Introduction
The Lehman Brothers was a financial institution that operated in the United States from 1850 to 2007. The firm offered households mortgage loans against illiquid collaterals, such as houses, besides being the primary dealer for US treasury bonds. In 2007, borrowers massively defaulted on loans, resulting in large, illiquid assets pools for lenders. The value for houses dropped drastically, which adversely impacted the Lehman Brothers that had heavily invested in a collateralized debt obligation (Labonte, 2018). Gross mismanagement, unethical leadership, false accounting statements that failed to portray the actual bankrupt image of the firm, the massive debt load of America's households, and lack of support from the Federal government resulted in the bankruptcy of the Lehman Brothers in 2007 (Akhtar & Kanwai, 2014). The effects of the firm's status rippled through advanced and emerging money markets globally. Impacted industries, such as banks, responded promptly while business owners learned critical lessons from the 2008 economic downturn. The possibilities of the recession occurring in the future much rely on the policies that the United States implemented that strengthened the economy post-recession. My business also experienced challenges that shaped have shaped my current operational systems.
Question One: Describe how the crisis impacted other markets
On September 15, 2008, Lehman Brothers shocked the United States by filing for bankruptcy for having debts that were more than $600 billion. The financial institution had been operational for more than 150 years, and hence, was deemed as too-big-to-fail (Labonte, 2018). Lehman Brothers had mortgaged many US households over a century, but the company experienced severe loan defaults by borrowers in 2007. The ripple effect of the Lehman collapse included the plunging of subprime markets that affected both financial and non-financial institutions. Secularization vehicles that absorbed banks' illiquid assets by lending them short term liquid cash against the narrow asset baskets tightened their liquidity threshold almost instantly (Labonte, 2018). The national and international stock markets responded by plunging immediately. The Lehman Brothers' first-quarter announcement of a $2.8 billion loss in 2007 resulted in an instant stock return decrease of 3%. A subsequent announcement of $3 billion loss in the second quarter triggered a -4% savings and loan returns, -4.10% revenue from brokerage firms, -6% decline in primary dealers' value, and -2.90% bank revenue. Hence, the Lehman Brothers' collapse resulted in the sharp global reduction of stock markets, bank deposits, and brokerage firms.
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Choose an industry that was hit the hardest or one that benefitted from the collapse and describe how managers in that industry respond to the events
The banking industry experienced the worst aftermath of the Lehman collapse. Managerial players, such as central banks, responded by executing fiscal, monetary and systematic policies that maintained the banking sector through and post the recession. For instance, the United States launched the Term Auction Facility in 2007 to offer extended terming funding for banks. The US also engaged in currency swaps with other central banks, such as the European Central Bank (ECB) to increase dollar reserves in other banks to enhance the financial institutions' liquidity. Economists anticipated that banks would engage in broad-based fire sales to increase their liquidity as a survival measure. Instead, the business firms invested in narrow basket (eligible) assets and used them as collateral to obtain liquid funding from central banks. Federal reserves expanded the collateral basket as a means of subtly coercing banks to purchase eligible assets that would also be used as surety in exchange for emergency liquid cash. In Germany, banks capitalized on ECB's extended collateral basket that had risen from 9 trillion in 2007 to 2009's 13 trillion. Banks also opted to invest in emerging market economies that had experienced minimal effects of the Great Depression. Additionally, financial institutions limited their trading in capital intensive investments. Instead, banks focused on increasing customer deposits, besides changing their revenue mix and asset portfolio (Bank for International Settlements, 2018). Banks also resolved not to engage in an uncontrollable, thinly capitalized, and highly leveraged investment sprees that would result in the shortage of funding liquidity The banking industry responded to the Lehman collapse by sourcing for liquidity from their central banks through collateralized transactions, investing in emerging market economies, and reducing their investment in capital intensive markets.
Provide examples of lessons managers need to keep in mind post the 2008 business environment
Industry managers affected by the 2007 recession should keep in mind several lessons post the 2008 business environment. First, firms should have efficient analytical models for fiscal, monetary, and system policies to prevent an economic crisis. Moreover, firms should enhance their information gathering, besides consistent monitoring of market performances. Institutions should supervise their macroeconomic and microeconomic strategies to identify weak areas that may require immediate corrective action to avert recessions (Claessens & Kodres, 2014). Moreover, executives should lobby for improved incentives by governments to enhance financial stability. Organizations should also have adequate risk management strategies because risks will always be present. Nevertheless, the early detection and correction of hazards mitigate economic downturns significantly. Firms should also desist from encouraging fallacies, such as the increasing housing value fallacy that resulted in the collapse of the Lehman Brothers. Financial institutions should adopt ethical accounting standards and fair value accounting to prevent large debts that may result in their shutdown. Finally, banks should desist from high-level shadow banking that exacerbates the chances of an economic crisis. Hence, managers from various industries may avert financial downturns by implementing wise economic policies.
Explain whether an event of this magnitude could occur again, given regulations implemented after the crisis
In the future, a tremendous financial crisis resulting from poor economic choices by companies and governments has limited chances of reoccurring, given the regulations implemented after the catastrophe. First, regulators have adopted the Base III macroprudential capital requirement that incorporates a surcharge for globally systematically important financial institutions (G-SIFIs) and countercyclical capital buffer . Moreover, the Liquidity Coverage Ration has been instituted that envisions liquidity agreed on liquidity standards. Third, the secularization model has been enhanced, and policies for sound compensation behaviors have been implemented to dissuade chances for unwarranted risk-taking. Some financial transactions have been subjected to adherence to the International Financial Reporting Standards and Generally Acceptable Accounting Principles (Claessens & Kodres, 2014). Furthermore, data gaps have been closed, such as the credit likelihoods of critical systematic banks. Additionally, there is an increased accountable collection of bilateral counterparty collateral data. Finally, over the counter market, derivative changes have been executed globally by financial and non-financial regulation bodies. Hence, the chances for a repeat of the 2007-2009 economic downturns are minimal, given the regulatory policies that have been implemented.
Explain if the American Economy is weaker or stronger today as a result of the Lehman Brothers’ bankruptcy and resulting reforms and provide explanations
After the Lehman Brothers' bankruptcy, the American economy is more robust because of the positive reforms that the government executed. First, the federal government extended liquidity to other institutions, such as central bank counterparties and insurance firms, by currency swaps that aimed to increase dollar reserves in foreign markets. The tools used included the Commercial Paper Funding Facility, Asset-Backed Commercial Paper Money Market Fund Liquidity Facility, and Term Asset-Backed Security Loan Facilities. The Treasury also devised the Temporary Guarantee Program for Money Market Funds exchange stabilization funds to guarantee money market fund shares. Additionally, the government created the Temporary Liquidity Guarantee Program to guarantee outstanding senior loans from banks and transactions that did not accumulate interests. Moreover, the Treasury approved the injection of $205 billion in 707 financial companies that were situated in 48 states and a capital enhancement in 9 major commercial organizations on Columbus Day. The United States government further implemented the Economic Stimulus Act that released $100 billion to low-income households in 2007 to increase their spending. In 2007, the government reduced tax rates from 5.25% to 3% to encourage capital investment from start-up firms in a bid to create employment opportunities that would salvage the alarming unemployment rate that had ensued post the Lehman Brothers collapse (Liang, McConnell & Swagel, 2018). Furthermore, the federal government announced that it would write-down major financial institutions' assets worth $100 billion in a bid to stimulate the economy. Moreover, Treasury worked with housing agents from the Urban Housing Development to find ways of modifying mortgages through the Hope Now Coalition. Finally, lenders were convinced to freeze the reset interest rates for subprime borrowers who amounted to 1.8 million. The measures that the United States' federal government executed resulted in a strong economy that has maintained its status quo to date.
Provide an example of how this monumental bankruptcy and the resulting credit crisis affected you or someone you know. For example, you could share a decision you made about your career or investments, or someone you knew or their business or their management decisions were affected
At the time of the 2007 Lehman Brothers' collapse, I owned a small lending firm that loaned middle-income loans while leveraging on their houses as collateral. The value of homes had appreciated steadily since the early 2000s, and my revenue stream was admirable. My business had been operational for 5 years with minimal challenges. In 2006, I approached Lehman Brothers for a loan to expand my organization. I used the assets that I had acquired as surety for my debt whose maturity date was 2010. When the Lehman Brothers announced a loss in the first quarter of 2007, my stocks in the real estate forex market declined instantly. I sought financial advice from a financial expert who assured me that the Lehman Brothers had been operational for too long to fail. They would probably announce a profit in the next quarter. However, I became hopeless when the firm cited a successive loss in the subsequent quarter. My debtors had begun defaulting because unemployment had increased steadily. I attempted to sell the houses I had acquired to pay the Lehman Brothers' loan, but I did not get any buyers. I lost my business when Lehman collapsed because I had invested the loan in increasing my lending capacities, yet I had poor repayment history from my creditors. From the crisis, I learned that I should not overinvest in illiquid assets. If I were to start another firm, I would focus on consumer deposits and cash lending with low-interest rates.
Lehman Brothers were renowned financial dealers that offered loans to households while using their houses as collateral. The gross mismanagement of the firm resulted in its collapse that impacted financial and non-financial markets negatively. Banks reacted by increasing their liquidity by offering their illiquid assets to central banks as surety. Business managers learned vital lessons from the crisis. The American government also instituted policies that have helped restore the economy post the 2008 economic downturn. In the future, I will employ a similar reaction as banks to shield my business from recessions. Hence, the Lehman collapse resulted in the destruction of the economy in the United States that was restored through corrective economic policies.
References
Bank for International Settlements. (2018). Structural changes in banking after the crisis . Retrieved from https://www.bis.org/publ/cgfs60.pdf
Claessens, S., & Kodres, L. (2014). The Regulatory Responses to the Global Financial Crisis: Some Uncomfortable Questions , International Monetary Fund. Retrieved from : http://financial-stability.org/wp-content/uploads/2016/02/2014-3_imf_some-uncomfortable-questions.pdf
Kanwal, W., & Akhtar, S. (2014). lehman Brothers (Financial Case) . Retrieved from https://www.researchgate.net/publication/324808648_lehman_Brothers_Financial_Case
Labonte, M. (2018). Systemically Important or “Too Big to Fail” Financial Institutions . Retrieved from Congressional Research Service website: https://fas.org/sgp/crs/misc/R42150.pdf
Liang,, N., McConnell, M. M., & Swagel, P. (2018). RESPONDING to the GLOBAL FINANCIAL CRISIS What We Did and Why We Did It , Yale School of Management. Retrieved from: https://www.brookings.edu/wp-content/uploads/2018/08/15-Outcomes-Prelim-Disc-Draft-2018.12.11.pdf
Podlich, N., Schnabel, I., & Tischer, J. (2017). Banks’ trading after the Lehman crisis – The role of unconventional monetary policy . Retrieved from https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3002414
