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Lehman Brothers

A Crisis of Value

Oonagh McDonald

This book explains the fundamental causes of the bank's failure, including the inadequacy of the regulatory and supervisory framework. For some, it was the repeal of the Glass-Steagall Act that was the overriding cause, not just of the collapse of Lehman Brothers, but of the financial crisis as a whole. The book argues that the cause is partly to be found both in weak and ineffective regulation and also in a programme of regulation and supervision that was simply not fit for the purpose. Lehman Brothers' long history began with three brothers, immigrants from Germany, who sold selling groceries and dry goods to local cotton farmers. Dick Fuld, the chairman and CEO, and his senior management, ignored the increased risks, choosing to rely on over-valuations of the firm's assets. The book examines the regulation of the Big Five investment banks in the context of the changes which took place in the structure of banking after the repeal of the Glass-Steagall Act. It describes the introduction of the European Union's Consolidated Supervision Directive in 2004. The book examines the whole issue of valuing Lehman's assets and details the regulations covering appraisals and valuations of real estate, applicable at the time and to consider Lehman's approach in the light of these regulations. It argues that that the valuation of Lehman's real estate assets was problematic to say the least, as the regulators did not require the investment banks to adopt a recognized methodology of valuation, and that Lehman's own methods were flawed.

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Oonagh McDonald

1 From Cotton Trader to Investment Banker: 1844–2008 A brief history On 29 January 2008, Lehman Brothers Holdings Inc reported record revenues of nearly $60bn and record earnings of over $4bn for its fiscal year ending 30 November 2007. Just eight months later, on 15 September 2008, Lehman Brothers sought Chapter 11 protection in the largest bankruptcy ever filed. Its collapse sent shock waves around the world. Everyone remembers the name, Lehman Brothers. Many regard its collapse as the cause of 2008's financial crisis

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Oonagh McDonald

3 The Fateful Weekend Lehman's last efforts to save the company On 10 September 2008, Dick Fuld presented what would be the firm's last earnings report, announcing the loss of $3.9bn, the second quarterly loss after June's loss of $2.8bn: This is an extraordinary time for our industry, and one of the toughest periods in our Firm's history. The strategic initiatives we have announced today reflect our determination to fundamentally reposition Lehman Brothers by dramatically reducing

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Oonagh McDonald

9 Monitoring Value Corporate governance after 2002 The purpose of this chapter is to consider who should have been responsible for keeping an eye on the value of assets in which Lehman Brothers chose to invest heavily, and on its risk management procedures. Lehman's board, as any other board, would have been expected to monitor the company in accordance with corporate governance requirements. The first question therefore is: what exactly was the Lehman board expected, indeed, required to do. The other two questions are

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Oonagh McDonald

5 The Largest Bankruptcy in American History The Lehman Chapter 11 bankruptcy case represents the ‘largest, most complex, multi-faceted and far-reaching bankruptcy case ever filed in the United States’. 1 As the parent corporation, Lehman Brothers Holding Incorporated (LBHI) managed and directed the affairs of the enterprise, which consisted of a global network of approximately 8,000 subsidiaries and affiliates, with offices in every major centre in the world engaged in the various business activities of Lehman, ranging from derivatives

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From Hubris to Nemesis

January to September 2008

Oonagh McDonald

2 From Hubris to Nemesis: January to September 2008 January 2008: outlook rosy In its financial report for the fiscal year ending 30 November 2007, published on 29 January 2008, Lehman Brothers reported record revenues of nearly $60bn, and record earnings in excess of $4bn. The highlights of the report included net revenues of $19.3bn (a 10 per cent increase over the previous year and the fifth consecutive record) and a net income of $4.2bn (a 5 per cent increase over the previous year and the fourth consecutive record

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Oonagh McDonald

8 Measuring Value Previous chapters have set out the ways in which Lehman Brothers sought to value its assets and to hide its losses. Professional standards for the valuation of commercial and residential real estate existed at that time, but as the bankruptcy Examiner Valukas demonstrates in his report, Lehman showed little interest in conforming to them or hiring those who knew how to apply them. Against that background it can be seen that the bankruptcy process did not itself cause the destruction of value, although it

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Oonagh McDonald

time to unwind its derivatives portfolio in a way that might have preserved value.’ 1 Alvarez & Marsal's co-founder and co-CEO, Bryan Marsal, was appointed CEO of Lehman Brothers, overseeing the largest bankruptcy in America history, at about 10.30 pm on Sunday 14 September 2008, just hours before Lehman actually filed for bankruptcy. He arrived at 8.30 am the following morning and saw everyone leaving with boxes. In December 2008, he estimated that the total value destruction would be between $50 and $75bn, once losses from

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Oonagh McDonald

collapse of Lehman Brothers and other banks The Emergency Economic Stabilization Act (EESA) was signed into law on 3 October 2008, almost three weeks after the collapse of Lehman. Section 133 of the Act required the Securities and Exchange Commission to carry out a study of mark-to-market accounting standards set by the Financial Accounting Standards Board (FASB), in SFAS No 157, Fair Value Measurement. 21 The study was especially important, since claims were being made, not only in America, but in Europe as well, that mark-to-market accounting led

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Oonagh McDonald

role for governments is to do nothing’. 8 George Soros stated bluntly: ‘On a deeper level, the demise of Lehman Brothers conclusively falsifies the efficient market hypothesis.’ 9 To consider its role in the financial crisis, the theory itself must be defined. It originated in the work of Paul Samuelson and Eugene Fama, first developed in 1965 in ‘Random Walks in Stock Market Prices’, which they expanded and defended in many subsequent articles. 10 However, the most useful definition of the theory is in Fama's 1970 article