In these articles....:
The 2008 Crisis//The Great Recession Case Study! Here's What Really Happened! Simplified!
What Are Investment Banks? How Do They Work?
---- I've mentioned about the fall of one of the largest Investment Banks of U.S. ---- Lehman Brothers.
& so today we'll dive deep & understand how an Investment Bank that even survived The Great Depression by still functioning pretty smoothly went bankrupt in the 2008's Great Recession!
---->> Now, I'm not saying that The Great Depression was any less then the 2008's Recession. As we all know how serious the condition of the Economy was in the Great Depression, but yet if the Lehman Brothers can survive that, then it's a pretty obvious question that why did it failed in the 2008 Crisis!
Also Read: The Great Depression Case Study! Here's Everything You Need To Know! Simplified!
So, let's start from the very beginning of how actually was Lehman Brothers formed....!
So here we go;
Well, so,
Henry Lehman, Mayer Lehman & Emanuel Lehman were 3 brothers.
Back in 1840,
Henry Lehman immigrated to the U.S., Alabama; from Germany.
Henry first started as a door to door salesperson.
& sooner when he had enough funds, he opened his own store.
It was just a normal store which basically sold everyday items we need.
Henry Lehman's other brothers joined him too. They both; one at a time fled to the U.S. from Germany to join their brother & help in Business.
By the year of 1850; they were all there in the U.S., Alabama. & that's when the Business / Store was officially named "Lehman Brothers"!
After 5 years Henry Lehman passed away due to Yellow Fever & his other 2 brothers were left in control of the Business.
Now, due to the store being in Alabama, USA & that too back in the year of 1850.
Around 50% of the store's customers were Cotton Farmers & they used to pay with Cotton.
It may seem silly today! ---- But back then, Cotton was a pretty valuable Commodity & worth using as a form of Currency!
Anyways, so because of getting paid with Cotton; Lehman Brothers also had to seek out people who actually needed Cotton, in order to sell it to them & get cash!
& in this way they gained connections with a lot of people.
Soon enough, only "Cotton" quickly became their Business; as they were now just buying Cotton from Cotton Farmers & selling it into the Market or to whoever needed it!
So you see they became somewhat of a Cotton Broker.
As they were serving as a MiddleMen in "Cotton Trading"!
After a while they opened an office in New York.
It was called the New York Cotton Exchange.
They started making smart & logical moves from here, as they started trading other Commodities with Cotton, as well.
& this proved to be a great thing for them to do, too.... 'cuz Cotton wasn't much worthy anymore, by the end of the Century.
& also here you can clearly see how greatly they modified their business & made that jump into the field of "Finance"!
Later; this business was sort of like a legacy or family business as it was carried out by the Children of the Brothers & then later their children.
Lehman Brothers soon moved away to the Business of Underwriting!
Underwriting basically means assuring the buyer that the seller will sell & also assuring the seller that the buyer will buy; whatever is being traded & if something goes wrong than an Investment Bank will take over that Risk!
& hence, so they were serving as a middle person between a Company & the Investors that the Company is looking for to sell their stocks to!
They quickly succeeded in this as they took the risk to carry out smaller Businesses which were backed off by larger Banks as they seemed too Risky to'em.
By the year of the 1900's they were serving as Underwriters for a lot of Businesses.
Underwriting basically means assuring the buyer that the seller will sell & also assuring the seller that the buyer will buy; whatever is being traded & if something goes wrong than an Investment Bank will take over that Risk!
Lehman Brothers transformed to a large Reputable Investment Bank!
In the year of 1929, during The Great Depression ---->> Robert Lehman, grandson of Emanuel Lehman really managed the Business well! Inspite of pretty much everything being so down & literally 0 to NO Businesses being around! He did a really good job by still keeping the Investment Bank up & running, smoothly!
Then, in the year of 1984,
Lehman Brothers was bought by American Express for $360 Million.
& it was up until the year 1994, that Lehman Brothers was announced as an Independent Investment Bank!
& during this time is when they really turned out to be the biggest bank they've been ---- the 4th Largest Investment Bank of the U.S.!
Also Read: What Are Investment Banks? What Do They Do & How Do They Work? Explained In Simple Words!
Before they collapsed, they really had $619 Billion in Assets & 25,000 Employees!
Then, how'd they collapse?
Well, here's a quick explanation & overview about the fall of Lehman Brothers....
The 'Collapse' will make a lot more sense to you if you know how the 2008 Crisis really went!
Read: The 2008 Crisis//The Great Recession Case Study! Here's What Really Happened! Simplified!
Anyways, so, in the year 1994 (which is also around the beginning of the Dot Com Bubble)
Read: The Dot Com Bubble (Tech Bubble) Explained! What Caused The Dot Com Boom?)
Mr. Richard S. Fuld became the CEO of Lehman Brothers.
& he focused the most on Complex Financial Products.
After the year of 2000 (after the Dot Com Bubble Started Bursting!), many such financial products regulated in the Market that weren't under anyone or controlled by anyone.
& that was also due to the Share Market being bearish (down) & banks interest rates being low.
So these complex financial products were basically the only Investment Opportunities for the Investors.
Anyways, so, many Investment Banks including the Lehman Brothers went with these Complex Financial Products in order to earn more profit! & CDO's (Collateralised Debt Obligations) were one of them.
Continue reading; to know what CDO's really are....
[By The Way, this is where the 2008 Crisis//The Great Recession started!]
So, now, this is a bit of the story of the Crisis itself....!
So as I said, Back in 2000 the interest rates of the Banks & the Share Market was down, too!
But, during that time the Housing Market was growing rapidly & the banks were giving out loans & many people were taking home loans as well, 'cuz of the low interest rates.
So, here banks were lending money to people & were basically the one's to have the mortgages.
& so, the investors saw this an opportunity; as they witnessed the Housing Market growing & a lot of people taking loans.
& so the Investors went wild for mortgages.
Investment Banks saw this as an opportunity & bought a lot of mortgages with their large capital & created a Complex Financial Product named CDO's standing for Collateral Debt Obligations.
Basically, the people who'll own CDO's will be payed the loan repayments by those the loan was given out to....!
This was a good opportunity for investors to earn a passive income & receive payment with interest after a fixed period of time.
Note ---- They got paid by the amount of portion they owned!
The Investment Banks got these CDO's rated, as well.... by the Credit Rating Agencies they owned.... They got these a AAA (triple A) rating.... Credit rating agencies actually performed a deep analysis of how safe an Investment is.... & AAA was the highest/safest marked Investment.
Anyways, so the Investment Banks // Lehman Brothers were sold out of CDO's in no time.
But the demand for the CDO's was still very high!
But Banks had already given out loans to everyone who is capable of repaying'em!
What I mean is that.... Banks tend to give out loans to those individuals who have a good credit score & basically have a stabled job that can co-op with the loan!
So basically Banks tend to analyse aperson's financial history to determine if he/she can take out a loan!
In this way, there won't be many people defaulting on loans repayments.
Defaulting = To failing to pay a loan repayment!
But in this case, as I said; the Banks had already given out loans to those people who were capable of repaying the loan on time.
Coming back to Investment Banks being sold out & yet the demand being high....
Investment Banks asked banks for more mortgages....
& then the banks did something that literally pulled the entire scenario to an economy's downfall!
The Banks started giving out loans to such people who weren't quite capable of repaying the loans at all.
Actually, banks were in a misconception that if there's a default then they can put up the property for sale in order to recover the money - avoid losses.
But it isn't quite of what happened! Continue reading to know what really happened!
Anyways, so Banks went on to giving on those low quality loans!
& these loans/mortgages were Risky indeed....
'Cuz if you payed for'em & 0 in return is what you''ll get!
These low quality loans are known as Sub Prime Loans!
Banks then sold these mortgages to Investment Banks like Lehman Brothers & Investment Banks to investors after still getting'em rated AAA, by the Credit Rating Agency.
So the risk of these sub prime loans was transferred...., by Banks to Investment Banks & then from them to the Investors.
Many Investment Banks sold Billions of these low quality mortgage CDO's.
One more mistake that Banks made was that, they didn't informed a lot of borrowers about the Adjustable Interest Rates.
Actually, the Interest Rates which were low in the year 2000, have now by the year of 2007-2008 increased & people who took loans have to now pay the interest which they currently have (the increased interest rates)!
These types of Interest rates that can be adjusted/changed with time are known as Adjustable Interest Rates.
In the beginning, people were however paying back the loans on time.
But as soon as they Interest Rates went up; many people especially the one's who were incapable of paying back the loan...., started defaulting.
With time, there were many people defaulting & arguing of not being informed about the Adjustable Interest Rates.
So, the Banks had no other choice than to take over the property & put it up for sale.
Soon enough, there were way too many people defaulting on loans.
& so there were way too houses up for sale.
But the thing is that, due to a lot of people who were willing to buy homes have took the hone loan's itself & so Banks were unable to find any buyers for the homes.
& so due to the Demand being this low, yet the supply of houses being very high.... Pushed the prices of the Houses down! [The Housing Bubble Started Bursting!]
Also Read: Who Decides The Price & Value Of A Stock? The Demand & Supply Rule Explained!!
& the people who's houses were being taken over by the Banks saw that their house's price is now worth way less than the loan they've got to pay & so they started defaulting even more & at this point literally no one was willing to pay the loans.
Now, due to all this the value of the CDO's became literally 0 ; as of the borrowers were not paying any money at all.
Lehman Brothers still had a lot of CDO's left; like CDO's which were once worth Billions of Dollars ($$$$).
& something that dragged the position of Lehman Brothers to an even worse condition is that Lehman Brothers bought those CDO's off debt & lending Companies.... so, basically they've borrowed the money. & so they had Billions Of Dollars Debt & even if they had Billion in Assets, the Debt was still more than the Assets they owned!
So, Lehman Brothers started looking for People who would buy their Business but nobody was willing to do that & one of the major reasons was the debt Lehman Brothers was in.
Then Lehman Brothers basically went to the Government for help...., that was cause generally Government tend sto save larger Companies from going bankrupt, so that people don't loose their jobs.
But Lehman Brothers were turned down by the Government, too. Actually, during that tine Government have already saved/bailed out many Companies by putting in Billions of Dollars...., & again the major problem with the Lehman Brothers was that, it had a lot in Debt, & so there was a lot in Risk!
After all this on 15th September 2008...., Lehman Brothers filed for Bankruptcy!
During that day, the Dow Jones fell 500 points by 4.4% ...., the most it have ever felled after the 9/11 Attack!
Lehman Brothers had around 691 Billion $ in Assets & in Liabilities or basically Debt is what I mean here.
It had 25,000 employees that lost their jobs.
& after this if I talk more about the Crisis than due to people loosing their jobs, even the capable people also started defaulting on loans & the financial of operations of the Banks literally kind of freezed for a while, due to no money circulation.
It was not just Lehman Brothers that went Bankrupt...., there were a ton of Businesses & Companies that went Bankrupt & a bunch of people who most their jobs.
Lehman Brothers that officially started in the year of 1850 went Bankrupt in 2008...., being 158 years old!
& this is how Lehman Brothers Bankruptcy was the Biggest Bankruptcy in the World!
Articles You May Like----
The Great Depression Case Study! Here's Everything You Need To Know! Simplified!
The 2008 Crisis//The Great Recession Case Study! Here's What Really Happened! Simplified!
Who Decides The Price & Value Of A Stock? The Demand & Supply Rule Explained!!
What Is Bankruptcy? What Happened When A Business Goes Bankrupt // Files For Bankruptcy?
What Are Investment Banks? How Do They Work?
Anyways, so that is all for today!
I hope you understood whatever I explained!
Thanks For Reading!
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