Investment Risk Management of Lehman Brothers - Research Paper Example

Section/# Lehman Brothers Case Analysis Assessment of the factors that contributed to the financial failure of the firm; as well as an indication of how management failed to manage the risk related to each factor. When individuals consider the 2007/2008 global financial meltdown, one of the first firms that actually comes to mind is that of Lehman Brothers. As an investment firm, Lehman Brothers was ultimately beholden to its clients (investors) as a function of maintaining a level of profitability and relevance within the market. However, as is all too well known, Lehman Brothers declared bankruptcy and imploded as a direct result of the fact that it engaged in risky financial decision-making that ultimately contributed to the failure of the firm. As a function of such an understanding, the following analysis will include several course sections. These include the following: an assessment of the factors that contributed to the financial failure of the firm, a discussion and representation of mortgage backed securities and the risks associated with leveraging them to a particularly high degree, in evaluation of management’s role with respect to the collapse of Lehman Brothers, a discussion of the recent debt crisis within the Euro zone and the relevance that Lehman Brothers example provides for this particular scenario, and final evaluation of the role of federal government and seeking to regulate ultimately decrease the incidence of such collapses in the future. Naturally, each of the aforementioned sections will corresponds to a section that provides recommendations and potential solutions that could have otherwise ameliorated the factors involved (Kershaw & Moorhead, 2013). It is the ultimate hope of this particular author that such a level of discussion and analysis will be beneficial to the reader in seeking to gain a further level of understanding concerning the case of Lehman Brothers and the corresponding importance that this has with respect to other firms in the current market. 2. Factors that contributed to the financial failure of Lehman Brothers Firstly, as a function of assessing the factors that contributed to the financial failure of the firm, these are ultimately contingent upon the high exposure of certain types of investments that Lehman Brothers engaged with. Essentially, mortgage backed securities (MBS) were a mainstay of the financial backbone that Lehman Brothers relied upon as a function of funding its continuing operations and providing investment security to its clients (Steele, 2014). However, as a direct result of the fact that these mortgage-backed securities were inherently unstable and essentially directly linked to the solidity of the mortgage market, this represented a lack of diversification and placed investors in an extreme risk of losing sizable parts of their overall investment portfolio. A secondary factor that must be discussed with respect to why Lehman Brothers ultimately collapsed and failures of management that contributed to this is with regards to the fact that Lehman Brothers willfully and knowingly ignored key factors and insights with respect to the warning signs that mortgage-backed security reliance contributed to. As individuals within the firm came to superiors and voice their concerns with respect to the fact that any sudden shop in the mortgage market could create a ripple effect that would inevitably cripple the investment potential that the firm reflected, these individuals were not only ignored, they were oftentimes punished. Finally, the level of direct culpability lies on management within Lehman Brothers as these individuals were responsible for hiring accounting and auditing firms that were knowingly taking a friendly picture of what might be the case with respect to the ultimate portfolio of assets that the firm represented. As a function of recommendation, the clear and obvious choice would be for Lehman Brothers to have sought to diversify their investments; so that a sudden shock within the mortgage market would not take a seat out from under the entire firm. Similarly, it was also the responsibility of management to listen to those individuals within the lower positions of the company, specifically analysts, that came forward with key concerns and worries regarding the financial stability that the firm might be able to reflect. Finally, a further recommendation would have been to higher industry leading auditors and accounting firms that were not in league with Lehman Brothers and would have provided an honest opinion with respect to how the firm was performing and what factors could be changed as a function of seeking to benefit the end consumer. 3. Mortgage Backed Securities and high risk. Assess the sufficiency of risk management techniques used by financial institutions today, indicating whether or not you believe the risk is appropriately managed to avoid a subsequent financial crisis. Provide support for your position.  As indicated above, the role of mortgage-backed securities (MBS) provided a direct and verifiable risk that ultimately contributed to the collapse of Lehman Brothers. Naturally, the sufficiency of risk management techniques used by Lehman Brothers was not sufficient to ameliorate the shock that was exhibited within the market as the mortgage market began to unravel. Fast forwarding to the current time, the individual analyst is necessarily interested as to whether or not current risk management techniques are sufficient to ward off or avoid another financial crisis. Essentially, the answer to this question is unknown. Whereas the recovery that has been exhibited since 2007/2008 has been rather anemic, the ultimate potential of firms to have a risk management strategy that is effective and able to integrate with challenges of the long-term is ultimately doubtful. Instead, almost each and every firm that is currently operating within the market is focused directly upon the short-term and how continued profitability can be affected (Lubben & Woo, 2014). As such, it is the further belief of this particular analyst that an undue level of emphasis has been placed upon risk management techniques that should have been learned from the Lehman Brothers collapse that helped contribute to the 2007/2008 global financial crisis. Likewise, in terms of a recommendation for how this could be affected relatively easily, it is the representation of existing literature that diversification of assets and avoiding a reliance upon a single approach is ultimately the most effective way in which longevity within the market and risk management techniques can be essentially and effectively performed. 4. Evaluation of management’s role within a financial investment firm for establishing proper risk management procedures for high-risk investments and the appropriate level of accountability for portfolio performance. As was clearly denoted within the previous analysis, the culpability of blame for the financial destruction that occurred within Lehman Brothers, and elsewhere, is ultimately the fall of her management within the firm as they willfully and knowingly chose to ignore levels of warning concerning the portfolio performance that was being exhibited and the likely trends that could take place in the future. However, merely seeking to place blame is not in and of itself sufficient towards seeking to end this process around the globe. Instead, it is the understanding of this particular analyst, and the understanding of many individuals who have studied this particular issue, that the upper management within Lehman Brothers, and indeed any individual that was fully aware of the dangers that were taking place and did not attempt to put a stop to it should be directly held responsible for the consequences that took place. Ultimately, there existed many legal ramifications, and to a large degree some of these are still relevant, prior to deregulation that took place during Ronald Reagan’s presidency. Although it is not legally possible to change the law and to hold an individual responsible for a crime committed during a time in which such a law did not exist, effectively regulating the markets and providing warning to further individuals within the business and financial sectors as to the ramifications of these crimes would be an effective start in seeking to decrease the overall incidence of such behavior in the future. 5. Analysis of the impact to the performance of foreign markets and recommendation of a strategy for financial firms to minimize investment risk in Euro zone Markets Essentially, the weakness of the euro zone and the potential for a fall within one or several of the weakest economies of the Euro zone presents a very similar issue to the one that took place and has been described above with respect to the case of Lehman Brothers. As such, a rubric of financial success and insight would be for investment firms and financial firms that invest within these markets to necessarily categorize their investments based upon I and low risk. Although this is obviously done, it will additionally be necessary for firms that hold securities or debt backed securities within these nations to limit themselves to a low percentage of overall investment. Such a process would ensure that even if the ripple effect of a Eurozone default were felt throughout the globe, the ultimate impact upon a particular firm that was partially invested within one or several of these economies would not be so disastrous as to cause the entire firm itself to collapse under the weight of losses incurred as a result of such financial issues (Sieczka et al., 2011). 6. Evaluation of the role of the Federal government, if any, related to the regulation of investments by financial institutions. As discussed with great detail in the preceding analysis, the federal government and its deregulation, over a period of nearly 30 years, was a primary player in the bankruptcy of Lehman Brothers and financial meltdown that occurred between 2007 and 2008. As a direct result of an understanding that deregulation was partially to blame for this crisis, many individuals, both within the public and the private sector, began to demand a higher level of engagement so that such a situation might not arise again within the future. Sadly, the overall amount of energy, legislation, and momentum that has been directed towards this particular in has been relatively limited (Fleming & Sarkar, 2014). As such, even though further levels of regulation are not only required but demanded in order for further financial meltdown such as the one that has been discussed to be countered, the dangers that face the current system are unfortunately not less than those which ultimately contributed to the collapse that has been specified. References Fleming, M., & Sarkar, A. (2014). The Failure Resolution of Lehman Brothers. Economic Policy Review (19320426), 20(2), 1-54. Kershaw, D., & Moorhead, R. (2013). Consequential Responsibility for Client Wrongs: Lehman Brothers and the Regulation of the Legal Profession. Modern Law Review, 76(1), 26-61. doi:10.1111/1468-2230.12001 LUBBEN, S. J., & WOO, S. (2014). Reconceptualizing Lehman. Texas International Law Journal, 49(2), 297-327. Sieczka, P. P., Sornette, D. D., & Holyst, J. J. (2011). The Lehman Brothers effect and bankruptcy cascades. European Physical Journal B -- Condensed Matter, 82(3/4), 257-269. doi:10.1140/epjb/e2011-10757-2 Steele, S. (2014). The Collapse of Lehman Brothers and Derivative Disputes: The Relevance of Bankruptcy Cultures to Roles for Courts and Attitudes of Judges. Law In Context, 30(1), 51-84. Read More