Collapse of Lehman Brothers

Collapse of Lehman Brothers

In the spring of 2008, the U.S. government was watching financial markets closely as several investment banks started to feel the effects of losses related to mortgage-backed securities. These firms had in recent years promoted the sale of complicated investment products known as collateralized debt obligations and credit default swaps, propelled by the ever growing housing bubble. The situation became so bizarre that some firms, such as Goldman Sachs, started betting against the likelihood of their own products panning out for investors. In other words, they hedged their bets, buoyed by credit ratings agencies such as Moody's and Standard & Poor's that gave even the shakiest investments the industry's top AAA rating. By spring 2008, however, some banks had begun to fail as the housing bubble imploded. The Federal Reserve facilitated the buyout of Bear Stearns by JP Morgan Chase, and the purchase of Merrill Lynch by Bank of America. On June 9, 2008, Lehman Brothers, the fourth largest investment bank in the United States, posted its first loss—$2.8 billion for the quarter—in 14 years. Both the president and the chief executive officer of the company resigned. On September 10, the company posted another quarterly loss, of $3.93 billion, and a write-down of $5.6 billion from investments in subprime loans. In the following days, Lehman Brothers looked for another bank to buy it out, and the U.S. government sought ways to help the company remain solvent.

However, a buyout did not come through, the government decided not to help Lehman Brothers any further, and the company folded in the largest U.S. bankruptcy in history on September 15, 2008. Lehman Brothers had $639 billion in assets and $619 billion in debt, an unprecedented debt ratio for a top firm. It had almost 26,000 employees worldwide and held at least $40 billion in direct client assets (including those of large hedge funds) when it went under. Its collapse sparked chaos in U.S. and world financial markets. Global stock markets lost $10 trillion in value following the Lehman Brothers bankruptcy, and banks stopped lending. The government's $700-billion bailout, or Troubled Assets Relief Program, followed, designed to stop other companies supposedly “too big to fail” from doing so and causing a complete economic meltdown. Nevertheless, the country entered the Great Recession in 2009, and experienced a period of economic stagnation for years afterward. Lehman's executives, especially former chief executive officer Richard Fuld Jr., later came under investigation for moving funds and increasing executive pay just prior to the bankruptcy. Fuld himself walked away with $480 million. However, the Security and Exchange Commission reported in 2011 that it would be hard to prove that Lehman Brothers had engaged in illegal practices. Barclays bought Lehman Brothers' North American holdings in October 2008.

The following is a portion of a speech by President Barack Obama one year after the collapse of Lehman Brothers:

…. First of all from my economic team, somebody who I think has done extraordinary work on behalf of all Americans and has helped to strengthen our financial system immeasurably, Secretary Tim Geitner—please give him a big round of applause. Somebody who is continually guiding me and keeping me straight on the numbers, the chair of the Council of Economic Advisers, Christina Romer is here. We have an extraordinary economic recovery board and as chairman somebody who knows more about the financial markets and the economy generally than just about anybody in this country, Paul Volcker. Thank you, Paul. The outstanding mayor of the city of New York, Mr. Michael Bloomberg. We have Assembly Speaker Sheldon Silver is here, as well; thank you.

We have a host of members of Congress, but there's one that I have to single out because he is going to be helping to shape the agenda going forward to make sure that we have one of the strongest, most dynamic, and most innovative financial markets in the world for many years to come, and that's my good friend, Barney Frank. I also want to thank our hosts from the National Park Service here at Federal Hall and all the other outstanding public officials who are here.

Thanks for being here. Thank you for your warm welcome. It's a privilege to be in historic Federal Hall. It was here more than two centuries ago that our first Congress served and our first President was inaugurated. And I just had a chance to glance at the Bible upon which George Washington took his oath. It was here, in the early days of the Republic, that Hamilton and Jefferson debated how best to administer a young economy and ensure that our nation rewarded the talents and drive of its people. And two centuries later, we still grapple with these questions—questions made more acute in moments of crisis.

It was one year ago today that we experienced just such a crisis. As investors and pension-holders watched with dread and dismay, and after a series of emergency meetings often conducted in the dead of the night, several of the world's largest and oldest financial institutions had fallen, either bankrupt, bought, or bailed out: Lehman Brothers, Merrill Lynch, AIG, Washington Mutual, Wachovia. A week before this began, Fannie Mae and Freddie Mac had been taken over by the government. Other large firms teetered on the brink of insolvency. Credit markets froze as banks refused to lend not only to families and businesses, but to one another. Five trillion dollars of Americans' household wealth evaporated in the span of just three months. That was just one year ago.

Congress and the previous administration took difficult but necessary action in the days and months that followed. Nonetheless, when this administration walked through the door in January, the situation remained urgent. The markets had fallen sharply; credit was not flowing. It was feared that the largest banks—those that remained standing—had too little capital and far too much exposure to risky loans. And the consequences had spread far beyond the streets of lower Manhattan. This was no longer just a financial crisis; it had become a full-blown economic crisis, with home prices sinking and businesses struggling to access affordable credit, and the economy shedding an average of 700,000 jobs every single month.

We could not separate what was happening in the corridors of our financial institutions from what was happening on the factory floors and around the kitchen tables. Home foreclosures linked those who took out home loans and those who repackaged those loans as securities. A lack of access to affordable credit threatened the health of large firms and small businesses, as well as all those whose jobs depended on them. And a weakened financial system weakened the broader economy, which in turn further weakened the financial system.

So the only way to address successfully any of these challenges was to address them together. And this administration, under the outstanding leadership of Tim Geitner and Christy Romer and Larry Summers and others, moved quickly on all fronts, initializing a financial—a financial stability plan to rescue the system from the crisis and restart lending for all those affected by the crisis. By opening and examining the books of large financial firms, we helped restore the availability of two things that had been in short supply: capital and confidence. By taking aggressive and innovative steps in credit markets, we spurred lending not just to banks, but to folks looking to buy homes or cars, take out student loans, or finance small businesses. Our home ownership plan has helped responsible homeowners refinance to stem the tide of lost homes and lost home values.

And the recovery plan is providing help to the unemployed and tax relief for working families, all the while spurring consumer spending. It's prevented layoffs of tens of thousands of teachers and police officers and other essential public servants. And thousands of recovery projects are underway all across America, including right here in New York City, putting people to work building wind turbines and solar panels, renovating schools and hospitals, repairing our nation's roads and bridges.

Eight months later, the work of recovery continues. And though I will never be satisfied while people are out of work and our financial system is weakened, we can be confident that the storms of the past two years are beginning to break. In fact, while there continues to be a need for government involvement to stabilize the financial system, that necessity is waning. After months in which public dollars were flowing into our financial system, we're finally beginning to see money flowing back to taxpayers. This doesn't mean taxpayers will escape the worst financial crisis in decades entirely unscathed. But banks have repaid more than $70 billion, and in those cases where the government's stakes have been sold completely, taxpayers have actually earned a 17 percent return on their investment. Just a few months ago, many experts from across the ideological spectrum feared that ensuring financial stability would require even more tax dollars. Instead, we've been able to eliminate a $250 billion reserve included in our budget because that fear has not been realized.

While full recovery of the financial system will take a great deal more time and work, the growing stability resulting from these interventions means we're beginning to return to normalcy. But here's what I want to emphasize today: Normalcy cannot lead to complacency.

Unfortunately, there are some in the financial industry who are misreading this moment. Instead of learning the lessons of Lehman and the crisis from which we're still recovering, they're choosing to ignore those lessons. I'm convinced they do so not just at their own peril, but at our nation's. So I want everybody here to hear my words: We will not go back to the days of reckless behavior and unchecked excess that was at the heart of this crisis, where too many were motivated only by the appetite for quick kills and bloated bonuses. Those on Wall Street cannot resume taking risks without regard for consequences, and expect that next time, American taxpayers will be there to break their fall.

And that's why we need strong rules of the road to guard against the kind of systemic risks that we've seen. And we have a responsibility to write and enforce these rules to protect consumers of financial products, to protect taxpayers, and to protect our economy as a whole. Yes, there must—these rules must be developed in a way that doesn't stifle innovation and enterprise. And I want to say very clearly here today, we want to work with the financial industry to achieve that end. But the old ways that led to this crisis cannot stand. And to the extent that some have so readily returned to them underscores the need for change and change now. History cannot be allowed to repeat itself.

So what we're calling for is for the financial industry to join us in a constructive effort to update the rules and regulatory structure to meet the challenges of this new century. That is what my administration seeks to do. We've sought ideas and input from industry leaders and policy experts, academics, consumer advocates, and the broader public. And we've worked closely with leaders in the Senate and the House, including not only Barney, but also Senators Chris Dodd and Richard Shelby, and Barney is already working with his counterpart, Sheldon [sic] Bachus. And we intend to pass regulatory reform through Congress.

And taken together, we're proposing the most ambitious overhaul of the financial regulatory system since the Great Depression. But I want to emphasize that these reforms are rooted in a simple principle: We ought to set clear rules of the road that promote transparency and accountability. That's how we'll make certain that markets foster responsibility, not recklessness. That's how we'll make certain that markets reward those who compete honestly and vigorously within the system, instead of those who are trying to game the system.…