Question

Specify the causes of the Lehman bankruptcy and insolvency as the firm moved through time.

Answer 1

Lehman Brothers (LB) was one of the most successful investment bank at the time of its collapse in the year 2008. There were various reasons and series of events that led to its bankruptcy and insolvency. In the paragraphs below, we walk through these reason and the event that led to the peaceful demise of LB:

• The bank had ventured into the areas of mortgage-backed securities (MBS) and other collateral debt obligations (CDOs) in 2003 and 2004. In simplest term, the bank started trading into a portfolio of real estate loans given to not so creditworthy people. Such loans were backed by the real estate properties owned by not so good borrowers.
• The portfolios of MBS and CDOs grew with time during 2003 to 2007.
• Real estate in US started signs of weakness in the year 2007. The housing prices declined. There were cases of delinquencies in home loans.
• Investors and lenders started losing confidence in the portfolios held by LB. This was because the borrowers started defaulting, the market values of the properties fell down and hence the portfolio of LB fell down in values. The exposure ran huge.
• To make it even worse,  LB has raised short-term funds (bilions of dollars) through repurchase agreementsto run business operations.
• The short term liabilities were backed by long term assets. There was a maturity ismatch. The liabilities matured while assets lost value. Eventually LB didn't have any money or liquid assets to pay back its maturing liabilities.
• In September 2008, they wrote off a significant portion of their defunct portfolio.
• Tide of tie took over and it became technically insolvent: Liabilities were in excess of the market value of he assets held by LB. It declared bankruptcy and eventually went into insolvency.