Investment banking is inherently risky. Their over-riding
purpose is to chase profit. To do so, they weigh up all of their possible opportunities
and all of their possible outcomes in a hope of predicting their best gamble. In
the face of the largest economic crash since the 1930s, investment opportunities
were limited and the inherent flaws of every firm were brought to the fore.
With the benefit of hindsight, it is clear that the ambitious decisions taken
as part of Lehman Brothers’ operating model, were misguided. In accordance with
Zingales (2008), their foray into subprime mortgaging with high leverage was
their undoing.
Valukas (2010) stated that these choices together with the global
recession brought the downfall of Lehman. Therefore, their demise was a
consequence rather than a cause of the recession. The high leverage model left
them exposed when the recession brought volatile conditions. Markets had already
been on their way down for about a year before September 2008, Lehman exacerbated
this so what was to come was worse than ever predicted. DOW Jones dropped 504 points
as a result of Lehman’s bankruptcy and AIG were being forced into collapse as
well. From this perspective, is it possible to call Lehman “too big to fail”?
Perhaps it was, as another company’s existence was based on Lehman’s fortunes.
Businesses across the globe, both big and small, were
directly affected by the shockwaves Lehman sent through the market. Either,
there were indirect effects, such as money flow between firms halting or,
direct problems for institutions who had a close working relationship with the
bank. Bad debt securities that had passed onto the Fed, led to a week long
period when they had to freeze redemptions as there were worries that their
reserves couldn’t cope with the demand. The Fed also pumped excessive amounts
of money into the economy for years afterwards in the form of a stimulus
package from early 2009 to combat this. Their aim was to continue economic
growth and ease the country out of a recession. Jordan (2010) and Whelan (2010)
cite SunCal Cos as an example of firms that were directly affected by Lehman. A
land developer and home builder based in California whose primary lender was
Lehman, ran into debts in and around $230million. They managed to survive and
are still operating today. However, outside USA, as far afield as Israel, a 3D
graphics development company called Orad Hi-Tec Systems witnessed their stocks
lose value, Tsipori (2010). Lehman was their largest shareholder and had been
the underwriter for their IPO held in 1999. This was an obvious outcome.
However, it can be said that Lehman was a wakeup call to the
banking sector. Richard Wolff, a journalist for The Guardian (2011) indicates
that Europe felt threatened afterwards and the situation encouraged European
countries to bail out their banks no matter the cost because they all believed
it was better than the alternative. Lehman’s demise forced the market to be
reassessed as there were clear problems, Zingales (2008). Market regulations were
tightened in an attempt to increase transparency and tackle the complacency
that can come with large, sustained profits.
Overall, I believe that the government followed the right
course of action in the Lehman saga. A view reinforced with the discovery of corruption
at the top and fraudulent records. The government had to show that they were
prepared to let a bank fail. The government couldn’t afford to continue to act
like a generous uncle. They had to re-incentivise a sector that had become
negligent and refused to learn from the past - Enron, an American energy provider
had applied an accounting gimmick similar to Repo 105 on their reports to
transfer liability and subsequently failed in late 2001. In any case, Lehman was
accepting bankruptcy. When they realised they were losing alarming sums of
money from mortgages, instead of acting immediately and confronting their
mistake head on, they hid it on their balance sheet in the hope that they could
fool another bank into purchasing them and burdening them with debt. For
Richard Fuld to initiate a very aggressive strategy for expansion, he
maintained an even more passive one to stop bankruptcy.
This is the price of capitalism. Only the most organised,
profitable and competitive companies survive and grow. Those who can’t make
sense of the markets, embrace the competition or maintain the confidence of clients
fail. And they deserve to fail!
No comments:
Post a Comment