2008 bankruptcy of American investment bank
The bankruptcy of Lehman Brothers, also known as the Crash of '08 and the Lehman Shock, on September 15, 2008, was the climax of the subprime mortgage crisis. After the financial services firm was notified of a pending credit downgrade due to its heavy position in subprime mortgages, the Federal Reserve summoned several banks to negotiate financing for its reorganization. These discussions failed, and Lehman filed a Chapter 11 petition that remains the largest bankruptcy filing in U.S. history, involving more than US$ in assets.
The bankruptcy triggered a 4.5% one-day drop in the Dow Jones Industrial Average, then the largest decline since the attacks of September 11, 2001. It shook confidence in the government's ability to manage the crisis and prompted a general financial panic. Money market mutual funds, a key source of credit, saw mass withdrawal demands to avoid losses, and the interbank lending market tightened, threatening banks with imminent failure. The government and the Federal Reserve system responded with several emergency measures to contain the panic.
As of May 2022, parent company Lehman Brothers Holdings, Inc. remained in liquidation before the Bankruptcy Court for the Southern District of New York. Caretaker offices in the US and abroad have continued to oversee payments to the company's creditors.
Background.
Rise of mortgage origination (1997–2006).
Lehman Brothers was one of the first Wall Street firms to move into the business of mortgage origination. In 1997, Lehman bought Colorado-based lender Aurora Loan Services, an Alt-A lender. In 2000, to expand their mortgage origination pipeline, Lehman purchased West Coast subprime mortgage lender BNC Mortgage LLC. Lehman quickly became a force in the subprime market. By 2003 Lehman made $18.2 billion in loans and ranked third in lending. By 2004, this number topped $40 billion. By 2006, Aurora and BNC were lending almost $50 billion per month.:129
Lehman had morphed into a real estate hedge fund disguised as an investment bank.:135 By 2008, Lehman had assets of $680 billion supported by only $22.5 billion of firm capital. From an equity position, its risky commercial real estate holdings were thirty times greater than capital. In such a highly leveraged structure, a three- to five-percent decline in real estate values would wipe out all capital.
Exposure to the mortgage market.
Lehman borrowed significant amounts to fund its investing in the years leading to its bankruptcy in 2008, a process known as leveraging or gearing. A significant portion of this investment was in housing-related assets, making it vulnerable to a downturn in that market. One measure of this risk-taking was its leverage ratio, a measure of the ratio of assets to owners equity, which increased from approximately 24:1 in 2003 to 31:1 by 2007. While generating tremendous profits during the boom, this vulnerable position meant that just a 3–4% decline in the value of its assets would entirely eliminate its book value of equity. Investment banks such as Lehman were not subject to the same regulations applied to depository banks to restrict their risk-taking.
In August 2007, Lehman closed its subprime lender, BNC Mortgage, eliminating 1,200 positions in 23 locations, and took a $25-million after-tax charge and a $27-million reduction in goodwill. The firm said that poor market conditions in the mortgage space "necessitated a substantial reduction in its resources and capacity in the subprime space".
Lehman's final months.
In 2008, Lehman faced an unprecedented loss due to the continuing subprime mortgage crisis. Lehman's loss resulted from having held onto large positions in subprime and other lower-rated mortgage tranches when securitizing the underlying mortgages. Whether Lehman did this because it was simply unable to sell the lower-rated bonds or made a conscious decision to hold them is unclear. In any event, huge losses accrued in lower-rated mortgage-backed securities throughout 2008. In the second fiscal quarter, Lehman reported losses of $2.8 billion and decided to raise $6 billion in additional capital by offering new shares. In the first half of 2008 alone, Lehman stock lost 73% of its value as the credit market continued to tighten. In August 2008, Lehman reported that it intended to lay-off 6% of its work force, 1,500 people, just ahead of its third-quarter-reporting deadline in September.
On August 22, shares in Lehman closed up 5% (16% for the week) on reports that the state-controlled Korea Development Bank was considering buying Lehman. Most of those gains were quickly eroded as news emerged that Korea Development Bank was "facing difficulties pleasing regulators and attracting partners for the deal." It culminated on September 9, when Lehman's shares plunged 45% to $7.79, after it was reported that the state-run South Korean firm had put talks on hold.
Investor confidence continued to erode as Lehman's stock lost roughly half its value and pushed the S&amp;P 500 down 3.4% on September 9. The Dow Jones lost nearly 300 points the same day, on investors' concerns about the security of the bank. The U.S. government did not announce any plans to assist with any possible financial crisis that emerged at Lehman.
On September 10, Lehman announced a loss of $3.9 billion and their intent to sell off a majority stake in their investment-management business, which included Neuberger Berman. The stock slid 7% that day.
On September 12, Timothy F. Geithner, then president of the Federal Reserve Bank of New York, called a meeting on the future of Lehman, which included the possibility of an emergency liquidation of its assets. Bankers representing all the major Wall Street firms were in attendance. The meeting goal was to find a private solution in rescuing Lehman and extinguish the flame of the global financial crisis.:173 Lehman reported that it had been in talks with Bank of America and Barclays for the company's possible sale. "The New York Times" reported on September 14, 2008, that Barclays had ended its bid to purchase all or part of Lehman and a deal to rescue the bank from liquidation collapsed. It emerged subsequently that a deal had been vetoed by the Bank of England and the UK's Financial Services Authority. Leaders of major Wall Street banks continued to meet late that day to prevent the bank's rapid failure. Bank of America's rumored involvement also appeared to end as federal regulators resisted its request for government involvement in Lehman's sale. By Sunday, September 14, after the Barclays deal fell through, the news of impending doom swept through Lehman, and many employees arrived at the headquarters to clean out their offices. By Sunday afternoon, the government summoned Harvey Miller of Weil, Gotshal &amp; Manges to file for bankruptcy before the markets opened on Monday.:176
Bankruptcy filing.
Lehman Brothers filed for Chapter 11 bankruptcy protection on Monday, September 15, 2008. According to Bloomberg, reports filed with the U.S. Bankruptcy Court, Southern District of New York (Manhattan) on September 16 indicated that JPMorgan Chase &amp; Co. provided Lehman Brothers with a total of $138 billion in "Federal Reserve-backed advances". The "Federal Reserve-backed advances" as provided by JPMorgan Chase were for $87 billion on September 15 and $51 billion on September 16.
The filing remains the largest bankruptcy filing in U.S. history, with Lehman holding over $600 billion in assets.
Breakup process.
On September 22, 2008, a revised proposal to sell the brokerage part of Lehman Brothers holdings of the deal was put before the bankruptcy court, with a $1.3666 billion (£700 million) plan for Barclays to acquire the core business of Lehman Brothers (mainly Lehman's $960 million Midtown Manhattan office skyscraper), was approved. Manhattan court bankruptcy judge James Peck, after a seven-hour hearing, ruled: "I have to approve this transaction because it is the only available transaction. Lehman Brothers became a victim, in effect the only true icon to fall in a tsunami that has befallen the credit markets. This is the most momentous bankruptcy hearing I've ever sat through. It can never be deemed precedent for future cases. It's hard for me to imagine a similar emergency."
Luc Despins, the creditors committee counsel, said: "The reason we're not objecting is really based on the lack of a viable alternative. We did not support the transaction because there had not been enough time to properly review it." In the amended agreement, Barclays would absorb $47.4 billion in securities and assume $45.5 billion in trading liabilities. Lehman's attorney Harvey R. Miller of Weil, Gotshal &amp; Manges, said "the purchase price for the real estate components of the deal would be $1.29 billion, including $960 million for Lehman's New York headquarters and $330 million for two New Jersey data centers. Further, Barclays will not acquire Lehman's Eagle Energy unit, but will have entities known as Lehman Brothers Canada Inc, Lehman Brothers Sudamerica, Lehman Brothers Uruguay and its Private Investment Management business for high-net-worth individuals. Finally, Lehman will retain $20 billion of securities assets in Lehman Brothers Inc that are not being transferred to Barclays." Barclays had a potential liability of $2.5 billion to be paid as severance, if it chooses not to retain some Lehman employees beyond the guaranteed 90 days.
On September 22, 2008, Nomura Holdings, Inc. announced it agreed to acquire Lehman Brothers' franchise in the Asia Pacific region including Japan, Hong Kong and Australia. The following day, Nomura announced its intentions to acquire Lehman Brothers' investment banking and equities businesses in Europe and the Middle East. A few weeks later it was announced that conditions to the deal had been met, and the deal became legally effective on Monday, October 13. In 2007, non-US subsidiaries of Lehman Brothers were responsible for over 50% of global revenue produced.
Impact of bankruptcy filing.
The Dow Jones closed down just over 500 points (−4.4%) on September 15, 2008, at the time the largest drop by points in a single day since the days following the attacks on September 11, 2001. This drop was exceeded by a 6.98% plunge on September 29, 2008.
Lehman's bankruptcy was expected to cause some depreciation in the price of commercial real estate. The prospect for Lehman's $4.3 billion in mortgage securities getting liquidated sparked a selloff in the commercial mortgage-backed securities (CMBS) market. Additional pressure to sell securities in commercial real estate was feared as Lehman got closer to liquidating its assets. Apartment-building investors were also expected to feel pressure to sell as Lehman unloaded its debt and equity pieces of the $22 billion purchase of Archstone, the third-largest United States real estate investment trust (REIT). Archstone's core business was the ownership and management of residential apartment buildings in major metropolitan areas of the United States. Jeffrey Spector, a real-estate analyst at UBS, said that in markets with apartment buildings that compete with Archstone, "there is no question that if you need to sell assets, you will try to get ahead" of the Lehman selloff, adding "Every day that goes by there will be more pressure on pricing."
Several money funds and institutional cash funds had significant exposure to Lehman with the institutional cash fund run by The Bank of New York Mellon and the Reserve Primary Fund, a money market fund, both falling below $1 per share, called "breaking the buck", following losses on their holdings of Lehman assets. In a statement The Bank of New York Mellon said its fund had isolated the Lehman assets in a separate structure. It said the assets accounted for 1.13% of its fund. The Primary Reserve Fund owned $785 million or 1.2 percent of its holdings in Lehman commercial paper.:178 The drop in the Primary Reserve Fund was the first time since 1994 that a money-market fund had dropped below the $1-per-share level.
On Monday, September 15, 2008, the market staged a run on AIG with shares plummeting 61 percent. Shareholders also fled from Goldman Sachs and Morgan Stanley. Two weeks later, the Fed agreed to give the bank holding company status which provided vital access to the Fed discount window.:179
Putnam Investments, a unit of Canada's Great-West Lifeco, shut a $12.3 billion money-market fund as it faced "significant redemption pressure" on September 17, 2008. Evergreen Investments said its parent Wachovia Corporation would "support" three Evergreen money-market funds to prevent their shares from falling. This move to cover $494 million of Lehman assets in the funds also raised fears about Wachovia's ability to raise capital.
Close to 100 hedge funds used Lehman as their prime broker and relied largely on the firm for financing. In an attempt to meet their own credit needs, Lehman Brothers International routinely re-hypothecated the assets of their