Flashback Friday: Revisiting the collapse of the Lehman Brothers  

One of the most well-known bankruptcy stories in American history was the collapse of Lehman Brothers, the fourth-largest investment bank, which took place on September 15, 2008.

At the time of the collapse, the financial company had $639 billion in assets and $613 billion in liabilities, while employees in business suits carried cardboard boxes and left their office building. The subprime catastrophe, which spread through financial markets and resulted in roughly $10 trillion in lost economic output, turned the bank into a symbol of the surfeits of the 2007–2008 Financial Crisis.

In this story, we look at the rise and fall of one of the most prominent investment bankers and the impact that it had globally.

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Beginnings and their rise to glory

Lehman Brothers, founded in the mid-19th century by German immigrant Henry Lehman, began as a modest dry-goods store in Montgomery, Alabama, in 1844. The transformation into Lehman Brothers came with the arrival of Henry's brothers, Emmanuel and Mayer. Their ambitions quickly expanded beyond dry goods, leading them into the intricate world of cotton and commodities trading.

In 1858, a pivotal shift occurred as Lehman Brothers relocated its operations to New York, a burgeoning hub for commodities trading. While Henry managed the grocery and general store business, his brothers laid the groundwork for what would become a financial industry powerhouse.

Over the next century and a half, Lehman Brothers underwent numerous transformations and forged alliances. Although Lehman Brothers' 2008 bankruptcy catalysed rather than caused the Great Recession and the subprime mortgage crisis, it sent shockwaves across global markets, triggering a significant selloff.

The firm's journey was marked by resilience. In 1984, Shearson/American Express acquired Lehman Brothers for $360 million. In 1994, Lehman Brothers embarked on its path via an IPO, raising over $3 billion in capital. The repeal of the Glass-Steagall Act enabled Lehman Brothers to venture into both investment and commercial banking.

Lehman Brothers thrived, becoming the nation's fourth-largest investment banking firm by 2007. Much of its growth was fuelled by substantial investments in mortgage-backed securities (MBS), a twist of fate that, ironically, contributed to its eventual downfall.

The warning signs

A strategy shift towards sophisticated financial products like mortgage-backed securities and collateralised debt obligations (CDOs) marked the beginning of Lehman Brothers' route to its tragic collapse. When Lehman bought many mortgage firms, including BNC Mortgage and Aurora Loan Services, which specialised in Alt-A loans without complete paperwork, this change occurred in the early 2000s. At first, these actions seemed profitable; from 2004 and 2006, Lehman's real estate division contributed significantly to a 56 percent increase in capital markets unit revenues.

Despite these early gains, ominous signs began to emerge. The housing market in the United States revealed growing weaknesses, particularly with an increase in subprime mortgage defaults. Surprisingly, in February 2007, Lehman's stock price soared to a record high of $86.18 per share. Lehman kept on downplaying the significance of escalating home loan concerns despite mounting anxiety, assuring investors that the risks were under control.

The countdown to the collapse

Lehman's stock price fluctuated throughout 2007 as the U.S. housing market's cracks grew worse. Lehman responded to the economic crisis in August 2007 by closing down portions of its mortgage business and laying off 1,200 employees who worked in the mortgage industry. Despite this issues, Lehman continued to maintain a significant presence in the mortgage sector.

Lehman's susceptibility resulted from its considerable portfolio of mortgage-related assets and excessive leverage, as seen by a leverage ratio of 31. As a result, Lehman's stock price declined by almost 48 per cent in March 2008. This fall took place amid mounting worries that Lehman would be the next big Wall Street Company to have huge issues. Investor confidence continued to decline despite Lehman's ability to raise money and take steps to lower its risk. Lehman's first losses since being spun off from American Express were reported in June 2008, when it posted a huge $2.8 billion second-quarter deficit.

Global financial fallout

The global financial crisis began on September 15, 2008, when Lehman Brothers filed for bankruptcy. The financial markets around the world experienced shockwaves as a result of this catastrophe. It set off a series of crises, including stock market crashes and freezes in the credit markets. To stabilise the staggering global economy, governments and central banks were forced to undertake large bailout packages and financial support measures.

The collapse of Lehman Brothers serves as a warning of the dangers of uncontrolled risk-taking and financial excess as it had a ripple effect on the larger global financial crisis, which in turn affected people, financial institutions, and economies all over the world.

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