The post-Lehman world

The collapse of Lehman Brothers sent shockwaves across the world and started the worst financial crisis in nearly a century. Five years after the event, Jules Gray looks at what has changed

 
The collapse of Lehman Brothers significantly altered the financial climate and triggered a catastrophic knock-on effect. Five years on, has Wall Street learned from past mistakes?  

Once one of the most recognisable and respected names in global finance, it is remarkable to think that it has now been half a decade since the collapse of Lehman Brothers. It was Wall Street’s fourth-largest financial institution at the time, so the shocking announcement in September 2008 that it was filing for Chapter 11 bankruptcy protection had a catastrophic knock on effect for global financial markets.

The root of Lehman’s downfall was its exposure to vast amounts of debt, primarily in real estate assets, in the years leading up to the crisis. Such levels of gearing left the bank highly susceptible to market fluctuations. In 2007, the firm was forced to close its subprime mortgage lender BNC Mortgage after a downturn in the industry, causing an immediate loss of 1,200 jobs in 23 branches, and over $50m in charges.

By 2008, the subprime mortgage crisis in the US was starting to take hold and Lehman was shown to still be greatly exposed. By the second quarter of 2008, Lehman announced losses of $2.8bn and sought to raise an additional $6bn in new capital. During the first half of 2008 alone, the company lost a stunning 73 percent of its value. By September, the company revealed additional losses of $3.9bn, causing a seven percent slide in stock value in a single day. Rumours of buyouts from other firms, including Barclays, and , failed to materialise, leading to the announcement of the firm’s bankruptcy.

Where are Lehman’s assets?
In the aftermath of its collapse, a great deal of rival firms circled the remains of Lehman’s operations, eager to take on what were thought to be undervalued assets. Barclays acquired the vast majority of Lehman’s North American operations for $1.75bn – later revised down to $1.35bn. It would see Barclays take on $47.4bn worth of securities, as well as $45.5bn in liabilities. While the deal was considered a great deal lower than expected, it was accepted because of a lack of any “viable alternatives”, according to Luc Despins, who was then the creditors’ committee counsel.

In the aftermath of its collapse, a great deal of rival firms circled the remains of Lehman’s operations, eager to take on what were thought to be undervalued assets

Japanese brokerage firm Nomura also took on part of Lehman’s business, acquiring the Asian division and some of its European operations for the incredibly low sum of $225m. This didn’t include any of the liabilities of Lehman’s European businesses, but meant that many of their key employees joined Nomura. The deal proved a steal for Nomura, as these non-US subsidiaries accounted for more than 50 percent of Lehman’s revenue in the company’s final annual report.

An attempt to quickly sell off Lehman’s asset management business, Neuberger Berman, to two private equity groups by the end of September 2008 ultimately stumbled. Bain Capital and Hellman & Friedman had agreed to buy the firm for $2.15bn, but were later defeated by a rival bid from Neuberger’s own management team.

Mutual issues
Lehman was not the only bank to succumb to the crisis. Government-sponsored firms Fannie Mae and Freddie Mac came under a great deal of pressure due to the subprime mortgage crisis, and are thought to have exacerbated the problems in 2008.

Brokerage firm Bear Stearns was also a high profile casualty of the crisis. Heavily invested in securitisation, in particular mortgages, in 2007 the bank was forced to pledge $3.2bn towards bailing out one of its own funds, the Bear Stearns High-Grade Structured Credit Fund. By mid-July the firm announced that two of its subprime hedge funds had lost almost all their value, and it was subsequently taken to court over misleading investors over the funds’ performance. In March 2008, Bear Stearns was set to receive a $25bn bailout from the Federal Reserve, before the deal was changed to a $30bn loan to JPMorgan Chase, which was in turn made to acquire the struggling firm.

Another firm to fall by the wayside was Washington Mutual Bank, at the time the largest savings and loan association in the US. Shortly after Lehman’s collapse in mid-September, the Federal Deposit Insurance Corporation (FDIC) placed Washington Mutual into receivership after $16.7bn in deposits was withdrawn over the course of just nine days. JPMorgan Chase later bought it, while the holding company, Washington Mutual, maintained control of $33bn in assets. However, in 2009 the holding company filed a lawsuit against the FDIC over what it felt was an unjust seizure and enforced sale.

Troubled assets
In order to save the struggling banks, the US government put together it Troubled Asset Relief Program (TARP). It meant that the government would purchase assets and equity from the troubled financial institutions, and was originally intended to reach $700bn. However, as of the end of last year just $418bn was taken out. Most of this sum has now been returned to the government.

There is concern in some quarters that many of the lessons learnt from the crisis may not be being taken seriously

Some aren’t convinced of its effectiveness. Anat Admati, Finance and Economics Professor at Stanford University’s Graduate School of Business, wrote in the Guardian in October, “Authorised through TARP, the US Treasury invested hundreds of billions of funds in financial institutions. Meanwhile, only $8.6bn was directed at the ‘troubled assets’ of distressed homeowners, and some funds were abused.

“Combined with many loans and guarantees programmes administered by the Federal Reserve, the FDIC and the Federal Reserve Bank of New York, TARP helped calm the panic that followed Lehman’s bankruptcy. The direct cost of TARP will likely be relatively small, but so were its benefits; it was not the best use of taxpayer money.”

Five years on and some of the key players from the crisis – from bank CEOs to regulators charged with sorting the mess out – have either moved on or are still firmly encamped in their roles. There is also concern in some quarters that many of the lessons learnt from the crisis may not be being taken seriously.

Christy Romero, Special Inspector General for the TARP programme, also told the Guardian recently that there was still much work to be done in reforming the financial sector, in particular in the area of executive pay, “Yes, the financial system has stabilised, in part due to the TARP bailout, but are we rid of the toxic corporate culture that led to the financial crisis? Not sufficiently. Excessive executive pay is still far too routine, in spite of corporate scandals and continued losses. The root cause of the financial crisis was a pervasive culture of rampant risk-taking and greed, combined with unchecked power.”

As for the effectiveness of the TARP programme, Romero says most of the change needed at the banks should happen internally, “TARP was not meant to finance criminal activity, but our jurisdiction is narrow, and law enforcement is but one effective method. Companies must change from within. Adopting strong board and management oversight, for instance, will help curb risk and greed to the point where a company can absorb its own losses without coming to taxpayers, hat in hand, again.”

Where are they now?

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Dick Fuld

One of the most high profile people to emerge from the crisis was Lehman Brothers’ Chairman and CEO Dick Fuld. Having headed up the company since 1994, Fuld is now held by some as the face of the crisis; the man whose attitude towards risk caused much of the damage to the industry and the wider economy.

Despite Lehman entering bankruptcy, Fuld was still rewarded with a staggering $34m pay out in 2007. By 2011, he – along with other senior former Lehman executives – paid out around $90m as a settlement in a shareholder lawsuit.

He is currently out of full-time employment. Understandably, few firms are willing to trust a man whose reputation in the financial services sector is so toxic.

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Hank Paulson

Another whose reputation was badly tarnished by the crisis was then US Secretary of the Treasury Hank Paulson. Having assumed the role in 2006 after heading up Goldman Sachs, Paulson was considered the architect of the US governments’ plan to help financial institutions buy up many of the troubled mortgages in the market.

The Paulson Plan was criticised as potentially leading to a conflict of interest, as firms taking on the mortgages with help from the government included his former employers, Goldman Sachs. It was never fully implemented, with the government instead choosing to direct the money into TARP. Paulson departed in 2009 when President Bush’s term ended, and has since set up a think tank called the Paulson Institute.
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Lloyd Blankfein

Goldman Sachs emerged relatively unscathed from the crisis, even benefiting from the subprime mortgage crisis between 2007 and 2008 by short-selling mortgage-backed securities. The way the company profited while others were losing vast amounts of money drew heavy criticism from the press, and the company’s CEO and Chairman, Lloyd Blankfein, bore much of the abuse. His defiant stance during the crisis, as well as his colossal $95m earnings at its height, added to the criticism.

Despite all of this, Blankfein remains in control at Goldman’s. An SEC fine of $550m for selling subprime mortgages in 2010 couldn’t displace him, and his firm even received a vote of confidence in the form of a $5bn investment by Warren Buffett’s Berkshire Hathaway.
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Ken Lewis

Although Bank of America had to take a government bailout, the firm’s CEO, Ken Lewis, is thought to have successfully steered it away from serious harm. Indeed, one of the positive outcomes of the crisis for Bank of America was its acquisition of Merrill Lynch. However, Lewis drew some criticism for overspending on the investment bank, as well as on mortgage lender Countrywide Financial, which caused a number of lawsuits and heavy losses, and eventually led to the government bailout.

After a shareholder meeting in 2009 led to him losing his title of chairman, Lewis retired that same year, having pocketed $34m for his work during the crisis. He has since kept a relatively low profile.
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John Thain

Merrill Lynch was badly hit by the subprime mortgage crisis in 2007, ultimately writing down $8.4bn in losses. CEO E Stanley O’Neal was ousted as a result and replaced by John Thain. Having previously served as the CEO of NYSE for three years, Thain was tasked with saving the firm and negotiating its sale.

Bank of America promptly bought the company for a premium that year, although Thain was criticised by his new bosses for asking for a $10m bonus in 2008, and he made matters worse by spending $1.2m redesigning his office.

At the beginning of 2009, Thain left the company and has since re-emerged at CIT Group, where he’s been widely praised for turning the company around after bankruptcy in 2009.
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Jamie Dimon

While many of his contemporaries were criticised for their conduct during the crisis, JP Morgan Chase CEO Jamie Dimon was widely seen as someone who had handled it well. The firm’s balance sheet was far healthier than its rivals, and the bank used TARP finances to make a number of acquisitions.

The purchase of Bear Stearns for just $1.5bn was seen as a coup, as was the acquisition of Washington Mutual for just $1.9bn. During the time of the crisis, he banked $65m.

He remains in his role as CEO, but since the crisis JPMorgan Chase has suffered a few setbacks, the most notable of which was the $6bn it lost due to a rogue London-based trader known as the London Whale.

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