service 14 (2020).
Marthinsen, John E. “Causes, Cures, and Consequences of the Great Recession.” Demystifying Global Macroeconomics. De Gruyter, 2020. 659-714.
Shenai, Neil. Markets after Lehman. Social finance. Palgrave Macmillan Cham, 2018.
Tuch, Andrew F. “The Remaking of Wall Street.” Harv. Bus. L. Rev. 7 (2017): 315.