Lehman Brothers

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Raffles Institute of Higher Education

Business Management Department

Lehman Brothers (2008)

Principles of Banking and Finance

Ms. Daniela Tello

Done by:

Fransisca Dewi Christina (007MG015)

Fifiliani Wijaya (006MG015)

Wendy (002TH015)

19th January 2016

                                            Word Counts: 1.799

Table of Contents

Introduction        

Lehman Brothers collapsed        

The reason of collapse        

Using REPO 105 to buy time        

What is Repo?        

Repo 105 and accounting rules        

Loan vs Sales in accounting        

The Impact and consequences of the collapsion        

Conclusion        

REFERENCES        

Introduction

Lehman brothers were a company that founded in 1850 by Henry Lehman and his two brothers. They started their business by opening a small shop selling utensils and groceries. They followed the trends in the world and their business keep evolving from selling merchandise into investment bank in 1975.  

Lehman Brothers become a global financial service firm that had played important role in the financial history in the United States for more than 150 years. It was the fourth largest investment bank in US after Goldman Sachs, Morgan Stanley, and Merrill Linch.

However, on 2008, the Lehman Brothers, Inc. declared bankruptcy and in $613 billion debts. It resulted in wide losses to the economy in United States and even around the world and it is one of the largest accounting scandals ever.

This report will introduce readers with more knowledge about the Lehman Brothers’ scandal and what has causes the financial crisis.

Lehman Brothers collapsed

Lehman brothers have survived all the challenges before, such as; the rail road bankruptcies (1800s), the great depression (1930), two world wars (1994), and even the long term capital management collapse.

However the US housing market disaster had made Lehman brothers declared its bankruptcy on 15th of September 2008, which was the day of the worst economic crisis began, even the world was greatly shaken by it.

We believe that people around the world won’t ever forget about this crisis, since the after effects are greatly affecting the world.

 Lehman bankruptcy also has surpassed the bankrupts of Enron and even WorldCom.

The reason of collapse

In 2003 – 2006 where the US housing had peaked, Lehman brothers adopted a strategy to gain greater profits in the housing market.

Instead of doing safe investment, the Lehman Brothers adopted the tricky lending program; the sub-prime mortgage has enabled people who are not qualified to lend money (Poor credit history) to get home loans. With this lenders will have higher risk of getting their money back and that’s why they charge them with higher interest rates than they charge the prime lenders such as using ARM (Adjustable Rate Mortgage) system where the interest will begin to float after a period of time. This has caused large foreclosures (Lenders seize back the property) in 2006.

Lehman Brothers aggressively buy property assets throughout 2006 and made them to have difficulties to raise cash and sells assets to reduce its leverage in balance sheets (Examiner’s Report, Volume 1). What makes it more worst is even thought when the US housing prices started to decline in 2006 and other parties leave the market, however the Lehman still greedy and continue its tricky lending program and increase its real estate holdings.

In the mid of 2007, Lehman brothers starts to search about the real value of their real estate assets and its liquidity. And in order to reduce their leverage in balance sheets Lehman brothers choose to sell its assets. However, is hard to sell the assets and it seems like nobody is interested on buying it because of the slowing market. And Lehman also unwilling to sell it on discounted prices since they don’t want to take another losses.

The purpose of sub-prime mortgages is for Lehman to gain additional profit but with the large foreclosures skyrocketed in the end; they faced with financial difficulty and instead of gaining additional profits, they ended up with bankruptcy.

Using REPO 105 to buy time

Because of financial crisis in 2007 and 2008, Lehman needed to reduce its reliance on borrowed money. They had assets including commercial mortgage-backed securities and subprime mortgages which values had been decreased in the market. So that was a bad time to sell stuff off and pay back their debts. That’s why they use Repo 105.

This accounting trick was used in order to keep the stock prices from dropping and forestall regulators from stepping in and forcing bankruptcy at an earlier date. Even though in the end, they still didn’t have enough money to save their company.

What is Repo?

Many financial institutions have short term needs for cash. In business practice, usually they will borrow money from other big companies and transfer ownership securities as collateral. Repo (shortly repurchase) is actually a way for bank to borrow money from lenders (usually a big companies that has extra cash). Investment banks usually use the repo market all the time.

The bank will “sell” its asset such as bond, to make the loan safer for the big company.  So if one day the bank goes bankrupt before it repays the loan, the big company can sell the bond and get its money back.

The bank supposed to buy back the bond at the end of the loan and company gets amount as interest. Everybody knows that the bank isn’t really selling the bond to the big company; they just want to borrow money. It’s usually a short term deal, since the bank often buys back the asset just days after they sell it.