The month of September has some chilling reminders that the world is not immune to global catastrophe. We took time this week to remember the fallen from the cowardly terror attacks on September 11, 2001. That day, much like Pearl Harbor, will always be a day of infamy in American and world history. The “Global War on Terror,” continues to this day and wartime operations continue in Afghanistan, making it the longest war in US history.
But September also is the month of the most momentous economic calamity of this century, and perhaps second only to the Great Depression. We have described the events leading up to the “Financial Crisis of 2008” in previous blogs in July and August, and they reflected a rolling crisis over an extended period dating back to the 4th quarter of 2007. However, the grand tsunami of financial catastrophe can be traced to the bankruptcy filing of Lehman Brothers on September 15, 2008.
Lehman Brothers had been an American banking icon on Wall Street since 1850. It is hard to understate its role in American finance. They were involved in some of the most important and most lucrative deals in US history! Just consider Lehman’s history:
The History of Lehman Brothers included some of the biggest moments in global finance:
- It issued the stock for some of America’s most iconic brand names: W. Woolworth Company, Macy’s, Gimbel Brothers, Inc., The Studebaker Corporation, B.F. Goodrich Co., RCA, Compaq Computers, among many others.
- Lehman arranged the first financing for major oil companies often in the news such as Kerr-McGee and Halliburton.
- Famous merger in 1983-1990 with Shearson/American Express in 1984 and then Shearson/Lehman merged with EF Hutton in 1988 (“When EF Hutton talks, people listen.”)
- Lehman backed the take-over bid by the management team of F. Ross Johnson and RJR Nabisco, ultimately losing the bid to Kohlberg Kravis Roberts in what was then one of the largest “leveraged buyouts” in Wall Street history. It was dramatized in popular culture by the famous book and then movie – “Barbarians at the Gate.”
Lehman was in the same category as Salomon Brothers, Goldman Sachs, KKR, during Wall Street’s hey-day. They were among the giants of Wall Street. Their movement into mortgage origination in 1997 would become the most profitable department within the bank. By 2006, mortgage loans and mortgage backed securities were generating almost $250 million a month in revenue.
Lehman, however, was exposed to – and some would say helped create – the contagion of sub-prime mortgages. The government’s reduction of lending standards, requirements to lend into poor credit neighborhoods, and the government’s willingness to underwrite the paper on many sub-standard loan packages, led to a collapse in credit quality and underwriting standards. We created an over-sized market of bad credit debt. When adjustable rates adjusted upwards, people stopped paying. Foreclosures commenced, the value of the mortgages dropped, the values could not be priced as they all dropped at the same time. In the first quarter of 2008, Lehman was sitting on $680 billion of mortgage notes, and only $22.5 billion in firm capital to back it up.
The Timeline of the Lehman Brothers collapse:
- “August 2007 – closure of sub-prime office BNC Mortgage”: Twelve-hundred positions and 23 branch offices were all eliminated due to “deterioration” in the mortgage market. Lehman would continue underwriting mortgage backed securities.
- “September 2007 – the last gasp of profitability”: The stock price jumped 46% on a report that Lehman would still conclude its 55th straight quarter of profitability. The moves out of sub-prime were being rewarded by the market.
- “June 9, 2008 – the days appear numbered”: Reporting a substantial loss for the first time in years, major staff shake-ups were announced. CEO Richard Fuld, who had been with the company since starting in the basement as an intern, remained in his position, but was isolated from other management staff. The stock got a bump in August when reports of the Korean Development Bank (KDB) were considering buying into the company. But when talks broke off in September, there were signs of storm clouds closing in, as KDB officials were quoted in the Wall Street Journal as saying they “….could not properly price the firm’s capital holdings, and therefore could not make an informed decision on an offer sheet.”
- “September 9, 2008 – KDB is out, stock plunges”: When the news hit the public, Lehman’s stock price collapsed, dropping 45% in one day and driving the S&P down 3.4%. It was clear that Lehman’s size would have a direct and proximate impact on the overall marketplace…. the original “Too Big to Fail” bank.
- “9/11 – Down Goes Lehman”: A very sad day indeed. Lehman Brothers had occupied several floors in the Twin Towers 7 years earlier when the terrorist attacks occurred. Hundreds of employees lost their lives. 9/11 would be another dark day in Lehman’s history, as the stock price dropped 40%, and the Federal Government announced they would not bail out the company.
- “9/13 – Paulson, Geithner, steal Lehman’s deal”: In an emergency meeting at the New York Federal Reserve offices, a deal was negotiated to save Lehman through a merger/acquisition by Barclay’s Bank in England and Bank of America. The Brits, however, after agreeing in principle, backed out, under pressure from their own government. Bank of America, fearful of taking on a deal they could not underwrite, went to the Hank Paulson, the US Treasury Secretary, and Timothy Geithner, Chairman of the New York fed, asking for a bailout, or another partner. Fearing problems with Morgan Stanley, the Feds let the BOA withdraw, leaving Lehman without a bailout savior.
- “9/15 – The Board votes to liquidate”: Infuriated that the Feds would not grant a bailout, despite doing so in the past (Bear Stearns, Long Term Capital Management), and blaming Paulson and Geithner for not keeping Bank of America at the table, the Board of Directors for Lehman voted at 1 AM, on September 15th, to put the company in bankruptcy. The collapse of real estate prices had destroyed the value of the mortgage securities market, and Lehman did not have the capital to support what it owed. Thousands of employees would be laid off the next morning.
- “September 2008 and what followed – The Financial Fallout”: The bankruptcy filing announcement precipitated the worst intra-day drop in the stock market’s history (over 1000 points) and finished down 554 points. While the volatility continued with up and down days through the remainder of the year, the downward trend and sense of dread in the larger economy was a constant feeling. The market would drop again 449 points on 9/17 … again dropping 774 points on 9/29 … the Dow would end up down 13% by the end of October.
Lehman’s employees were immediately let go on the day of the bankruptcy filing. Scenes of employees leaving with personal items in boxes was an indelible portrait of the fearful times which followed. Although the stock market would continue to decline until reaching bottom in March 2009 (Closing at 6443, a 50% drop since October 2007), the hinge-point in the Financial Crisis was the Lehman Brothers collapse. The Feds – so willing to bail out banks and everyone else on Wall Street after Lehman – most likely could have prevented the entire crisis by saving Lehman Brothers that September 2008.
Since then, Congress enacted a great deal of regulation to help prevent the next crisis from occurring. But most analysts will tell you – big banks are bigger than ever, they are too big to fail, and the next crisis we may not be able to bail ourselves out of. The public will not be in the mood to bail out anyone, and much of our political division comes from the Financial Crisis: bankers were bailed out by Main Street – the taxpayer. Now, the same people are richer than ever, but Main Street lost their homes, their savings – no one bailed them out.
Our financial system is the greatest system of wealth creation ever conceived by mankind. But that does not prevent the system from malfunctioning thanks to government intervention. Policies that force banks to lend to poor credit quality note-holders was doomed to fail, and it did.
Capitalism and the free market are the only systems that work for a free society, but what goes up will come down. We have been in a 9-year bull market, super-charged by the pro-economy policies of the current Administration. History, and common sense, suggest we are due for a correction. Is your money protected? We may be able to help. Give us a call at (877) 912-1919 or visit TyJYoung.net.