Next month is the 11th anniversary of the fall of the famed investment banking firm Lehman Brothers (“Lehman”), which froze up the nation’s credit system when it collapsed on Sept. 15.
The firm was founded as a dry goods business in 1850 in Alabama by brothers Henry, Emmanuel, and Mayer. Lehman began focusing on cotton trading and moved to New York during the late 1850s. That office eventually became its headquarters.
By 1900, Lehman had begun moving into underwriting new issues of common stocks for corporate clients, as well bond trading and financial advisory services. During the ensuing decades, it underwrote issues for corporations like Sears Roebuck, RCA, and Macy’s. In 1984, Lehman was acquired by American Express and merged with Shearson, the company’s brokerage subsidiary. This lasted until 1994, when American Express decided to get out of the brokerage business and spun off Lehman.
The company saw considerable success in the years that followed, as it increased its net revenues more than six-fold, to $19.2 billion. By the end of 2007, it was the fourth largest investment bank in the United States and seemed poised to continue its stellar growth.
But Lehman had become increasingly reliant on the subprime and commercial real estate markets. This went hand-in-hand with a 46 percent increase in its leverage ratio, from 24 to 1 in 2003 to 35 to 1 in 2007. Much of this leverage took the form of short-term debt with maturities as short as a single day. So Lehman had to continuously sweet talk its lenders about the “solid value” of the assets it had pledged as collateral for these “here-today-gone-tomorrow” loans.
The sweet talk was undercut by continued erosion of the housing and mortgage markets during the summer of 2007. Lehman’s common stock price fell 37 percent from June to August, as the firm closed its sub-prime mortgage arm, wrote off $3.5 billion in mortgage related assets, and laid off more than 6,000 employees by year’s end.
Things got even worse in 2008. In January, Lehman closed its wholesale mortgage lending unit and laid off another 1,300 employees in a vain attempt to stem further hemorrhaging from its sub-prime mortgage operations. Then Standard & Poor’s credit rating agency downgraded its outlook on Lehman from “Stable” to “Negative” on the expectation that its revenue would decline by at least another 20 percent, which caused Lehman’s stock price to plunge an additional 48 percent.
Lehman attempted to counter by selling $4 billion in convertible preferred stock, but the fresh cash was quickly soaked up by more write-offs. Rumors flew that other firms were refusing to trade with Lehman.
The company contemplated “taking itself private,” but financing wasn’t available. Lehman’s next move was to try and locate buyers for $30 billion of its commercial mortgages, whose actual market value couldn’t be determined because their trading activity was virtually non-existent. Talks with the Korea Development Bank, China’s CITIC Securities, and the Royal Bank of Canada went nowhere.
The time had come for the federal government to step in if Lehman was to be saved. But public backlash against the earlier Bear Stearns bailout made such a rescue politically untenable. With voices from all sides of the political spectrum screaming at the feds for using taxpayer funds to bail out big Wall Street firms that had caused this mess, while refusing to lift a finger to help American families in danger of losing their homes.
On Sept. 15, 2008, Lehman had to file for Chapter 11 bankruptcy, leaving its viable businesses to be snapped up at fire-sale prices by sharp-eyed bottom fishers.
At the time it was the largest Chapter 11 bankruptcy in American history. In retrospect, it’s generally regarded as the most disastrous decision by the feds since the early 1930s, when the Federal Reserve chose to shrink the nation’s money supply by one-third, which shattered the American economy for the rest of the decade.