Why Did Lehman Brothers Go Bankrupt?

*updated 01/08/09*

Well, it's really a devastating week for all of us I guess. Yeah, all of us because I think we are all affected by the bankruptcy of Lehman Brothers, directly or indirectly.

For those still not in the know, Lehman Brothers filed for Chapter 11 bankruptcy last September 15, 2008. The institution is the fourth largest investment bank in the US and has been standing in Wall Street for 158 years. Yes, you read that right --- 158 years ago. What I really want to know is how did this giant, an old one at that, get bankrupt? So shouldn't we be thinking over this seriously because if it happened to them, it will surely be possible for us, too.

What does Chapter 11 mean?

Under Chapter 11 Business Bankruptcy is a legal process by which a business may declare bankruptcy but continue to operate under the direction of a court-appointed trustee. This process is called "reorganization," because the trustee reorganizes the business to be more efficient and to be able to pay the creditors of the business. The bankruptcy court may also exempt the business from paying all or part of its debts. Chapter 11 bankruptcy is usually sought and granted in the case where the value of the business is greater than the sum of its assets; in other words, the business has a significant amount of goodwill as a "going concern" which would be lost if the business were sold or liquidated.

In many cases, a business may re-emerge from Chapter 11 and continue to operate normally. In other cases, the reorganized business can be sold after some period of time.

Source: About.com - US Business Law/Taxes

It seems that even financial giants are susceptible to bad credit. There has been a mortgage crisis in the US that led to Lehman Brothers' downfall.

WHAT HAPPENED?

Let's see the timeline:

1850: Lehman Brothers was founded by two cotton brokers in Montgomery, Ala. The firm moved to New York City after the Civil War and grew into one of Wall Street's investment giants.

(Fast Forward)

Summer of 2007: Lehman's slow collapse began as the mortgage market crisis unfolded, when its stock began a steady fall from a peak of $82 a share.

March 2008: Lehman managed to avoid the fate of Bear Stearns, the other of Wall Street's small fry, which was bought by JP Morgan Chase at a bargain basement price under the threat of bankruptcy.

Summer of 2008: Lehman started to have more downs than ups. A series of write-offs was accompanied by new offerings to seek capital to bolster its finances. The investment bank also fought a running battle with short sellers. The company accused them of spreading rumors to drive down the stock's price; Lehman's critics responded by questioning whether the firm had come clean about the true size of its losses. As time passed and losses mounted, an increasing number of investors sided with the critics.

June 9, 2008: Lehman announced a second-quarter loss of $2.8 billion. The company said it would seek to raise $6 billion in fresh capital from investors.

Sept 8, 2008: The situation grew more dire after the government announced a takeover of Fannie Mae and Freddie Mac. Lehman's stock plunged as the markets wondered whether the move to save those mortgage giants made it less likely that Lehman might be bailed out.

Sept 10, 2008: Lehman said that it would spin off a majority of its remaining commercial real estate holdings into a new public company. And it confirmed plans to sell a majority of its investment management division in a move expected to generate $3 billion. It also announced an expected loss of $3.9 billion, or $5.92 a share, in the third quarter after $5.6 billion in write-downs.

Sept. 13-14, 2008: It was do or die for Lehman. The Treasury had made clear that no bailout would be forthcoming. Federal officials encouraged other institutions to buy Lehman, but by the end of the weekend the two main suitors, Barclays and Bank of America, had both said no.

Sept 15, 2008: Lehman filed for bankruptcy.

Sept 16, 2008: Barclays said it would buy Lehman's United States capital markets division for $1.75 billion, a bargain price. Nomura Holdings of Japan agreed to buy many of Lehman's assets in Europe, the Middle East and Asia. Lehman also said it would sell much of its money management business, including its prized Neuberger Berman asset management unit, to Bain Capital and Hellman & Friedman for $2.15 billion.

Oct. 5, 2008: Richard S. Fuld Jr., Lehman’s chief executive, testified before a Congressional panel that while he took full responsibility for the debacle, he believed all his decisions “were both prudent and and appropriate” given the information at the time.

Source: NY Times - Lehman Brothers Holdings Inc.

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