On September 15, 2008, the venerable Wall Street brokerage firm Lehman Brothers seeks Chapter 11 bankruptcy protection, becoming the largest victim of the subprime mortgage crisis that would devastate financial markets and contribute to the biggest economic downturn since the Great Depression.

Lehman Brothers History

At the time of its collapse, Lehman Brothers was the country’s fourth-largest investment bank, with some 25,000 employees worldwide—but it began as a humble dry goods store founded by German immigrant Henry Lehman in 1844 in Montgomery, Alabama.

After Henry’s brothers Emanuel and Mayer joined him in 1850, the business became known as Lehman Brothers.

In 1994, American Express—which had acquired the firm a decade earlier—spun Lehman Brothers off in an initial public offering (IPO). Under the leadership of CEO Richard Fuld, the investment firm began to expand its offerings in the aftermath of the 1999 repeal of the Glass-Steagall Act, which had barred affiliations between commercial banks and investment banks and their activities.

In this newly deregulated financial industry, Lehman Brothers increased its involvement in proprietary trading (or trading with the firm’s own money to make a profit for itself), securitization, derivatives, asset management and real estate.

Subprime Mortgages 

The housing boom of the early to mid-2000s saw Lehman and other Wall Street firms become heavily involved in collateral debt obligations (CDOs) and mortgage-backed securities (MBSs).

Lehman also expanded into loan origination, acquiring five mortgage lenders between 2003 and 2004, including some specializing in subprime mortgages, which were given to borrowers with weaker credit who ordinarily wouldn’t have been able to obtain a mortgage.

As housing prices began to fall rapidly in mid-2006, many subprime borrowers began to default on their payments, revealing the risky nature of these debts.

Despite these warning signs, Lehman Brothers continued to originate subprime mortgages and increase its real estate holdings after housing prices went into decline, and by the end of fiscal year 2007 the firm held some $111 billion in commercial or residential real-estate-related assets and securities (more than double what it had held at the end of the previous year).

Signs of Trouble

Due to the weakening real estate market, as investors and ratings agencies expressed serious doubts about these types of assets, due to their lack of liquidity in the market, they began to lose confidence in Lehman and its investment banking peers.

Bear Stearns, one of Lehman’s closest competitors, was the first to go under, narrowly avoiding bankruptcy with a sale to J.P. Morgan Chase (backed by the federal government) on March 16, 2008. In the aftermath of Bear’s sudden collapse, rumors circulated that Lehman Brothers would be the next to fall.

Like Bear and other investment banks, Lehman’s reliance on short-term funding deals known as repurchase agreements, or “repos,” to raise the billions of dollars it needed to run business operations each day made it especially vulnerable to any crisis in investor and market confidence.

Lehman sought to reassure its investors, raising $6 billion in equity in June 2008, despite reporting its first loss since going public in 1994.

Then on September 10, the firm announced that it expected $5.6 billion in write-downs (reductions in the estimated or nominal value of an asset) for its “toxic” assets and a $3.93 billion loss for the third quarter. In addition, Lehman said it planned to spin off $50 billion of toxic assets into a separate publicly held corporation.

Largest Bankruptcy in U.S. history 

In response to this announcement, the major ratings agency Moody’s threatened to downgrade Lehman’s debt ratings, and on September 12, Federal Reserve Chairman Timothy Geithner, Treasury Secretary Henry Paulson and others met at the Fed in New York to discuss the firm’s fate.

Despite concerns about the consequences a Lehman Brothers collapse would bring, the federal government and representatives of the administration of President George W. Bush ultimately refused to bail out another investment bank.

Hopes of a sale to another bank fell short as well: One prospective buyer, Bank of America, decided to buy Merrill Lynch instead, while British regulators blocked a last-ditch deal to sell Lehman to Barclays of London.

Out of options, Lehman Brothers declared bankruptcy early on the morning of September 15. The firm declared $639 billion in assets and $613 billion in debts, making it the largest bankruptcy filing in U.S. history.

That day, the Dow Jones Industrial Average plunged more than 500 points, its steepest decline since reopening after the 9/11 terrorist attacks. Lehman’s collapse sent financial markets into turmoil for weeks, leading many to question the federal government’s decision to let the bank fail.

After Lehman’s bankruptcy filing, Barclays agreed to purchase the firm’s North American investment banking and capital markets businesses, saving some 10,000 jobs.

As James Peck, the judge who approved the deal, put it in court: “I have to approve this transaction because it is the only available transaction. Lehman Brothers became a victim, in effect the only true icon to fall in a tsunami that has befallen the credit markets. This is the most momentous bankruptcy hearing I’ve ever sat through. It can never be deemed precedent for future cases. It’s hard for me to imagine a similar emergency.”

READ MORE: The 2008 Crash: What Happened to All That Money?

Sources

Lehman Brothers Bankruptcy, Yale School of Management.
A Brief History of Lehman Brothers, Reuters.
William D. Cohan, House of Cards: A Tale of Hubris and Wretched Excess on Wall Street (New York: Doubleday, 2009).
“Judge approves Lehman, Barclays pact,” Reuters, September 19, 2008.
“4 Reasons Why Lehman Failed,” The Atlantic, September 7, 2010.