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The History of Lehman Brothers

Lehman Brothers trace their roots back to a general store founded by German immigrant Henry Lehman in Alabama in 1844. Just six years later, Henry Lehman and his brothers founded Lehman Brothers. The firm prospered over the following decades as the U.S. economy grew into an international powerhouse and faced plenty of challenges over the years, including: railroad bankruptcies, the Great Depression, two world wars, a capital shortage caused by a spin off by American Express Co. (AXP), and the Long Term Capital Management collapse and Russian debt default in the late 1990s.

The Disastrous Misstep

In the early part of the 21st century Lehman acquired five mortgage lenders, including subprime lender BNC Mortgage and Aurora Loan Services, which specialized in Alt-A loans (made to borrowers without full documentation). At first Lehman’s real estate businesses enabled revenues in the capital markets unit to surge at a faster rate of growth than other businesses in investment banking or asset management.

By February 2007, Lehman had a market capitalization of close to $60 billion. However, by the first quarter of 2007, cracks in the U.S. housing market were becoming apparent as defaults on subprime mortgages rose. A month later, a day after the stock had its biggest one-day drop in five years on concerns rising defaults would affect Lehman’s profitability, the firm reported record revenues and profit for its fiscal first quarter. In the post-earnings conference call, Lehman’s chief financial officer (CFO) said that the risks posed by rising home delinquencies were well contained and would have little impact on the firm’s earnings. He also said that he did not foresee problems in the subprime market spreading to the rest of the housing market or hurting the U.S. economy.

By August 2007 Lehman’s stock had fallen sharply. The company eliminated 2,500 mortgage-related jobs and shut down its BNC unit. In addition, it also closed offices of Alt-A lender Aurora in three states. Lehman continued to be a major player in the mortgage market underwriting more mortgage-backed securities than any other firm. By the fourth quarter of 2007, Lehman’s stock rebounded. However, the firm did not take the opportunity to trim its massive mortgage portfolio, which in retrospect, would turn out to be its last chance.

The Failure

Lehman’s huge portfolio of mortgage securities made it increasingly vulnerable to deteriorating market conditions. On March 17, 2008 Lehman shares fell on concern it would be the next in a series of Wall Street firms to fail. Then, on June 9, Lehman announced a second-quarter loss of $2.8 billion and reported that it had taken measures to raise capital from investors, boosted its liquidity pool, decreased gross assets, and reduced its exposure to residential and commercial mortgages.

However, these measures were perceived as being too little, too late. The company’s hedge fund clients began pulling out, while its short-term creditors cut credit lines. Lehman announced a sweeping strategic restructuring of its businesses, but amidst reports of potential downgrades to Lehman’s credit ratings they were quickly running out of time. By mid-September, Lehman declared bankruptcy.

QUESTION:

Were the actions of the leadership at Lehman Brothers within the letter and spirit of their company’s ethical code? Given the fallout we’ve seen from Enron, Nortel, and Lehman Brothers what must we do differently in the future? How can we structure and communicate expectations for ethical conduct more successfully?

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