Ethical Issues in the Collapse of Lehman Brothers

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Serge IRAGUHA
Business and Society
November 25, 2012
Ethical Issues in the Collapse of Lehman Brothers

Lehman Brothers Holdings Inc. used to trade on the NYSE under the symbol LEH as the fourth largest investment bank in the US. It provided global financial services in investment banking, fixed income sales, trading US treasury securities, investment management, private equity, and banking. But on September 12, 2008 it found itself under financial predicaments when it filed for bankruptcy. With $600 billion in debt, LEH stands as the largest bankruptcy in world history. The company experienced an alienation of most of its clients, drastic losses in its stock, and loss of its assets when it got devaluated by credit rating agencies. This was mainly because Lehman Brothers had been taking excessive risks to the point that it became insolvent. Many argue that letting Lehman Brothers fail was one of the triggers of the financial crisis; the demise of Lehman Brothers accelerated the global financial crisis and sparked debate over ethical issues on Wall Street and in the financial industry in general. The Lehman Brother’s case highlights some of the negative ethical practices that affected the current financial crises in the United States. Consequently, exploring the Lehman Brothers case will not only give a clear image of how important ethics are in business but also steps to be taken to deal with them on large scale. The financial crisis put the whole world in jeopardy, thus understanding the moral aspects and the ethical implications of the matter helps in understanding how crucial ethics are for the success of any business. The root of the Lehman Brothers problem came when they began doing mortgage loans. Before the global financial crisis, it was very beneficial for an investment bank to acquire a portfolio of mortgage loans from a commercial bank, because it relieved its debt on a balance sheet. The investment bank would then create mortgage backed securities (MBS,) packages of mortgages loans that were sold to investors. The investors would receive a return on their investments when the borrowers made their monthly mortgage payments. Lehman Brothers would sell an MBS, which was also comprised of debt, to investors around the world. As long as mortgage payments came in, the investors would profit, as would the investment bank. Even if some defaults occurred, housing prices were going up, and the investment bank could count on the value of the home as collateral. Or so they thought... According to Larry Swedroe Lehman Brothers started taking on an obscene amount of leverage on a degree of 30 to 1, meaning that for every 30$ wager, they put only 1$ and borrowed the rest. They were investing in the MBS mentioned above because they thought that these investments were safe and were backed by the market prices of houses at the time. The plunge of housing prices and the increasing number of defaults on subprime mortgages in 2007, conversely, meant that many individuals holding these mortgages did not make payments and the collateral that the banks held on those risky loans was not worth as much as it was during the height of the housing bubble. In some cases, the quantity of mortgage debt was even greater than the value of the home itself, which encouraged homeowners to default on their mortgages. This caused MBSs to become “toxic assets,” which eventually led to a credit freeze in the United States and Europe. Basically the misjudgments of investment banks in their investment decisions, including their repeated violations of the basic banking principle not to borrow short-term and lend the proceeds long-term, transformed the housing crisis into a financial crisis. By failing to disclose full information about the MBS’, especially the debt they carried, and consequently, misleading investors, the Lehman Brothers found themselves under ethical infringement that eventually led to their fall. When Lehman Brothers’ financial...
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