The Financial Crisis of 2008 - The Fall of Lehman Brothers - Case Study Example

The Financial Crisis of 2008 - The Fall of Lehman Brothers College: The Financial Crisis of 2008 - The Fall of Lehman Brothers The global financial crisis that shuttered the world economy in 2008 is a topic that has garnered a lot of attention as scholars seek paths to avoid such problems in future. In the era of housing boom, the world experienced great financial losses as close to 300 banks filed for bankruptcy after loan borrowers could not repay. The role that Lehman brothers, one of the largest financial institutions, played in the financial crisis has become a controversial issue. Since its founding, the company formed the back bone of the US financial market and was an important international player. However, as soon as the company filed for bankruptcy, the financial institutions were embroiled in an economic turmoil with the stock market sending sign of failure. While some scholars feel that the government was wrong for allowing the Lehman brothers to fail some feel that it was the would have been wrong to support a company that was bound to fail. However, there is evidence that the interests of the market place and the United States Federal government were unaligned in 2008 when Lehman Brothers and the credit markets took a turn to the worst. On this ground, the economic failure was inevitable even if Lehman Brothers was saved from failing. The controversy that surrounds the role of Lehman Brothers in the global financial crisis has always been a contentious issue. The collapse of Lehman Brother is considered not only the largest failure in the financial market but also the cause of the 2008 economic down turn. Since the creation of its humble foundation in 1850, the company became a major player in the US treasuries as one of the primary dealers. Over the years, the company filed high profit returns and built trust within the financial market as a stable organization. However, this did not go well when the company engaged in the home mortgages at the time of housing boom. Later, when the houses mortgage lost value and borrowers began to default their loans, the company announced the biggest losses. In 2008, the company filed for bankruptcy with a bank debt of $613 billion. This formed a critical turning point in the economy as the stocks bank and primary dealers decline by 2.9% and 6 % respectively, registered the highest loses the same day (Johnson & Mamun, 2012). This was a clear indication of the support that the company provided to the stock market and how its fall would have affected the economy. However, the failure of Lehman Brothers did not come by as a surprise, but was anticipated. The idea that the company was in the verge of collapsing was indisputable and there was a need to save the company. Evidently, the company had two options to run from the economic tragedy that was about to destabilize it financial stability. The first option was an acquisition that would see the company become part of another company. Other banks that faced the same ordeal were acquired and escaped failure. Companies such as Wachovia, Washington Mutual and Merrill Lynch escaped bankruptcy because they found buyers. In fact, The Bank of America was interested but decided to buy Merrill Lynch instead, while Barclay’s interests were shunned by British regulators. Another option for exit from bankruptcy was a bail out by the government (Puzzanghera, 2010). However, the company’s efforts to borrow from the Bank were denied a week before the collapse. While there are a number of reasons why the company may not have escaped the fall, it remains a controversial issue. The government and the public anticipated that a giant company such as Lehman Brothers would fail but ignored the consequences. The debate that now evokes different opinions is why the government and monetary lenders refused to save the company from failing. The proponents of the idea that Lehman brothers was not worth saving provide various perspectives to the issue. One of the arguments that prevail today is that there was a need to shock the financial system that was already operating on a risky edge. This argument can be directly connected to a number of wrong decisions that the international financial regulators had taken during the pre-crisis period. First, the government had encouraged the banks to provide risk credit facilities at much lower interest rates. They saw this as potential way of promoting investment and giving the public an opportunity to generate wealth (Stein, 2013). However, they failed to anticipate the challenges that would arise when every person was a potential investor. Consequently, the housing bubble erupted and the world was already heading to the worst crisis as value of defaulted loans increased considerably. On this ground, failing to save Lehman brothers was a crucial shock to send signals to economy regulators. Therefore, Lehman failure was a critical turning point that alerted the financial market to take better control of the economy. Secondly, the consequences of saving Lehman brothers would have had far reaching effects to the economy of the world. From a reflection of the company’s failure, there is evidence that the main cause of failure was over-indulgence in risky banking investments. At this period, most banks had engaged in the mortgage credit facilities and they offered unsecured loans to the investors. They overlooked the concept of investment saturation which was likely to lead to rupture of the housing bubble (Presley & Jones, 2014). Lehman was among the leading lenders of risky loans and hence the reason why the company experienced a big shock. At its closure, the company registered debts worth $613 billion, one of the largest at the time. Therefore, the failure of the company was a result of risky investment. On the ground, scholars argue that saving such as company would have sent the picture that it was in order for financial companies to engage in risky investments. The repercussions would have been much severe and it would have been reasonable to anticipate a worse economic crisis if the company had been saved through bailing. In addition, there are those who feel that the company was bound to fail and bailing the company would only have been a short-term solution to its problem. The company failure was partly to blame for the management wrong decisions. The company engagement in the risky markets was a major reason for its failure. Apart from this, research that followed after the collapse of the bank revealed that the company engaged in unethical behavior to conceal its desperate situation before the ultimate failure (Jones & Presley, 2013). The company engaged in accounting malpractice to save its name from the investor and economic regulators. When documenting the Repo 105, the company management temporarily transferred assets with repurchase agreements to manipulate its accounting values. Therefore, the regulators and investors saw a stable company while the management was already aware of the dangers looming within the international lender. Failure to bring to limelight its financial difficulties was a wrong management decisions that led it towards harsh times. If the company had admitted to instability, it would have engaged into acquisition before getting into the verge of collapse. By the time the company was looking for a buyer, it was too late and Barclays and the Bank of America felt that acquiring the company would have been the most risky investment. Therefore, the unethical practice of the company depicts that the company deserved to fall. Moreover, the government did not have the legal authority to bail out a private company during such a time. However, there is evidence that saving Lehman Brothers from failure was justified. From one perspective, it was worth to save the bank for its immense contribution in the economy of the country. Since the company had formed an important part of the international market stability, saving it would have saved the economy. The government undermined the role of the company in the economy and ignored the possible consequences of the failure of the economy. The role that Lehman Brothers played in the economy was clear from the reaction of the market the same day that the company filed for bankruptcy. One of the biggest shocks was felt by Dow Jones Industrial Average as the market experienced 500 points decline the same day. In addition, the stocks and banks and primary dealers experienced a negative trend (Wallison, 2013). Therefore, it would have been a worthwhile decision for the government to bail the company to save the financial crisis. While this may not have been a lasting solution, it would have paved way for a slower economic recovery rather than the shock that had severe consequences across the globe. From a different angle, Lehman brother was justified to access a bail to save it from bankruptcy. Criticism of the government point out that the government applied double standards while saving the economy, by bailing out some companies while refusing to save others. However, the government saved a number of companies from failing by lending to them before and after the crisis. The National Mortgage Association, The Federal Home Mortgage Association, and Bear Stearns are examples of companies that received financial assistance form the treasury department (Kiel, 2008). Secondly, when the Bank of America requested that the government take some responsibility for losses that Lehman had experienced within the real estate sector the government refused to the request. Therefore, the government was completely unwilling to give any financial assistance to a company whose failure would immerse the world economy into a crisis. It appears unfair that the government saved other companies but completely refused to offer any financial support that would save the company from collapsing. From a personal point of view, it was a good idea that the government did not bail out Lehman brothers out of failure. Apart from the legal limitations that underpinned the misalignment of the private sector with the government, saving the bank was already too late. At the time, the public was already portraying tension with the financial market as the international market kept declining. The possibility of the government of the government landing into an economic shortage could not have been ruled out (Kensil & Margraf, 2012). Bailing out the company meant that the tax payers would have to stick with heavy losses, which was politically unpalatable. Therefore, saving Lehman brothers would have adverse consequences for the treasury and hence it was right to let the bank fall. Secondly, saving the company would not have achieved an economic balance but would have motivated other companies to indulge in risky market in the faith that the treasury would bail them out of any crisis. At such an important time, it was more essential for the government to focus on long-term measures to solve the problem rather than a short-term problem that would have led the country into a worse economic turmoil. In conclusion, saving Lehman Brother from bankruptcy was short-term measure that would have had severe impacts on the economy. Although the collapse of Lehman had serious problems from for the economy, saving it would have been a worse decision. The company risk for failure in future would have been still high even if the government had intervened. This is why other companies such as the Bank of America felt that it was a risky strategy to acquire a company with huge debts while at the verge of collapsing. Secondly, the company acted unethically by failing to admit to economic problems when there were chances of saving the company. Therefore, the company deserved to fail for its ineffectiveness and the fact that it was a difficult choice to save the company at a late stage. While there has been a wide range of criticism that the government exercised double standards, there is evidence that such a move was unfavorable at a time when the government was already facing threat from the public who felt using treasury resource was abusing tax-payer’s money. From such a viewpoint, the failure of Lehman was essential to send a warning signal to investors who were engaging in risky business without focusing on the long-term changes of the market. References Jones, B., & Presley, T. (2013). Law And Accounting: Did Lehman Brothers Use Of Repo 105 Transactions Violate Accounting And Legal Rules?. Journal Of Legal, Ethical & Regulatory Issues, 16(2), 55-91. 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. doi:10.1080/09603107.2011.613762 Kensil, S., & Margraf, K. (2012). The Advantage of Failing First: Bear Stearns v. Lehman  Brothers. Journal of Applied Finance, 22(2), p. 60. Kiel, P. (2008, Oct 23). Why did treasury allow lehman to fail? ProPublica Retrieved from: Presley, T. J., & Jones, B. (2014). Lehman Brothers: The Case Against Self-Regulation. Journal Of Leadership, Accountability & Ethics, 11(2), 11-28. Puzzanghera, J. (2010, Sep 03). Bernanke: Fed had to let lehman fail. Orlando  Sentinel Retrieved from: Sorkin, A. R. (2009). Too big to fail: the inside story of how Wall Street and Washington fought to save the financial system from crisis--and themselves. New York: Viking. Stein, M. (2013). When does narcissistic leadership become problematic?: Dick Fuld at Lehman Brothers. Journal of management inquiry, 22(3), pp. 282-293. doi:10.1177/1056492613478664 Wallison, P. J. (2013). Bad history, worse policy: How a false narrative about the financial crisis led to the Dodd-Frank Act. Washington, D.C: American Enterprise Institute for Public Policy Research. Read More