Lehman Brothers: When the Financial Crisis Spinned Out of Control

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Lehman’s failure rocked Wall Street to the core. The Dow 504 point drop, the equivalent of 1,300 points today. Some $700 billion disappeared from pension plans and other investment funds. The ensuing panic plunged the US economy into a severe slowdownnow known as the Great Recession.

Today, Lehman Brothers and its CEO Dick Fuld are the stars of the reckless risk-taking that has destroyed the economy.

Frantic talks

Lehman’s final days were marked by frantic last-minute negotiations over his fate.

Until the end, everyone thought that someone would save Lehman Brothers: the company would certainly not be allowed to go bankrupt. Bear Stearns, a small investment bank, had been saved only six months earlier by Washington and JPMorgan Chase.

On Wednesday, September 10, South Korea’s Korea Development Bank dropped out of the race to become Lehman Brothers’ white knight. The news — combined with Lehman’s announcement of a record $3.9 billion quarterly loss — sent the bank’s shares tumbling 45%.

With South Korea absent, Treasury Secretary Hank Paulson called Bank of America CEO Ken Lewis to ask him to find a creative way to buy Lehman Brothers. Put on your “imaginative hat,” Paulson urged Lewis.

But on Friday, September 12, Bank of America said it was stepping down unless the government was ready to help. Lehman was simply stuck with too many “illiquid” mortgage assets, and it couldn’t sell them fast enough to meet other obligations. Instead, Bank of America decided to buy the next investment bank online to fail: Merrill Lynch.

“You just didn’t know what was going to happen when you walked into work on Monday,” said Brady Kim, who worked as an analyst at Lehman’s trading desk. “Were you going to work for Barclays? A Korean conglomerate?

The only option few saw coming was bankruptcy. “They’re not just going to let the bank run,” Kim said.

“Not a Penny”

This Friday evening, Paulson ordered the heads of major Wall Street companies to meet at the headquarters of the New York Fed. They were told to find a private sector solution to save Lehman.

US officials had little appetite for another bailout. They had just taken over faltering mortgage giants Fannie Mae and Freddie Mac the previous weekend. Fed officials said Paulson made it clear there would be no government assistance this time, “not a dime.”

Saturday brought an apparent breakthrough for Lehman: Barclays agreed to buy Lehman – as long as Wall Street stripped it of certain assets. But the deal with Barclays went up in smoke on Sunday when UK regulators balked at blessing the risky deal.

“Imagine if I said yes to a UK bank buying a very large US bank which…collapsed the following week,” UK Chancellor of the Exchequer Alistair Darling later told the Commission. investigation of the financial crisis.

“It was a pandemonium up there”

With no buyers, regulators pressured Lehman Brothers to file for bankruptcy on Sunday evening, before markets opened in the morning.

Lehman lawyers and executives left the New York Fed to inform the board that no bailout was forthcoming.

“We went back to corporate headquarters, and it was pandemonium up there,” Lehman Brothers bankruptcy counsel Harvey Miller later told investigators.

The Fed rejected a last-minute appeal from Lehman for additional central bank assistance, leading to early morning bankruptcy.

The collapse shocked the employees.

“I never thought the company would go bankrupt. It was terrible,” said James Chico, who worked as an analyst in Lehman’s back office for more than two decades.

Tom Rogers was on his honeymoon in Saint Lucia when the bank, his employer for seven years, went bankrupt.

“I came back, and it was just mass chaos,” said Rogers, who started as an intern at Lehman and rose to senior analyst in the company’s reinsurance business.

“Cataclysmic proportions”

The turmoil showed how fragile and interconnected the whole system was. The situation was exacerbated by the near collapse of AIG, the insurance giant. Regulators feared AIG’s demise would bring the whole system down – so AIG received a $182 billion bailout.

Fear and panic quickly spread through the financial system, causing credit markets to freeze. Even large, iconic industrial companies such as General Motors were unable to receive short-term financing.

“The financial crisis has reached cataclysmic proportions with the bankruptcy of Lehman Brothers,” concluded the crisis inquiry commission.

Fuld, who sadly told shareholders in April 2008 that “the worst is behind us,” has become one of the villains of the crisis. He led Lehman directly into an epic storm.

Between 2000 and 2007, Lehman’s assets more than tripled to $691 billion. And his debt ratio, known as leverage, jumped to 40 times his equity in the business. The company had relatively little capital to protect against trouble.

Madelyn Antoncic, chief risk officer at Lehman from 2004 to 2007, tried unsuccessfully to caution Fuld against taking on more mortgage risk.

“At the top level, they were trying to push so hard that the wheels started to come off,” Antoncic told the commission.

For his part, Fuld told lawmakers in 2008 that the pain of Lehman’s failure “will stay with me for the rest of my life.”

The former Lehman Brothers boss, who made and lost a billion-dollar fortune on Wall Street, has made few public appearances since the crisis. He did speak at an event in 2015 where he admitted he would do some things differently.

“I missed the market violence and how it spread across asset classes,” Fuld said.

Richard Fuld, former chairman and CEO of Lehman Brothers, speaks at a hearing in 2010.

Where were the regulators?

Full doesn’t deserve all the blame. The company’s demise underscored the wild risk-taking that regulators and CEOs had allowed to spill over to Wall Street.

Consider, for example, the deregulation in 2000 of exotic financial instruments known as derivatives. Regulators had little information about how these exchanges tied banks together. When a bank failed, other financial institutions fell into a sort of domino effect.

Even a month before Lehman’s bankruptcy, Fed officials were still seeking information on the bank’s 900,000 derivative contracts. And they had no idea of ​​the risk posed by AIG’s massive derivatives portfolio.

“Those charged with overseeing our financial system were flying blind as the crisis unfolded,” Angelides said.

It wasn’t until 2010, with the passage of the sweeping Dodd-Frank Financial Reform Act, that derivatives had to be bought and sold on exchanges.

Regulators also failed to convince Lehman Brothers to slow its headlong plunge into mortgages. The company continued to purchase real estate assets for much of the first quarter of 2008.

The Treasury Department’s Office of Thrift Supervision only issued a report warning of Lehman’s “outsized bet” on commercial real estate only two months before its collapse. The OTS was abolished by Dodd-Frank.

Likewise, the SEC declined to call Lehman Brothers for exceeding risk limits — even though the agency knew about it.

“The SEC … knew of the company’s disregard for risk management,” the commission said.

Lehman Brothers also got away with using accounting gimmicks to hide the amount of money it borrowed. Bart McDade, president and chief operating officer of Lehman, wrote in an email at the time that accounting maneuvers are “another drug we laugh about.”

Should Lehman have been saved?

Economists would debate for decades whether Washington should have rescued Lehman to prevent the chaos that followed. Former Federal Reserve Chairman Ben Bernanke argues that regulators lacked the authority to lend to a failing Lehman.

“We basically had no choice and had to let it fail,” Bernanke told the commission.

But others say Bernanke and Paulson should have realized that allowing Lehman to go bankrupt would make the crisis worse.

“Our regulatory system is made up of humans — and humans make mistakes,” said Georgetown University business professor James Angel. “The Fed clearly could have done a better job of containing the damage.”

Washington’s inconsistent response – deciding not to save Lehman after saving Bear and before helping AIG – “added to the uncertainty and panic,” the financial crisis inquiry concluded.

Could this happen again?

Today’s financial system is safer thanks to the reforms put in place after 2008. Banks have accumulated vast amounts of capital. Regulators are more vigilant.

But some worry about the risk of a further slowdowneven if it does not start with the banks.

“I’m worried right now,” said famed Yale professor Robert Schiller, pointing to “very expensive” stocks and rising home values.

“We’re already in what could be a repeat of 2008,” Shiller said. “It will be different this time, but there could be a drop in house prices and a recession.”

Hope the the lessons of the last crisis have not been forgotten.

A decade later: It’s been 10 years since the financial crisis rocked the US economy. In a special year-long series, CNN will examine the causes of the crisis, how the country is still feeling its effects, and the lessons we have — and haven’t — learned.

CNN’s Julia Horowitz contributed to this report.

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