Analysis of Lehman Brothers in 2008
Lehman Brothers Holdings, Inc., headquartered in New York, has regional headquarters in London, England, and Tokyo, Japan. Stock Code: LEH. Through its branches, Lehman Brothers Holdings Inc. provides a wide range of financial services to corporations, governments, municipalities, investment institutions, and high net worth individuals around the world. The main business of the company is divided into three parts: capital market business, investment banking business and investment management business.
The Capital Markets Division provides services for capital flows for institutional investors, including secondary market trading, financing, mortgage origination and securitization, prime brokerage, and research on fixed income and equity products. These products include cash, derivatives, secured financing, structured instruments, and investments. It also offers the following equity and fixed income products: US, European and Asian equities, government and agency securities, money markets products, senior corporate securities, high-yield emerging market securities, mortgage and asset-backed securities, preferred shares, municipal securities, bank loans, foreign exchange, financing, and derivatives.
The division also invests in real estate, private equity, and other long-term investments. The investment banking division provides advice to corporate, institutional, and government clients on mergers, acquisitions, and other financial matters. The unit also helps clients raise capital by underwriting debt and equity instruments of public and private developers. The investment management department is divided into two parts: private investment management and asset management.
Private investment management mainly provides investment and wealth consulting and capital market execution services to high-net-worth individuals and middle-market institutional clients. The asset management division mainly provides personalized investment management services to high net worth individual clients, mutual funds, and other institutional investors in small and medium-sized markets.
The process of the Lehman incident
On June 12, 2008, Lehman announced that Herbert McDade would succeed Joseph Gregory as chief operating officer and that Erin Callan, chief financial officer, would be replaced by Ian Lowitt. Critics say the move was a forced choice for Lehman and that the two ousted executives were in effect holding the bag for the company's management. Two days earlier, Lehman reported a forecast loss of about $2.8 billion, or $5.14 per share, for the second quarter. Lehman shares closed down 4.42% at $22.70 on June 12, the day the news was announced.
On June 30, 2008, Lehman Brothers shares fell 11% to $19.81, their lowest level since May 2000. Analysts cited the market's lack of confidence in Lehman's financial health and rumors of a sale amid the firm's declining performance as the main reasons for the stock's recent eight-year low.
On July 11, 2008, Lehman's shares closed at $14.49, down 16% on rumors that it might follow Bear Stearns's lead, hit hard by Fannie Mae and Freddie Mac.
On July 22, 2008, the hottest news on Wall Street was that Goldman Sachs had manipulated the share prices of Bear Stearns and Lehman Brothers, quickly becoming a topic of conversation at weekend gatherings in New York's financial community.
On September 7, 2008, it was reported that Jeremy Isaacs, the long-serving head of Lehman Brothers' European and Asian operations, would step down at the end of the year. Benoit Savaret, Lehman's chief operating officer for Europe and the Middle East, and Andrew Morton, head of fixed income, were also stepping down.
On Sept. 10, 2008, Lehman Brothers reported a $3.9 billion loss in the second quarter of that year, the biggest quarterly loss in its 158-year history. Lehman Brothers decided to sell a 55 percent stake in its asset management unit and spun off $30bn of struggling real estate assets. Separately, Martin Bienenstock, a lawyer representing the Royal Bank of Scotland, said at a court hearing that the bank was seeking between $1.5 billion and $1.8 billion in debt from Lehman Brothers.
On Sept. 12, 2008, U.S. Treasury Secretary Henry Paulson announced that the Federal Reserve would not bail out Lehman Brothers. Lehman shares fell 13.5% to close at $3.65, a 14-year low. On September 13th, its last resort, Bank of America, acting on behalf of the Federal Reserve, rejected Lehman's takeover bid. On September 14th, the International Swaps and Derivatives Association (ISWA) announced that it would allow investors to write off credit derivatives linked to Lehman to avoid the whirlpool that followed its collapse.
At 1 a.m. on Sept. 15, 2008, Lehman Brothers announced that it had filed for Chapter 11 bankruptcy protection. Lehman eclipsed Drexel Burnham Lambert's failure in 1990, making it the largest investment bank failure in U.S. history. It is important to point out that there is a difference between filing for Chapter 11 and outright bankruptcy.
A direct bankruptcy filing means that the company is immediately dead and there is no longer any room for maneuver, leaving only one way to liquidate. Filing for bankruptcy protection means the company can reorganize its business in the coming months and try to make as much money as possible again. The bankrupt company can continue to operate as usual, its management continues to run the company's day-to-day business and its stocks and bonds continue to trade in the market.
Barclays, Britain's third-largest bank, announced on September 17 that it would buy Lehman Brothers' New York headquarters, two data centers, and some trading assets for $1.75 billion after Lehman filed for bankruptcy protection. Nomura Holdings Ltd. (NMR), Japan's largest securities firm, signed back-to-back agreements with Lehman Brothers on Sept. 22 and 23 to acquire Lehman's operations in the Asia-Pacific region (excluding South Korea) and Europe and the Middle East.
French power giant EDF has agreed to buy Eagle Energy Partners I, L.P from Lehman Brothers in a move aimed at optimizing EDF's gas supply business, EDF Trading Ltd., a unit of EDF.YY, said Sept. 29. On the same day, private-equity firms Bain Capital LLC and Hellman & Friedman LLC agreed to pay $2.15 billion for most of Lehman's investment-management businesses, including Neuberger Berman. On Oct. 3, Nomura Holdings signed a third agreement with Lehman, agreeing to buy Lehman Brothers' Indian back office. In less than three weeks, the once brilliant Lehman had been dismembered. At this point, Lehman finally fell to the bottom and could never see the light again.
The reason behind
The subprime crisis lasted for 10 months from February 2007 when the subprime problem appeared to December when the whole country faced bankruptcy. As the leader of the whole financial system, the Federal Reserve must have done a lot of policy reserves and risk prediction work in the past 10 months. Therefore, the nationwide rescue can be regarded as the first application of the Federal Reserve policy. At that time, the Federal Reserve must have thought that the situation was not too bad. On January 11, 2008, Bank of America announced an overall M&A by 18.22% share exchange, involving a transaction price of about $4 billion nationwide. In this way, the interests of both shareholders and creditors across the country have been protected. This action has strong rationality. After all, letting a bank fail will have far-reaching social effects, and it will not be approved easily unless it is absolutely necessary. This is also the basis for analyzing and acquiescing the legitimacy of invisible contracts from the perspective of the Federal Reserve.
Later, when bailing out Bear Stearns, the Federal Reserve thought about the same starting point as when bailing out the whole country: it was to avoid the social panic caused by bank failure. The only difference is that, compared with the policy of rescuing the whole country, the Fed has significantly tightened the invisible contract this time. The actual strategy is that the Federal Reserve will provide $29 billion for JPMorgan and JPMorgan will raise $1 billion to acquire Bear Stearns in cash. Although the share price of Bear Stearns dropped from the highest point of $96.38/share to $1.85/share when it was acquired, the shareholders suffered heavy losses, but the creditors' rights and interests of Bear Stearns were fully protected.
In September, however, the situation suddenly deteriorated. On the one hand, Fannie Mae and Freddie Mac, AIG, and other super large enterprises have problems one after another, and the Federal Reserve's responsibility for aid has increased several times in an instant, but in fact, the Federal Reserve simply can't take care of them all.
On the other hand, the Federal Reserve's implicit rescue agreement for financial institutions has stimulated moral hazard. For example, even though Lehman has made huge losses in CDO companies, it is still increasing its position in long CDO companies according to the second quarter report of 2008. Behind such bold behavior is a bet that the Federal Reserve will help anyway.
Because the market's expectation of the Federal Reserve's assistance is very consistent, creditors still dare to continue to put money to institutions engaged in high-risk product investment. Therefore, it must be after some careful consideration that the Federal Reserve decided to choose a reckless institution with enough influence to deter the market, voluntarily give up all potential commitments to it, and let it go bankrupt completely, so as to warn all market participants not to have illusions and completely cut off the source of risk. Unfortunately, Lehman has become a model of the opposite.
The reason why we chose Lehman is that it is large in scale and powerful enough; But it wasn't as big as Fannie Mae and Freddie Mac or AIG. At that time, the Federal Reserve judged that the collapse of Lehman would not lead to the collapse of the financial system. More importantly, among many institutions that have suffered a heavy blow, Lehman is the one with the highest proportion of venture capital investment and the one with the heaviest losses. Relatively speaking, among the investment banks of the same scale, the proportion of Merrill Lynch's securities brokerage business and asset management business is very high, so it is relatively safe; Although Morgan Stanley also has a lot of losses in derivatives, its asset structure is obviously better than that of Lehman; Goldman was even profitable until the third quarter.
Impact on the international economy
The international impact of the incident is that countries' worries about inflation may be replaced by worries about austerity. Magnus, a senior economic adviser at UBS, believes that debt default and the decline of asset prices will create a vicious circle of chain pressure on the economies of various countries, which will lead to difficulties in bank operation and increase the difficulty for enterprises to obtain loans. In the end, they have to resort to extreme means such as layoffs and production cuts to tide over the difficulties, thus leading to the economy entering the era of global deflation.
The central banks of all countries, especially the emerging countries, will face very severe challenges: on the one hand, the long-term overheating of their economies makes them dare not take inflation lightly; On the other hand, the global deflation crisis caused by the event of Lehman Brothers makes them face a dilemma in choosing their own interest rate policy.