Accounting/Finance related ethics
Lehman Brothers
Introduction
Lehman Brothers began its operations in the year 1850 in Montgomery, Alabama, US. Founded by Henry and Emanuel Lehman, it initially provided financial services. Before its foreclosure due to financial impropriety and eventual bankruptcy in the year 2008, Lehman Brothers traded in the New York Exchange under the symbol LEH and it was one of the largest investment banks in the United States, the fourth after, Merrill Lynch, The Morgan Stanley and Goldman Sachs. It had over 26,000 employees in the year 2008.
The collapse and eventual bankruptcy of the Lehman Brothers investment bank can largely be attributed to the cosmetic accounting gimmicks which were normally applied at the end of every financial quarter to paint the company as stable when in essence it was going through very difficult moments. They practiced a kind of repurchase financial agreement that temporary shifted the securities from the bank’s balance sheet. These repurchase financial agreement were once described as Lehman as ordinary sale of securities. These transactions led to the wrong conclusions about the company’s financial position or condition between the later years of 2007 and 2008. (Sorkin, 2009)
The bankruptcy of Lehman Brothers can also be traced to the failure of one of its branches that dealt with the Subprime mortgage i.e. the BNC Mortgage. The closure of BNC Mortgage, the subprime lender led to the loss of over 1200 job positions in a total of twenty three branches. These retrenchments were explained as normal restructuring exercises that were necessitated by the poor economic conditions that were prevailing at the time. (McDonald, 2009)
The subprime mortgage financial crisis continued to drain the Lehman Brothers dwindling cash reserves in 2008. These losses were related to the large portfolios held in subprime and other related low rated mortgage portfolios when making the collaterals under the mortgages. It’s not clear why Lehman Brothers held on these large unproductive subprime mortgages for such a long period. Throughout most of 2008, huge losses were incurred due to the subprime mortgage securities. For instance, during the second financial quarter of the year 2008, the company lost $2.5 billion and to offset the loss, Lehman brothers had to sell assets worth $6billion. Lehman Brothers stocks at the New York Stock lost 73% of their value. In September 2008, the company made a profit of $489 million against their perennial rivals Merrill Lynch and Citigroup posted $1.97 and $5.1 billion respectively. The company had a little reprieve when its shares rose by almost 46% but that was all.
On 9th September, Lehman’s Stock value declined by almost half of its remaining value and the S & P 500 share index dropped by 3.4% while the Dow Jones dropped by 300 points. Investors were now getting concerned by the financial state of the Lehman Brothers and for sometime most investors hoped that the US government might subsidized the company’s debt to prevent the bank crash but the US government never made any announcement to that effect.
At 1 a.m. on the morning of the 15th day of September the year 2008, Lehman Brothers filed for bankruptcy under chapter 11 of the company’s Act citing inability to meet its entire financial obligation with a glaring debt of $613 billion in banks debts and another $155 billion in bond debt and the assets of Lehman Brothers were $639 billion. Its subsidiaries however were instructed to continue with their operations until further notice.
These subsidiaries were later acquired by different companies on various dates. For instance, on September 16, the same year, Barclays Plc acquired most of the bank’s operations in North America for $1.75 billion which was later revised to $1.35 billion and included the 38 storey Lehman Brothers headquarters in Manhattan together with the responsibility of maintaining over 9000 former employees of the bank. On September 29, the same year i.e. 2008, Neuberger Berman, its former investment management division was sold to some equity firms. Bain Capital Partners together with Hellman and Friedman for a total of $2.15 billion.
In March 2010, a report into the conduct of Lehman Brothers management and its auditors, Ernst & Young, revealed that Lehman Brothers had adopted an accounting practice known as repo 105 that temporarily turned and exchanged $50 billion worth of assets into cash just before its accounts went into publication. This was an accounting malpractice that was conspired by both the external auditors i.e. Ernst and Young together with the management of Lehman Brothers. However, the wall street journal (Eaglesham & Rappaport, 2011)) and the Guardian (Clark &Andrew, 2010) reported that Stock Exchange Commission (SEC) were not confident that Lehman Brothers operations were illegal as no laws specifically prohibited such practices.
The major cause of the Lehman Brothers Bankruptcy was mainly due to its incompetency in handling the Subprime mortgage crisis and other low rated mortgage securities. The major firms like Merrill Lynch and JP Morgan Chase took decisive actions to avert the final catastrophe that befell Lehman Brothers. In fact, in March 16, a rival bank Bear Sterns opted for a fire sale of all its assets and liabilities by JP Morgan Chase to save its customers and creditors the bankruptcy option that was imminent. Financial analyst predicted that Lehman Brothers was also heading the same direction. A suggestion was also made that Lehman Brothers were unable to sell or dispose of the lower rated mortgages as such a huge amount of its capital was tied to these mortgages that were not profitable. From that time onwards, Lehman Brothers management was fighting a losing battle as the economy also entered the infamous 2008 financial crisis that saw the American economy take a nose dive. (William, 2010) The unemployment rate was raising and the inflation rate was also taking its toll on the local economic activities. The levels of savings were dropping and most people were not investing. http://research.stlouisfed.org/publications
In October 2011, the management of Lehman Brothers was compelled to pay 148 million pounds from their pension plans after their appeal to overturn the initial judgment failed.
To conclude, Lehman Brothers contribution in this scandal was that its management tried very hard but didn’t manage to hide the true picture of the company’s financial condition. The repurchase financial agreement and the repo 105 were unethical accounting tricks that were meant to hide the true financial position of Lehman Brothers Investment bank. These tricks were successful for sometime but the true cause of the problem was the subprime Mortgage financial crisis that was not addressed satisfactorily.
References
Clark, Andrew (2010). “Could Lehman’s Dick Fuld end up behind bars?”. The Guardian March 12 (London). Retrieved 2010-05-07.
Eaglesham, J. & Rappaport, L. (2011) “Lehman Probe Stalls; Chance of No Charges”. Wall Street Journal, March 12. Retrieved 2011-03-13.
McDonald, L.G. (2009) A Colossal Failure of Common Sense: The Inside Story of the Collapse of Lehman Brothers. Crown Business
Sorkin, A. R. (2009) Too Big to Fail: The Inside Story of How Wall Street and Washington Fought to Save the Financial System—and Themselves. Viking Adult
William, M. T. (2010). “Uncontrolled Risk: The Lessons of Lehman Brothers and How Systemic Risk Can Still Bring Down the World Financial System”. Mcgraw-Hill.
http://research.stlouisfed.org/publications/iet/
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