Source – doctorhousingbubble.com
– “…If anyone had any doubts that too much leverage is a bad thing, we are quickly realizing how a small dry-goods store can turn into a massive investment bank years later that has brought the entire world’s attention onto it. A systemic crisis seems more and more probable as the year progresses”
Lehman Brothers: The Rise and Fall of Lehman Brothers. A History that Goes Beyond the Great Depression
Lehman Brothers, an investment bank that dates back to 1850, prior to the Civil War has now filed for bankruptcy. A storied institutions that has survived two World Wars, the Great Depression, and practically every other calamity in its 158-year history is no longer solvent. As of 1am on September 15, 2008 the investment bank announced that it would file for Chapter 11 bankruptcy protection.
This astonishing news comes during a weekend when most of the market on Friday was expecting that someone would surely come to the table to help the firm. Whether it was a private purchase or a government sponsored bailout like what occurred with Bear Stearns and JP Morgan, bankruptcy was not expected by many. Early talks indicated that Bank of American and Barclays were in close talks to take over the troubled investment bank. The Federal Reserve which aided in helping the Bear Stearns deal and the U.S. Treasury which just last weekend entered into the biggest bailout known to humankind by aiding Fannie Mae and Freddie Mac both seemed unwilling to come to the aid of Lehman Brothers. I am sure as time goes on more and more details will emerge as to why this occurred.
Bank of America in an unprecedented move went ahead and managed to get their hands on Merrill Lynch for a stunning $29 a share deal. It is stunning enough that Bank of America went after Merrill Lynch especially given that the Friday close per share value was $17. This is the same Bank of America who recently completed its take over of troubled mortgage lender Countrywide Financial. If you recall the deal, BofA offered a higher share price than the current market price for Countrywide but only months later, implied that they would not be back stopping all the debt of Countrywide. The Federal Home Loan Bank had extended a stunning amount of loans to Countrywide so it is yet to be seen how things playout with the Merrill Lynch purchase since the fate of Merrill was very likely going to precede that of Lehman Brothers.
It is unprecedented that in only six months, 3 of the top 5 investment houses on Wall Street are no longer in their previous form. I can imagine that at this point all eyes must be on Goldman Sachs and Morgan Stanley.
The story of Lehman Brothers takes us back to 1844 when a 23 year old Henry Lehman emigrated to the United States from Bavaria. He decided to settle in all places Montgomery Alabama where he decided to open a dry-goods store. In 1847 another brother arrived and in 1850 yet another. The firm changed its name in 1850 to the current Lehman Brothers name.
Cotton had a high market value and seeing a market for this, the 3 brothers started to accept payment in cotton for goods and also created a secondary market for trading in cotton. It makes you wonder how many tranches can be spun from a shipment of cotton? Seeing the need to be closer to the liquid market of cotton in New York the firm relocated to New York in 1858. It later joined the Coffee Exchange and also the New York Stock Exchange. It was sometime before the initial founding of the firm that Lehman Brothers actually underwrote its first public offering. In 1899 it underwrote a public offering for the International Steam Pump Company. It wasn’t until 1906 that the firm started underwriting some bigger public offerings. The names of Sears Roebuck and Company, Woolworth, Macy & Company, and B.F. Goodrich where all part of their earlier team deals with Goldman Sachs. It was making a big name for itself on Wall Street.
During the Great Depression, much of the focus of Lehman went toward venture capital as the equity markets were being hammered. In the 1930s Lehman Brothers underwrote the IPO for DuMont and also helped to provide capital to get RCA going. It also had its hand in financing Halliburton. Like I said, Lehman Brothers has a storied past.
In 1975 the firm merged with Kuhn, Loeb and Company to form at the time the 4th largest investment bank. The merger didn’t go quite as planned and strife arose in the firm. The firm was sold to American Express. AMEX started to break away from banking and brokerage operations and sold off operations to Primerica which in 1994 was broken off as an IPO for the current Lehman Brothers ticker. The firm did exceptionally well purchasing fixed income such as Lincoln Capital Management and Neuberger Berman which still are profitable today. Since the IPO in 1994 Lehman had steadily increased revenues and grew in employees from 8,500 to approximately 28,000.
As glorious as this past may seem Lehman could not resist the subprime markets. In August of 2007 Lehman closed its subprime lender BNC Mortgage which left 1,200 positions gone. This clearly was only the beginning for Lehman and their mortgage and credit problems. In 2008 Lehman was posting unprecedented losses. For the most part their problems arose from holding onto lower grade tranches and holding on too long to subprime mortgages. It is up in the air whether they held onto to these assets because of a foolish investment move or whether their simply wasn’t a market for these assets. For the 2nd quarter the frim had $2.8 billion in losses and was forced to liquidate $6 billion in assets. It is simply stunning to see the stock movement for the firm:
It is hard to believe that only one year ago, this once behemoth of Wall Street had a $47 billion market cap and now is filing for bankruptcy. As the troubles mounted in late August rumors started piling on that a bailout from the Korea Development Bank was in the works. This never materialized. On September 10 Lehman announced another stunning loss of $3.9 billion and made it clear that they were also in the works of selling off the prized jewel in Neuberger Berman to raise capital. The rest we already know and weekend talks broke down and Lehman was forced with no other option but to file for bankruptcy.
Now truly these are unparalleled times. The ink is only drying on the Fannie Mae and Freddie Mac deal which puts at risk $200 billion of taxpayers’ money and given the current housing market is very likely to use up every single penny. Even though many pundits are quick to tell us no money is lost most unbiased analyst are quick to point out that some money will come out of the taxpayers’ wallet. This is the first major bankruptcy of a major investment bank and it is yet to be seen how the already weak markets are going to respond. The Federal Reserve also announced that they will be accepting equities which is simply astounding. Clearly this weekend meeting has the smell of panic more than anything else.
It is easy to lose perspective of what really is going on. You need to remember that debt is at the center of all this. Most of the debt is secured by residential housing but also commercial real estate. We can all rest assured that most of the balance sheets of many of these firms have been overly generous in estimating the value of their assets. A forced mark to market in today’s market is not going to go well. It is a game of financial brinkmanship and many are trying to offload as many toxic debt products without being stuck with the debt. The financial musical chairs are quickly running out. We go from Fannie Mae and Freddie Mac to this in one week. Clearly the balance sheets of these companies are weaker than anticipated. And with housing showing no signs of recovery, we can expect more of the same. The next question that comes to mind is what will happen to Goldman Sachs and Morgan Stanley? The mortgage market looks to be dominated by the government for the foreseeable future through Fannie Mae and Freddie Mac so it makes you wonder what role these companies will have in the debt markets.
If anyone had any doubts that too much leverage is a bad thing, we are quickly realizing how a small dry-goods store can turn into a massive investment bank years later that has brought the entire world’s attention onto it. A systemic crisis seems more and more probable as the year progresses