Lehman Brothers: Here Today, Gone

Lehman Brothers: Here Today, Gone Tomorrow

Lehman Brothers was once one of the most respected and also one of the smallest of the major investment banking firms on Wall Street. Until it dipped into the subprime mortgage crisis, it had "focused on bond trading for much of its history, and built a reputation as the ultimate white-shoe financial firm: untouchable, a Wall Street flagship, and an engine of the city's economy" (Rayman, 2008, p.2) History will likely render Lehman's name forever associated with transactions it undertook during the last twenty years of its history in the subprime mortgage market, and Wall Street will remember it as the firm that spawned the great credit meltdown of 2008.

The Fall of the House of Lehman began, like all crises seem to, slowly and then all at once. In the summer of 2007, its stock was trading as high $82 a share, up from its average of $5 per share in 1994, before it became heavily involved in mortgage-backed securities. Rumors about the extent to which Lehman was heavily invested in subprime mortgages began to percolate -- and with good reason (Lehman Brothers Holdings, INC, 2009, Times Topics). Subprime loans became a backbone of the firm. Homeowners signed mortgages with loan companies, some of which were also owned by Lehman. Lehman bought the mortgages, bundled them, and sold the high-interest loans to investors at large pension funds and other financial institutions (Rayman 2008, p.1).

With home prices escalating, Lehman pushed the lending companies to extend the loans, and encouraged the companies to dilute their standards, even if the naive homebuyers were taking on more home than they could reasonably afford. Lehman's employees were "paid for how many mortgage-backed securities they put out each year, they had every incentive to look the other way and overstate the quality of the loans they were making" (Rayman 2008, p.1).

Many place the blame squarely on Lehman's CEO Richard Fuld, who to this day disavows responsibility for the crisis, stating to Congress that it was unavoidable. Yet it was he who first entered the business of selling mortgage-backed securities to investors. "You could argue that Lehman's growth precisely paralleled its increasing involvement" with subprimes although Fuld calls the fallout a 'financial tsunami' as if finding subprime loans on Lehman's books were acts of God (Rayman 2008, p.1).

The collapse in June 2007 of two hedge funds owned by Bear Stearns that had invested heavily in the subprime market pulled the mask off of the source of Lehman's profits. "As the year went on, more banks found that securities they thought were safe were tainted with what came to be called toxic mortgages. At the same time, the rising number of foreclosures helped speed the fall of housing prices, and the number of prime mortgages in default began to increase" (Credit crisis, 2009, Times Topics). But deregulation is also to blame as well as Fuld. "Lehman was able to broaden its portfolio following the repeal of the Glass-Steagall Act in 1999, during the Clinton administration. The act prevented banks from investing on Wall Street, thus shielding consumers from riskier transactions. Once that protection was gone, Lehman could gamble away, and it became among the largest issuers of mortgage-backed securities," despite its relatively small size (Rayman 2008, p.2).

Lehman also tried to stimulate more demand for mortgages by banks and loan subsidiary companies under its control (Rayman 2008, p.2). "Everyone in the whole system, from the homeowner to the CEO of Lehman, was rewarded on short-term performance, rather than on whether or not these loans would survive over the long-term...although these securitization trusts were based on many unaffordable and unsustainable mortgages, it didn't crumble right away because the companies were gouging so much out of the consumer, they still had a high rate of return" but then housing prices dropped and more and more homes were foreclosed upon (Rayman 2008, p.3).

At first "Lehman managed to avoid the fate of Bear Stearns, the other of Wall Street's small fry, which was bought by JP Morgan Chase at a bargain basement price under the threat of bankruptcy in March 2008. But by summer of 2008 the rollercoaster ride started to have more downs than ups. A series of write-offs was accompanied by new offerings to seek capital to bolster its finances," all of which failed (Lehman Brothers Holdings, INC, 2009, Times Topics). After the government announced its takeover of Fannie Mae and Freddie Mac. Lehman's stock plunged as the investors thought that a bail-out of so many major institutions in such rapid succession would be unlikely. Lehman Brothers was not deemed as important to the economy as Bear Sterns (Ledbetter & Martins 2008). When the Department Treasury confirmed the rumors that there would be no bailout of Lehman and Barclays and Bank of America refused to buy the company. Lehman was forced to file for bankruptcy. "Lehman's Chapter 11 filing was the biggest in history, as measured by the firm's reported assets at the time" (Examiner Named in Lehman Bankruptcy, 2009, Dealbook).