The period between 2007 and 2009 was a difficult time for many individuals and financial institutions in the United States as these groups experienced a continued decline in their fortunes. There were several institutions that received assistance from the government through financial interventions. There were others that were acquired by their rivals while some went into bankruptcy. The financial turmoil turned into a complete crisis when the Lehman Brothers filed for bankruptcy on September 15, 2008. While the events took place, more than ten years ago, there are still several lessons that can be learned by critical looking at the crisis. The aim of this review is to analyze Lehman Brothers’ bankruptcy by looking at its causes and effects.
Impact on Accounting Standards
One of the reasons that has been associated with the failure of the Lehman’s Brothers was that they made use of Repurchase Agreements in order to hide its losses. Carolyn (2016) analyzed the company and observed that it used Repo 105 and 108 transactions to hide its debts. The events can be followed when the housing markets begun to fall in the year 2007 and Lehman along with other financial firms recorded huge losses. Instead of Lehman selling their assets, they made use of Repo 105 and 108 transactions and would enter into these transactions at the end of each quarter and make a repayment through the use of borrowed money at the start of the next period. The assets and liabilities were thus temporarily removed at each quarterly and annual report. These trades amounted between $39 billion and $50 billion for the period between 2007 and 2008 (Carolyn, 2016). The transactions were also not disclosed on the notes in the financial statements by only stating that they were accounted for as secured borrowing arrangements. The Repo 105 and 108 transactions were thus the cause of the bankruptcy and they also helped to hide the actual financial position of the company for approximately one year. While the transactions did not violate accounting standards, it showed that the management used underhand means to mislead users of financial statements. Carolyn (2016) observed that such transactions ultimately led to the FASB issuing the SFAS 166 that provided details regarding accounting for transfers of financial assets. The new standard thus required all transferor’s entities to be included in the financial statements.
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Falsification of Auditing Accounts
The falsification of auditing accounts by auditors also served to hide the financial situation of Lehman brothers. Ernst & Young served as the external auditor of Lehman brothers between 2000 and 2008. The auditing company has been found to commit professional malpractice as it failed to issue auditing opinions even with the knowledge that Lehman Brothers had failed to disclose its liabilities through the use of transferred securities in Repo 108 and Repo 105 transactions (Burke, 2019). The external auditors thus failed to provide accurate information regarding the situation of Lehman brothers. Opinions were thus issued by the Southern District of New York that established that Lehman Brothers did not correctly apply the correct use of Repo 105 and 108 transactions to justify its borrowings and sales of assets. The federal law imposes a strict liability on companies and their auditors for providing statements that are misleading. The auditors are thus expected by the law to act as independent evaluators that would assess the fairness and the adequacy of the financial statements which have been issued by the management to the creditors, stakeholders and other individuals. However, Ernst & Young did not play this role as it supported the misrepresentation of financial statements in order to show that the company was performing well.
Impact on Financial Institutions
The failure of the Lehman brothers in the year 2008 can be described as the largest bankruptcy in the history of the United States. The company announced a $2.8 billion loss on its second quarter (Johnson, 2012). This announcement had several negative impacts which were experienced by savings and loans institutions, banks, brokerage firms, and primary dealers. Several months afterwards, the recession continued and the bank had some hope with some investors being ready to invest in Lehman and the stocks of the company rose by a small margin. The company continued to have a third quarter loss of $3.9 billion and filed for bankruptcy on September 15, 2008. The financial markets failed to respond well to the news of the bankruptcy with the Dow Jones Industrial Average declining by more than 500 points at the end of the trading session. When the company filed for bankruptcy, the stocks of primarily dealers and banks decreased by 6 % and 2.9% respectively (Johnson, 2012). Johnson (2012) also observed that the institutions that were impacted the most by the filing for bankruptcy were brokerage firms, savings and loans firms, and large banks. The bankruptcy of the Lehman Brothers was decisive in the Great Recession between 2007 and 2009 as it became a critical point for many financial markets.
Impact on Global Economic Security
The global economic security was highly impacted by the filing for bankruptcy. The collapse of Lehman Brothers triggered a slowdown in the growth of world economies and this led to a chain of debts and bankruptcies that took place. This could be associated with the domino effect which started with the Lehman’s brothers filing for bankruptcy and it caused a panic in the United States stock exchange and many people became more convinced about the crisis within the mortgage loans that were high-risk. This thus triggered a financial crisis which became increasingly spread throughout the world. This began with the United States losing its position as an economic giant and the general value of its GDP decreased by 0.96% in the year 2008 when compared to the profits in 2007 (Mieszala, 2019). The GDP per capita also decreased by 1.7% in 2008 and the consumer price index, an indicator of inflation, increased by 1% in 2008 with the unemployment rate rising 1.2%. This further influenced the global economies negatively with several countries experiencing a negative GDP. The Global GDP fell by 2.9% in 2008 and the impact was severe in developed countries that experienced a decrease by 4.1%. Several countries in Europe such as the United Kingdom, France, and Germany experienced a negative GDP. This showed that failure of the Lehman brothers created a global crisis that was felt in the decline of the economies of different countries.
Lessons on Board of Directors
One of the central individuals that has been blamed and thus provides several lessons regarding the Lehman Brother’s failure are the leadership and the board of directors. Klepczarek (2017) studied the company before its filing for bankruptcy and the role of the board played throughout the scandal and before the filing of bankruptcy. The author established that the firm was poorly managed and poorly supervised. The activities of the board of directors confirmed that there were several irregularities that involved the operation of the company. The board members thus failed to have sufficient competency and to dedicate enough time towards the control of the activities of the company (Klepczarek, 2017). The board failed to identify irregularities of the company and this raised questions regarding the transparency and integrity of their actions. The case thus provided several lessons regarding the selection of the board of a company. The directors need to be fully transparent and open. They should also show high level of competence and diligence as they conduct their supervisory activities. The shareholders should also perform their supervisory duties and actively engage in the appointment and the dismissal of the directors. Doing this will ensure that it eliminates the pathological systems in corporate governance that can be dangerous for the financial markets.
In conclusion, it was identified that Lehman’s Brothers played a huge role in the 2008 financial crisis. One of the reasons for the crisis was that it was fueled by suspicious use of the Repo 105 and 108 which misrepresented the financial statements of the company. This led to changes in the how companies presented their financial statements through the use of transfers of transactions. The external auditors were also found to have engaged in the misrepresentation by failing to show the activities of the company. The effect of the Lehman’s Brothers failure was experienced both in the United States and in the world. One of the lessons from the Lehman Brother’s failure was the need to have a competent board of directors.
References
Burke, J. J. (2019). Deconstructing the use of REPO 105 and Repo 108 Transactions Under SFAS 140: the Case of Lehman Brothers Holding Inc. and the Liability of Ernst & Young.
Carolyn Hartwell PhD, C. P. A. (2016). How Lehman Brothers and MF Global's Misuse of Repurchase Agreements Reformed: Accounting Standards. The CPA Journal , 86 (8), 32.
Johnson, M. A., & Mamun, A. (2012). The failure of Lehman Brothers and its impact on other financial institutions. Applied Financial Economics , 22 (5), 375-385.
Klepczarek, E. (2017). The importance of the board of directors. Lessons from Lehman's failure. Ekonomia i Prawo. Economics and Law , 16 (1), 59-73.
Mieszala, R. (2019). Impact of the collapse of the Lehman Brothers bank and the 2008 financial crisis on global economic security. Scientific Journal of the Military University of Land Forces , 51 .
