What would you do as CEO  of Lehman Brothers?

1) Read the Case. 2) Think about your action in the question slide.  3) The last slide will cover the actual decision taken. 

How to use this case?

Lehman Brothers has been operational for 158 years. They are one of the largest Investment Banks in the United States and emerged as a leading Mortgage Bank during 2006.  As per Wikipedia, Lehman had $680 billion in net assets and their capital amounted to $22.5 billion during the year 2008.

The Case 

Lehman borrows significant amounts to invest in lending money to people who required home loans.  They bundle these loans and allow investors to invest in them as a part of their portfolio.  This results in a highly leveraged position for Lehman.  This strategy brings in huge profits during the Real estate boom (which lasts until around 2006) and works in their favour.

The Fed happens to raise interest rates. Now, people are unable to afford high monthly interests for their houses.  The demand for houses fall and people are now unable to sell their houses as well. 

Federal Funds Rate from 1952 - 2008

This ultimately results in many people defaulting on their loans.

When people were unable to make payments, Lehman’s risky position results in huge losses, wiping out the majority of their portfolio.

Now, supposing today is a day before the crisis. Lehman is staring at these whopping losses that are about to go public.  As the CEO you have to take a call.

Should Lehman bear all the losses? (File for bankruptcy and save the rest of the market from collapsing.) OR  Should Lehman offset their losses?  (Sell these worthless positions to other companies and hang in there.)

The Question 

Lehman offset their losses. Tried to sell whatever worthless positions they could. This still left them with a debt of $613 Billion. This acted as a catalyst to the Housing Market Crisis of 2008. It later went on to file for bankruptcy and laid off close to 25,000 employees. 

What they did -