The collapse of the Lehman Brothers bank
Introduction
The collapse of the Lehman Brothers bank presents a case of one of the most massive bankruptcies experienced in US history. The bank was founded by a German immigrant in 1844, with it initially being a goods store. His brothers joined the immigrant, and the business grew into prominence and power. The combination of investment and commercial banking further catapulted their growth. Further expansion was experienced courtesy of dealings in securities, asset management, and proprietary banking. The after-effects of this fall are still being felt to date due to the bank’s position as one of the largest investment banks. Several factors and conditions contributed to the bank’s ultimate fall, but the housing crisis experienced in 2008 played a significant role. The bank engaged in sub-prime lending and over-leveraging, which acted as precursors to the fall. While several factors can be cited as the cause of the fall of Lehman Brothers, the poor-long term investments, over-leveraging, lack of trust, and the shaky funding were the main factors that caused their downfall.
Main Idea
The lending spree that the bank engaged in between 2003 and 2004 to cash in from the housing boom was a precursor to its fall. To achieve this, the bank acquired five firms which majorly specialized in sub-prime lending. This move, though earning the bank a high capitalization in the market, led to the firm crashing down. This is because the loan default rates for the sub-prime loans they offered reached an all-time high. The bank had over-leveraged, with the worth of its mortgage portfolio not compelling anymore. The collapse of the bank fueled the greatest economic downturn in the US and had far-reaching effects on a global scale due to the banks’ international status.
Supporting Arguments
Social Effects
Distrust
With the public having put a lot of trust and money into the firms they perceived as ‘fail-safe, which included Lehman, its fall triggered skepticism on the masses who were not sure of the economy anymore. People suddenly felt that the economy could collapse as a whole at any given time. This severely eroded the market confidence, which had far-reaching negative impacts on the economic system. The eroded confidence in the banks saw a rise in borrowing rates and home foreclosures. Studies have indicated that Americans have increasingly become more careful with their money and are ‘gun-shy’ on matters investment. Even ten years after the downturn, consumers have mostly remained distrustful of financial institutions and are still trying to recover financially. The mistrust was not only placed on financial institutions and the government that oversaw them but in the financial experts and the expertise they proffered.
Economic Effects
Stock market Plunge
The bank’s collapse caused the stock markets to take a plunge, which caused the most severe economic downturn, comparable only to the Great Depression of the 1930s. This caused a major crisis in debt across many countries, including Portugal, Ireland, and Spain. Approximately twenty-six thousand employees from the company lost their jobs while the investors lost colossal amounts of money. Retirement accounts linked to the financial markets indicated a sharp fall occasioned by the downturn. The year also saw the Dow Jones fall to an all-time low of 6,594, which meant it had declined by up to 50% from 2007. Investors pulling out their money from banks and their investment funds due to uncertainty on which banks were exposed to the sub-prime lending further plunged the stock market into a new low.
Credit Freeze
The bank had had major dealings in providing short term debt through commercial paper, and its collapse led to a shortage of this critical lending source in the whole world. This crisis played out in the interbank lending markets. The bank had had dealings with all the banks in the US and across the globe. This means on its collapse, firms that had Lehman’s debt would not be paid. Banks were suddenly not lending to other banks due to the prevailing uncertainty. Banks were unwilling to take the risk since they could not be sure of the actual state of other banks’ balance sheets. The cessation of lending saw a freeze in credit and liquidity in the world.
Decrease in Spending
Decreased consumer spending and coupled with low exports to the US had a severe effect on the flow of goods to the country. This had a reverberating impact with interruptions in the flow of goods, job growth, and in the manufacturing industry. The low confidence meant households were less willing to spend in purchases. Businesses had also become less willing to invest as they were uncertain of what the uptake of the new ventures would be. The decreased spending was also credited to the all-time low unemployment rate that hit 10%.
Examples
The distrust of financial institutions increased democrat influence in the US as they were mostly against financial institutions. The Occupy Wall Street movement is primarily popular for its distrust of big business while the Tea Party for those who were anti-government.
The credit freeze saw banks collapse as their loan making capabilities were hindered with institutions getting bankrupted.
An example of the firms that also severely suffered from the downturn includes General Motors and the Chrysler Corporation, which also filed bankruptcy.
Conclusion
The collapse of the Lehman Brothers bank led to the greatest economic downturn of global proportions, which had far-reaching effects worldwide. This is because the firm was one of the leading investment banks in the whole world. The fall can mainly be attributed to poor long term investment and over-leveraging, which severely exposed them when the housing boom dived. The effects of this collapse mainly caused distrust between financial institutions and the public, stock market plunge, and credit freeze.