Lehman Brothers Failure: Case Study

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Lehman Brothers’ failure was one of the most significant bankruptcy cases in the United States. The organization announced bankruptcy in 2008 after being in the market for more than one hundred and fifty years. Failure of the institution led to a series of events unfolding in the market, which caused a negative ripple. There has been a lot of research trying to establish the causes of failure in Lehman Brothers. Although most people believe that the management accounting techniques were the most significant cause of the catastrophe, there were other underlying reasons. One of the major causes was the firm’s massive investment in mortgage securities.

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Lehman had overinvested in securitized mortgages, making it more vulnerable than the rest of the organizations. The housing affluent had earlier led to over availability of mortgage-backed securities, and by 2007, the bank was their prime holder (Gennaioli & Shleifer, 2020). The bank had earlier acquired several lenders, who majorly focused on offering subprime loans which the US government had been pushing (Gennaioli & Shleifer, 2020). The risky subprime loans had overcrowded the market by 2007. The sinking of the securities had started earlier in 2006, but Lehman continued investing in housing mortgages. In 2007, the institution’s assets and securities stood at $100 billion (Gennaioli & Shleifer, 2020). Although by 2008, only assets worth $2 billion could be monetized.

Many lending institutions and banks encouraged individuals to take loans that they could never pay back by lowering mortgage interest rates. The lenders eventually created mortgage-backed securities, which were mortgages bundled up as instruments and later sold with minimum risk load (Gennaioli & Shleifer, 2020). The banks began to lend carelessly to individuals without any means of following up on the mortgage’s repayment. Many borrowers defaulted the loans, and the institutions started facing financial challenges (Wiggins & Metrick, 2019). The bubble burst of the housing mortgage led to the sell-out and falling of many lending institutions. If only the institutions had seen the risks involved in those loans earlier, they would have avoided their financial constraint during that period.

A companies’ culture can be determined using the ethics and values of its employees. Lehman bank rewarded risk without any validation at any cost. The management also manipulated the financial reports to stay afloat. The institution executives received fat checks as bonuses, which made them turn a blind eye to the account’s books unethical manipulation (“What is Cooking the Books? 2021). Although the officials later claimed that they were not aware of the book’s manipulation, all administrators must constantly maintain and ensure a good corporate culture that will lead to positive gains.

Another company that tried to give false entries in the accounting books was Enron, it was similar to Lehman since it faked profits. The only difference is that it misused unique purpose entities while Lehman misused Repo 15, which misled their accounts (“What is Cooking the Books? 2021). In 2011, Olympus was caught up in a vast fraud scandal, where management hid losses for almost two decades and made acquisitions to try and hide their poor investments (“What is Cooking the Books? 2021). The scandal was similar to Lehman since they too tried to hide their losses, the only difference is that Lehman did not hide for a long time. It has become harder currently to “cook books” having an automated payables system that avoids data manipulation.

The United States government was aware of the conditions in the market way before the crisis. Two decades prior, financial liberalization took place and was not well regulated, which led to high global liquidity (Wiggins & Metrick, 2019). A financial euphoria was created, which distorted risk perception, leading to high leveraging, which later led to businesses and households’ over-indebtedness. With inadequate regulations on banks and other lending facilities a bubble was created. The real estate ripple eventually busted in the US, triggering the financial crisis, which was felt globally.

The government pushed subprime mortgage loans, which were also one of the major causes of the problem. The crisis might not have happened in the first place were it not for the radical changes in the financial sector. Commercial banks were allowed to regroup loans into securitized mortgages and later resell them under a model advocated by Alan Greenspan, a former fed chair (Wiggins & Metrick, 2019). The model was meant to transfer risk from more conservative to less aversive investors while making huge returns. Although the government put up some measures to combat the crisis, it did so too late.

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The government had no other choice but to intervene in the 2008 financial crisis to cushion the economy since the recession would have worsened. The message in the government interventions was that in some cases, the government’s quick involvement in the economy is essential, especially when it has to do with a calamity that can cripple a country’s economy (Wiggins & Metrick, 2019). The US government put three acts that assisted in economic recovery: The troubled asset program saved the financial system from more damage by injecting money into struggling banks. On the other hand, the American recovery act avoided a second depression that many feared, where spending measures were implemented (Wiggins & Metrick, 2019). In 2010, the tax relief and job creation act was introduced, strengthening the economy’s recovery by cutting payroll tax. Although governments’ approach was significantly an ad hoc one, it greatly reduced further economic damage.

The crisis affected many people and organizations. Banks were the most brutal hit, where some closed, while others were bought off. Most people lost their homes, especially those who could not pay back the loans (Das & Sethi, 2016). The US citizens in the employment sector suffered the most, where one in every five employees lost their jobs (Das & Sethi, 2016). Most companies in the trading industries were also not spared, where they lost millions by having reduced sales during the period.

Lehman failure was contributed by different factors that went hand in hand since no single cause could be pointed out to be the only reason. From the officials’ unethical behavior to Repo 150 used by the accountants, it was hard to salvage the firm. The bank’s failure had undesirably impacted the economy and left negative print on society that lost confidence in lending institutions. The 2008 crisis made people more aware of the dangers of blindly taking loans without any means of payment. It also made big organizations realize that signing up to high-risk operations without consultations can lead to an economic crisis.

References

Das, V., & Sethi, A. S. (2016). Tough road for great recession victims: Column. USA TODAY. Web.

Gennaioli, N., & Shleifer, A. (2020). A crisis of beliefs. Princeton University Press.

What is Cooking the Books? | Accounting Scandals Throughout History. (2020). Medius. Web.

Wiggins, R. Z., & Metrick, A. (2019). The lehman brothers bankruptcy h: The global contagion. Journal of Financial Crises, 1(1), 172-199.

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BusinessEssay. 2022. "Lehman Brothers Failure: Case Study." June 19, 2022. https://business-essay.com/lehman-brothers-failure-case-study/.

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