Background
The US economy is clearly under siege. Although many financial analysts trace the current financial meltdown to the housing bubble that was witnessed earlier in the decade, it remains less clear as to how things got out of hand to reach such a terrible state. In the housing debacle, housing prices have been rapidly increasing over time from 1999 at a rate of 6 percent, therefore drawing the attention of many investors interested in real estate.
But the bubble was formed by 2006 when the housing prices moved out of line with key basics such as household income. The bubble was further inflated by the swift rise of lending to sub-prime borrowers (Bailey, Litan, & Johnson, 2008). Indeed, individuals previously locked out of mortgage trading markets became key targets for lending, often done with absolute disregard to set financial policies, and in full knowledge of industry supervisors and regulators who failed to curtail extreme risk-taking
Financial, Mortgage, and Investment institutions came up with innovative financial packages to sustain the huge appetite from borrowers who wanted to invest in the housing industry. However, some of these packages failed to observe the standard risk management procedures. With poor forecasting that the real estate business would continue to rise, borrowers were allowed to postpone paying monthly interest rates due to the lenders, notwithstanding the fact that some lenders never requested any down-payment to guarantee property ownership. These unethical practices propelled the already worsening situation to what it is today – a total financial meltdown.
Big conglomerates like the Lehman Brothers, Boston Properties, and Simon Property Group have all drowned in a state of insolvency (International Forecaster, 2008). This paper aims at presenting a case analysis of the Lehman Brothers in the ensuing financial crisis.
The Lehman Brothers is one of the Wall Street Firms that has been greatly affected by the current economic crisis to a point of filling for bankruptcy under Chapter 11 Bankruptcy protection (Shiller, 2008). Headquartered in New York City, its interests included investment management, investment banking, private equity, research, equity, private banking, trading, sales, and fixed income. As a conglomerate, its primary subsidiaries comprised of Lehman Brothers Inc., Eagle Energy Partners, SIB Mortgage Corporation, Neuberger Berman Inc., Lehman Brothers Bank, Aurora Loan Services, Inc., Crossroads Group., and FSB (Lehman, 2007). All this subsidiaries reflect on the point that Lehman was a financial services firm. This sector was the worst hit by the current financial crisis as outlined in the introduction.
The fourth-largest investment bank in the US dealing with big and complex financial investments, it was anticipated that Lehman would fall victim to the current economic crisis. The conglomerate had invested heavily in securities that were associated with the Sub-prime mortgage market, a key factor in the current economic quagmire. Mortgage investments were seen as high risk thereby knocking off the confidence investors had in Lehman Brothers (Stephenson, 2008).
The lack of confidence was further Jeopardized by the collapse of Bear Stearns. Lehman was left with no option than to write down huge amounts of toxic bad debt of around $60 billion, and adjust the value of its investments in commercial property and residential mortgages – key areas that brought about the housing bubble (Marcus, 2008). This saw its share price go down by more than 95 % in a period of one year. More painful was that the USA Treasury and investors were adamant to bail out the investment bank. Lehman Brothers had to announce insolvency.
It can be suspected that poor lending strategies coupled with non-compliance of set traditional financial rules were major contributing factors in the Lehman Brothers debacle. This boils down to sub-prime lending. Some executives in the conglomerate must have slept on their jobs to allow lending to individuals who are heavily indebted, otherwise known as high-risk borrowers. In absolute disregard of ethical practice, the culprits in this debacle were interested in the higher interest rates and fees that are associated with Sub-prime lending. While they chased the profit potential of this type of lending, they failed to instigate sufficient measures to put it under regulation (Hojnacki, White, & Shinck, 2008). This unethical practice coupled with speculation about the US mortgage market can be linked to Lehman Brothers Collapse.
The key stakeholders in the case are those people who were charged with overseeing the conglomerate’s financial operations and transactions. These are the executives, managers, supervisors, and to a larger extent the regulators of the US financial markets. Financial institutions were given much leeway to depart from traditional banking rules and procedures to a point that borrowers could be allowed to defer paying the monthly interest rates on loans advanced (Hojnacki, White, & Shinck, 2008).
Legal analysis
In the ever competitive market, governments must protect consumers from unfair business practices. The relationships between individual consumers and firms that provide them with goods and services must be protected from defective products, unethical or fraudulent business practices, and misleading information (AllBusiness. Com, 2009). In the US, the area of public law that regulates such private law relationships goes by the name of consumer protection law. Indeed, this serves as an umbrella law for an assortment of other consumer protection laws put in place by the Congress.
Under the federal consumer protection law, consumers must be protected from abusive or unfair practices in the collection of debts due to other businesses. Debts must be collected in a fair manner, and consumers provided with an avenue of disputing and checking if the information regarding the debt is accurate. This is provided for under the Fair Debt Collection Practices Act. Under the Fair Credit Reporting Act, the confidentiality of consumer reports is guaranteed. Businesses must not divulge any consumer information filed with them to anyone, including the Consumer Reporting Agencies (Federal Trade Commission, 2008).
Consumers are also protected under the Truth in Lending Act (TILA) when engaging in credit transactions with financial institutions since the lending arrangement and key terms regarding the lending, and including all the costs involved must be disclosed in truth to the consumer. Lastly, the consumers are protected under the consumer protection law from being haphazardly billed while repaying their loans without due regard to established regulations. This is provided for under the Fair Credit Billing Act (FCBA). Failure to comply with the above legal issues automatically leads to prosecution. These laws are implemented by the Federal Law Commission.
Lehman Brothers therefore failed to comply with the law since they failed to disclose their lending arrangement and key terms regarding the mortgage industry to their customers in the hope that they would make huge profits out of sub-prime borrowing (Hojnacki, White, & Shinck, 2008). Crucial information regarding the future of the industry was kept out of reach of its consumers despite all available information pointing to the fact that the country was headed for a housing bubble. This is a violation of the TILA Act. Sub-prime borrowing also attracts unfairly high interest rates and fees charged on the borrowers (Hojnacki, White, & Shinck).
This unfair billing is in contravention to the FCBA Act. The factors that made the conglomerate to flout the rules are purely profit based. The stakeholders wanted to make quick extra money out of this high-risk group of borrowers in total disregard of traditional financial regulations. This was made possible through the existence of a disjointed and weak financial regulation system, weak fiscal policies, and too much leverage that were entrenched by the Clinton administration (Bailey, Litan, & Johnson, 2008).
Ethical Analysis
First, it would be impossible for anyone to believe that the chief executives of Lehman Brothers, together with industry regulators were inept enough not to know what was going on in the mortgage industry. There must be something that allowed intelligent managers to insist on following unintelligent behavior (Greycourt, 2008).Massive leverage and high risk behaviors were only the symptoms of a much critical ailment – that of complete breakdown of ethical behavior across the management of Lehman’s.
Therefore, one of the ethical consideration observed is that the top executives at Lehman’s went ahead to act and behave in ways that served their own interests in complete disregard to what such self-centered behavior of seeking profit would have on their clients, employees and the broader American economy. Such behavior contravenes the ethical theory of utilitarianism which gains its roots from the ability to forecast the consequences of any particular action (Rainbow, 2002).
The choice that yields the greatest rewards to most people is the ethically correct one. This was not followed as the executives of the company chose to serve their own interests. The ethically sound behavior would be to carry the interests of your employees and clients at heart; they are the reason that you are in business.
The second ethical consideration in the Lehman Brothers debacle is that the collapse caused a lot of pain to people who had otherwise banked their faith and hopes on the enterprise. We saw instances of panic across the world after its collapse. People who had bought shares with the investment bank lost massive amount of money due to devaluation of their shares. Banks that had lent money to Lehman’s were left in disarray. This is a serious ethical issue and contravenes the ethical theory of rights.
The highest priority is accorded to the rights set forth by society (Rainbow, 2002). Lehman Brothers did not exist in a vacuum; it existed in a society governed by rules. Investors only agreed to put their monies in Lehman’s only because they knew they were protected by the rules set by society. To go under with, or devaluate the monies given by the investors is a serious ethical blunder on the part of Lehman Brothers. In this scenario, the only ethically sound behavior is to reimburse in total all the monies due to the investors without factoring in devaluation issues.
The Third ethical consideration is that the executives at Lehman Brothers saw the crisis coming. The crisis did not happen overnight. Indeed in the 1980’s, there was a similar small-scale economic crisis that hit the US financial sector and bore similar characteristics to the current one (Hojnacki, White, & Shinck, 2008). To say that they didn’t see it coming is a serious ethical issue, and is in direct contravention to the Casuist ethical theory.
In this theory, present ethical situations are compared with previous similar ethical situations and their outcomes (Rainbow, 2002). If Lehman’s executives and regulators could have compared the occurrences of the current economic crisis on its onset to previous similar economic meltdowns, they could have noticed its severity and act accordingly. However, this was not done, or was largely ignored. The ethically sound behavior is therefore to always compare current trends with previous similar events and draw a line of action.
Contributing factors: Corporate Culture and Corporate Governance
Analysts have pointed an accusing finger regarding Lehman’s failure on its corporate governance. Indeed, Lehman’s corporate culture helped fuel the unethical behaviors discussed above. Lehman had withered many trying moments, including the Great Depression of the 1930’s. For the Financial Services giant to be felled by the financial shakeup of 2008 shows that its corporate culture was deep asleep not to discern and reconnect the happenings of this decade to future situations (Spengler, 2008). This ineptness must have fueled the unethical behavior of overlooking set traditional financial regulations of mortgage lending in search of quick profit. As one financial analyst rightly said, Lehman’s corporate culture is masked in secrecy. Its corporate culture also failed in creating trust between its investors and the conglomerate, effectively deepening its economic woes.
Lehman’s corporate culture was seen as an inspiration to the ambitious and the greedy (Spengler, 2008). Indeed, professional and skilled risk managers were sidelined by the executives whose only preoccupation was how they could reap immense profits from the emerging mortgage lending market. This is an unethical behavior. Further, the executives were too preoccupied with how to gain ground on their arch rivals in the industry – Goldman Sachs- and didn’t have time to listen to their own professionals in risk management (Mathiason, Connon, & Wachman, 2009). This shows a disjointed corporate culture. Of course Lehman Brothers had very good risk assessors. But they got their options all wrong due to their appetite to achieve fast growth by using unethical behaviors.
The corporate governance at Lehman’s also contributed to the unethical behavior that led to its collapse. Its former CEO Dick Fuld ran the investment bank as if it was at war with itself, ignoring any signs of future collapse (Parker, 2008). Industry analysts describe Fuld as a burly CEO who’s only concern was to take risks with investments of other people who had trust in the bank. This reveals how Lehman’s corporate governance fuelled unethical behavior.
As reported by Parker, there existed a power struggle in the bank’s boardroom between two crucial players. Furthermore, the executive team, charged with the responsibility of steering the investment bank towards growth never engaged in any healthy debate. Indeed, old non-executives who lacked adequate banking experience sat at board meetings and served as the board of directors. This is another unethical behavior that threw Lehman Brothers into disarray as the old individuals were not in touch with the financial realities on the ground. If they were, they could have reorganized themselves after the earlier collapse of Bear Stearns.
Ethical Decision Factors to Consider
This case analysis has numerous factors that must be addressed to amicably solve the legal and ethical issues surrounding this case. One of the most important factors is the flouting of traditional financial laws and practices to chase personal ambitions. It has indeed been proved that the senior executives at Lehman Brothers did just that, thereby bringing an enterprise that was founded in 1850 to its knees.
Other factors that have arisen from this case and need to be addressed includes poor leadership structure, poor forecasting of priorities, weak or ineffective financial regulations on the part of the government, reorganization of corporate culture, engagement in high-risk borrowing and behaviors, refunds of investor’s money, and profitability versus the general good. These are some of the ethical and legal factors that were inarguably responsible for the insolvency of Lehman Brothers. They must be addressed in detail by other financial institutions to prevent a recurrence. Below is a table listing these ethical issues and the factors to be considered in each issue based on the theories of ethical thougt discussed in this case analysis.
Recommended Corrective Action
Various suggestions have been made regarding the future of the financial industry in the US in the face of the current global meltdown. Just before the onset of the economic crisis, many US financial institutions were accused of flouting traditional financial laws to chase personal interest. In the fight for customers to lend money just before the housing bubble, banks could defer interest rates, among many other homegrown solutions to keep customers streaming into their counters (Bailey, Litan, & Johnson, 2008). Flouting traditional banking laws was what brought about sub-prime borrowing.
The corrective measure here is to ensure that executives are well trained on flouting traditional financial laws. The best practice is for the federal government to formulate universally acceptable banking and financial laws to be implemented by all banks operating in US. A regulatory body should be created to keep this unethical behavior under check. Defaulters should be punished. A policy to that effect should be developed and presented to the Congress for ratification into law. This would help check such unethical behaviors that are perpetrated by our financial institutions while shrouded in secrecy.
The leadership structure of any corporation is its backbone. Productivity will be affected if there are competing interests in the leadership structure like it was the case with Lehman Brothers (Parker, 2008). It is unethical behavior for leaders to compete for personal gains instead of pulling the corporation out of the economic quagmire. Lehman Brothers could have been saved if the executives cared to listen to their professional risk assessors. But the leadership structure and chain of command was compromised. This again is unethical. The corrective action to be taken here is for companies to come up with rigid structures of command that will ensure that employees down the scale have their right to freely express themselves.
The structure should come up with amendments that will effectively make it illegal for chief executives of listed companies like Lehman to unilaterally make decisions without comprehensive consultations with all stakeholders. Dick Fuld unilaterally operated Lehman Brothers like his personal property, resulting to its insolvency. This should further be developed into a policy in conjunction with the labor office to ensure that it has some legal backing. These recommendations and amendments can also be used in reorganization of corporate culture.
In the ethical issue of profitability versus universal good, the recommendation is that no corporation must be allowed to trample on the rights of its employees or clients on account of chasing profitability. This is ethically wrong. The rationale behind this assertion is that no entity can exist without the assistance of employees and clients; entities do not operate in a vacuum (Spengler, 2008). A good policy to check such unethical behavior would be to develop frameworks through which corporations are made accountable for their daily activities. An independent employee and clients’ advisory body set at an organizational level whereby all can report their grievances and action taken can also serve to curtail this unethical behavior.
Many clients and investors are left in deep pain and anguish when companies they trusted so much go under with their hard earned investments. It is a demoralizing experience. As a recommendation, federal auditors should be facilitated to carry out impromptu audits on financial institutions, especially those suspected to be involved with underhand dealings (Stephenson, 2008). The best practice would also be to refund any monies owned to the clients within 21 days after the collapse to save them from more anguish.
Poor forecasting of priorities and engagement of high risk borrowing go hand in hand as one must obviously lead to the other. Engagement in high risk lending during the housing rush of the early years of this decade was as a direct result of poor forecasting that house prices would continue to rise (Hojnacki, White, & Shinck, 2008).
The events that followed are there for everyone to see. On high risk borrowings, otherwise known as sub-prime borrowing, the financial institutions must be made to follow the set down laws and regulations regarding borrowing, and every banking institution must be made to have provisions for bad debts. This can serve to be the industry’s best practice in borrowing. Policies regarding borrowing and lending have already been developed but financial institutions keeps on flouting them. What are therefore needed are tougher rules to ensure compliance.
No one for sure knows how long the economic crisis will continue to wreck havoc at a world-wide level, or how many more businesses will go under. The harsh reality is that it has been the worst economic crisis ever to be witnessed from the Great Depression (Marcus, 2008). Financial institutions have been worst hit by the wave, with the insolvency of Lehman Brothers sending shockwaves around the world. There is no magic word for survival. But financial institutions may hold on and resist insolvency if they transact their businesses with the ethics and legality they deserve. Any shortcut may spell doom – just like Lehman Brothers.
References
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