The Collapse of Lehman Brothers – Lessons Learned: Corporate Governance and Ethics. Executive summary
This essay discusses about the collapse of Lehman Brothers in 2008, from the perspective of corporate governance and ethics. It first gives some background about the collapse and analyze financial situation of the company before the incident happened. It reveals unethical or misleading financial or accounting practices in the company. Then we provide problem determination and lesson learned from a corporate governance perspective. That is what government, financial institutions and companies can do to have better control in the future. Introduction
Lehman Brothers was a company with a long and interesting history. It was founded in 1850 as a family business, by three brothers who immigrated to the US, and started as a shop, which later entered trading with cotton. During the more than 150 years existence the company became the fourth largest financial firm in the world. Before announcing bankruptcy on 15th of September 2008, they were providing full range of financial services. (See Exhibit 7) Lehman Brothers was tangled after the sub-prime mortgage disasters happened. The firm accumulated a very large commercial real estate portfolio. Lehman was also very highly leveraged and was taking no steps to get borrowing under control. On September 7th 2008, after the Government rescued Freddie Mac and Fannie Mae and Lehman announced a large third quarter loss three days later, the bank began to have pronounced liquidity problems. A large New York clearing bank asked the firm to provide more collateral to protect any daylight open position that may arise. Credit rating agencies threatened to downgrade the company unless some reasonable plan was announced that would restore capital and stabilize funding. Lehman had no such plan. That weekend, after exhausting private sector solutions, the government made it clear that no public money would flow to Lehman. Lehman Brothers Holdings, Inc. filed for bankruptcy. (Ryback, 2010) (See Exhibit 8) Financial situation and background
Let’s step back and investigate the financial situation of Lehman Brothers before it collapsed. On April 1, 2008, two weeks after the government arranged the sale of Bear Stearns (Bear), Lehman Brothers (Lehman) announced that it had raised $4 billion of new capital in the form of convertible preferred shares. (Yalman Onaran, 2009). On the news, Lehman’s stock rose 18% to $44.34, an increase of 18% from the prior day’s closing price (see Exhibit 1).
Lehman’s traditional strength was in fixed income. In 1995, over 55% of the firm’s revenues came from this area. By 2007 the proportion had fallen to 39% of the firm’s total, but fixed income remained the dominant business (see Exhibit 2). Fixed income securities made up 59% of the securities on its balance sheet at year end 2007 (see Exhibit 3), and Lehman was among the perennial leaders in fixed income underwriting (see Exhibit 4). The firm’s particular area of expertise and focus was in mortgage related securities. The first part of the strategy worked well, and Lehman had built dominant leadership positions in underwriting mortgage backed securities (see Exhibit 5), and by year-end 2007 mortgaged-related securities and loans accounted for 28% of the firm’s total assets, larger than any other asset class. (Rose, Ahuja, 2011) By the end of 2007, Lehman held $79 billion dollars of mortgage related assets on its balance sheet at year end, approximately half of which was commercial and half residential, and $5.3 billion was sub-prime. The firm’s Level III assets – those for which there was no traded market from which to derived valuations, requiring that they be “marked to model” according to the US accounting rule FAS 157 – increased by $6.5 billion during the quarter, to $38.9...