Editor’s Note: This story was originally published on September 14, 2018.
New York
UJ Business
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The iconic investment bank Lehman Brothers was in dire straits — and no one could come to its rescue.
Bank of America declined to save the 158-year-old Wall Street institution without government support. The UK government prevented Barclays (BCS) from acquiring Lehman Brothers and its distressed balance sheet. Additionally, Washington opted against another unpopular bailout.
As a result, Lehman Brothers was allowed to collapse. At 1:45 a.m. on Monday, September 15, 2008, Lehman Brothers sought Chapter 11 bankruptcy protection.
This triggered the largest and most complicated bankruptcy in U.S. history. However, this description fails to capture the extent of the havoc that Lehman’s downfall wreaked on the financial system. The failure of Lehman Brothers — and the chaos that followed — represented the most frightening moment for business and the U.S. economy since the Great Depression.
“It was the moment when the financial crisis fully exploded, and panic gripped the markets,” Phil Angelides, who led the official bipartisan investigation into the 2008 disaster, told UJ.
Lehman’s collapse sent shockwaves through Wall Street. The Dow dropped 504 points, equivalent to approximately 1,300 points today. Around $700 billion disappeared from retirement accounts and other investment portfolios. The ensuing panic threw the American economy into a deep recession, now referred to as the Great Recession.
Today, Lehman Brothers and its CEO Dick Fuld epitomize the reckless speculation that devastated the economy.
The final days of Lehman were characterized by frantic last-minute negotiations about its future.
Until the very end, many believed someone would step in to save Lehman Brothers: It seemed inconceivable that the firm could actually fail. Just six months earlier, Bear Stearns, a smaller investment bank, had been bailed out by Washington and JPMorgan Chase.
On Wednesday, September 10, South Korea’s Korean Development Bank withdrew from negotiations to become Lehman Brothers’ savior. This news—along with Lehman’s startling announcement of a $3.9 billion quarterly loss—plummeted the bank’s stock by 45%.
After South Korea pulled out, Treasury Secretary Hank Paulson reached out to Bank of America CEO Ken Lewis, urging him to find a creative way to acquire Lehman Brothers. “Put on your ‘imagination hat,’” Paulson advised Lewis.
Yet by Friday, September 12, Bank of America announced it would withdraw unless the government offered assistance. Lehman was burdened with too many “illiquid” mortgage assets, which it couldn’t sell fast enough to meet its obligations. Instead, Bank of America opted to purchase Merrill Lynch, the next investment bank at risk.
“You could never anticipate what would greet you at work on Monday,” recalled Brady Kim, an analyst on Lehman’s trading desk. “Would you be joining Barclays? Or some South Korean conglomerate?”
Few considered bankruptcy a plausible outcome. “They wouldn’t just let the bank go under,” Kim said.
That Friday evening, Paulson gathered the leaders of major Wall Street firms at the New York Fed’s headquarters. They were instructed to devise a private-sector solution to rescue Lehman.
American officials were reluctant to approve another bailout. Just the previous weekend, they had taken over struggling mortgage giants Fannie Mae and Freddie Mac. Fed officials indicated that Paulson made it clear that there would be no government support this time, “not a penny.”
Saturday seemed to signal progress for Lehman when Barclays tentatively agreed to acquire it, contingent upon Wall Street absorbing some of its assets. Yet that deal fell apart the next day as UK regulators expressed hesitance over the risky transaction.
“Just imagine if I had agreed to let a British bank buy a very large American one which… collapsed the following week,” recounted Alistair Darling, the UK Chancellor of the Exchequer, during an address to the Financial Crisis Inquiry Commission.
‘It was pandemonium up there’
With no buyers remaining, regulators pressured Lehman Brothers to file for bankruptcy on Sunday night, ahead of Monday morning’s market opening.
Lehman’s executives and lawyers departed from the New York Fed to communicate to the board that no lifeline was forthcoming.
“When we returned to headquarters, it was complete chaos,” Harvey Miller, the bankruptcy advisor for Lehman Brothers, later recounted to investigators.
The Fed denied Lehman’s last-minute request for more assistance from the central bank, leading to the early morning bankruptcy filing.
The collapse left employees reeling.
“I never thought the company would go out of business. It was devastating,” expressed James Chico, who had worked as an analyst at Lehman for over twenty years.
Tom Rogers was on his honeymoon in St. Lucia when his employer of seven years went belly-up.
“When I came back, it was total chaos,” said Rogers, who had started as an intern and rose to a senior analyst in Lehman’s reinsurance sector.
The turmoil illustrated the fragility and interconnectedness of the entire financial system. The situation worsened with the nearing downfall of AIG, the massive insurance corporation. Regulators feared that AIG’s failure would precipitate a complete collapse of the system — thus, AIG was extended a $182 billion bailout.
Anxiety and panic rapidly spread throughout the financial sector, leading to a credit crunch. Even renowned industrial giants like General Motors found it impossible to secure short-term financing.
“The financial crisis reached catastrophic levels following the collapse of Lehman Brothers,” concluded the financial crisis inquiry commission.
Fuld, who had notoriously asserted to shareholders in April 2008 that “the worst is behind us,” became one of the crisis’s scapegoats. He drove Lehman straight into an impending storm.
Between 2000 and 2007, Lehman’s assets surged more than threefold to $691 billion. Its leverage ratio skyrocketed to 40 times its equity. The company thus had limited capital to safeguard against potential crises.
Madelyn Antoncic, who served as Lehman’s chief risk officer from 2004 to 2007, tried unsuccessfully to warn Fuld against increasing mortgage exposure.
“At the senior level, they pushed so hard that the wheels began to fall off,” Antoncic told the commission.
For his part, Fuld confessed to lawmakers in 2008 that the repercussions of Lehman’s downfall “will haunt me for the rest of my days.”
The former CEO of Lehman Brothers, who gained and lost a fortune of $1 billion on Wall Street, has avoided the public eye since the crisis. Yet he attended a 2015 event where he acknowledged that he would approach some matters differently.
“I underestimated the market’s volatility and how it shifted from one asset class to another,” Fuld remarked.
Fuld shouldn’t bear all the responsibility; the firm’s fall highlighted the reckless risk-taking that regulators and CEOs had tolerated across Wall Street.
For instance, the 2000 deregulation of exotic financial instruments known as derivatives allowed traders to operate with little oversight into how their transactions linked banks together, setting off a domino effect when one institution faltered.
Even a month before Lehman’s bankruptcy, Federal Reserve officials were still trying to understand the implications of the bank’s 900,000 derivative contracts. They remained oblivious to the risks due to AIG’s massive derivative exposure.
“Those managing our financial system were operating blindly as the crisis unfolded,” Angelides remarked.
Only after the sweeping Dodd-Frank financial reform law was enacted in 2010 were derivatives mandated to be traded on exchanges.
Furthermore, regulators failed to curb Lehman Brothers’ reckless plunge into real estate. The firm continued acquiring real estate assets well into the first quarter of 2008.
The Treasury Department’s Office of Thrift Supervision didn’t issue a report cautioning about Lehman’s “excessive risk” in commercial real estate until merely two months prior to its downfall. The OTS has since been abolished due to Dodd-Frank.
Similarly, the SEC failed to reprimand Lehman Brothers for surpassing risk limits, despite its awareness of the situation.
“The SEC… was aware of the firm’s neglect of risk management,” stated the commission.
Lehman Brothers also avoided scrutiny by employing accounting tricks to obscure the extent of its debt. Bart McDade, Lehman’s president and COO, wrote in an email at the time that these accounting tactics were “another drug we’re on.”
Economists will debate for years whether the government should have intervened to rescue Lehman, to avert the ensuing chaos. Former Federal Reserve Chairman Ben Bernanke asserts that regulators lacked the power to lend support to a failing Lehman.
“We essentially had no option but to allow it to fail,” Bernanke informed the commission.
Conversely, others argue that Bernanke and Paulson should have recognized that permitting Lehman to fail would exacerbate the crisis.
“Our regulatory framework is comprised of humans — and humans make mistakes,” states James Angel, a business professor at Georgetown University. “The Fed could certainly have managed the fallout more effectively.”
The erratic response from Washington — opting not to bail out Lehman following the rescue of Bear Stearns and prior to assisting AIG — “added to the uncertainty and panic,” concluded the financial crisis inquiry.
Today, the financial system is more secure due to reforms implemented since 2008. Banks have significantly increased their capital reserves, and regulators are more alert.
Nonetheless, concerns persist over the potential for another economic downturn, even if it doesn’t originate with the banks.
“I’m apprehensive about the present,” expressed renowned Yale professor Robert Shiller, pointing to the “overvalued” stock market and climbing home prices.
“We might be on the brink of another 2008 experience,” Shiller noted. “It might manifest differently this time, but we could witness a decline in real estate values and an economic downturn.”
We must hope that the lessons from the previous crisis have not been forgotten.
A Decade Later: It’s been 10 years since the financial crisis shook the American economy. In a special yearlong series, UJ will explore the crisis’s causes, its continuing effects, and the lessons we have learned — and those we have not.
