By 2004, the firm had set out to acquire as many mortgage lenders as they could, and they had obtained big names such as Aurora Loan Services and BNC Mortgage. Around this time, they were operating as an Investment bank, making money off of commissions and principal trading. Commissions were when they took a percent of money after closing a deal, and principal trading was when they used their own money to invest into securities, in hopes of selling them later. They made money using these two principles with mortgages in the housing market. The biggest result from acquiring these companies was the fact they had mortgage backed securities (MBS). This was a type of security that was backed by mortgages that paid the holder periodically, and gave interest.
Through their involvement with the mortgages they assumed, they were able to grow 56% from 2004 to 2006. They had securitized nearly 146 billion dollars of mortgages in 2006. Things were looking great for the investment bank, until the housing market started to take a turn. Mortgages, are in essence, loans that banks issue when people want to buy a house or some other property.
Banks would buy a house for a customer, and that customer would pay the bank every month or so a portion of their debt with interest. Generally, banks only issued these loans to people who had excellent credit scores, proof of a job, and proof that indicated that they would be able to pay back the money with interest, so the bank would get their money back and a little more. However, during the 2000’s many banks lowered their standards for which they would issue a loan, allowing riskier people to borrow money. To counteract the risk, the banks would charge higher interest, so that on average, they would make more money if some users failed to pay back the debt.
Everything was going great for Lehman Brothers, as the housing market was doing well, home prices were rising, so mortgages were good, and that meant their MBS’s were doing fine. On March 14, 2007, the subprime market, the market responsible for selling mortgages to those who probably didn’t have the best credentials, had its biggest drop in over seven years. The stock plummeted, and many people became worried. With a falling housing market, prices would collapse, and then all the MBS’s would be worth less, hurting Lehman Brothers who had invested heavily into them. This was the beginning of the end for Lehman Brothers.
In early 2008, the Bear Stearns collapsed, the second largest writer of MBS’s. The bank was hit hard, and the stock plummeted, and many believed that they would be the next investment bank to fail. The firm was losing money, but they had investors who were pouring millions into the company in hopes that it could come back.
Throughout September of 2008, Lehman brothers realized that they were going to fail if they didn’t sell some of their assets. They tried to sell some of their 600 billion dollars worth of assets, but no big bank wanted to buy them because they deemed it to big of a risk given the current state of the housing market. Their assets were failing, their MBS were losing value, and the company was losing hope. They had used up most of their cash on hand, and they couldn’t find anybody to bail them out, not even the U.S. government. So without anything to do, Lehman Brothers filed for bankruptcy. They had $639 billion in assets, but $619 billion dollars in debt. The fourth largest investment bank of the U.S. was finished on September 15, 2008. The bankruptcy led some 25,000 people to lose their job, the equity markets to crash, and worsened the 2008 financial crisis.
Sources: https://www.investopedia.com/articles/economics/09/lehman-brothers-collapse.asp
https://www.marketplace.org/2018/09/10/economy/5-things-you-need-know-about-lehman-brothers
https://www.investopedia.com/articles/economics/09/subprime-market-2008.asp
https://www.investopedia.com/terms/m/mbs.asp
I thought it was really interesting how such a large and sturdy company still fell victim to the financial crisis of 2008. It is especially remarkable that this company, having existed for over 150 years and survived the Great Depression, still eventually collapsed. In addition, I think that the part about 25,000 people becoming unemployed and exacerbating the crisis itself reflects Bush's mentality during this period. Bush believed that there existed companies that were too big to fail - that is, if these companies would fail, the effects would be devastating. The Lehman Brothers was indeed a very large company, and its failure did indeed have large reaching consequences.
ReplyDeleteI enjoyed reading your post, as I found the topic very interesting. I liked how you organized the information in chronological order and elaborated on the types of investments they made. Additionally, its interesting to analyze the relationship between the dot-com crash in 2000 and the 2008 financial crisis: government policies made to alleviate the effects of the recession in 2000 possibly played a major role in causing the 2008 financial crisis.
ReplyDeleteSource: https://en.wikipedia.org/wiki/Government_policies_and_the_subprime_mortgage_crisis