In the early morning hours of Sept. 15, 2008, Lehman Brothers Holdings Inc. filed for bankruptcy, after months of mounting losses and investor flight, and having failed in a desperate, last-ditch effort to land either government support or a private sector buyer.
The bankruptcy marked the stunning end to a century-and-a-half-old investment bank. It was also just the beginning. Lehman's failure triggered a chain reaction that has dramatically altered the entire economic universe, most likely for years, if not decades, to come. Sept. 15 marks a financial demarcation line of immense importance. "It can clearly be seen as a major turning point," says Richard Grossman, an economics professor and economic historian at Wesleyan University in Middletown, Conn.
The Lehman bankruptcy can't be measured merely in size, although $560 billion in liabilities -- at last count -- easily makes it the biggest of all time. It can't even be measured solely by its short-term impact, although that is monumental as well. In the immediate aftermath of the bankruptcy, the world's banking system seized up. Major banks failed. The U.S. government was forced to pile hundreds of billions of dollars in loans and other financial support into weakened giants such as American International Group Inc., Citigroup Inc. and Bank of America Corp.; it is signing enormous checks still. Governments across Europe and Asia had to intervene with hundreds of millions of dollars more to bolster collapsing banks and deteriorating economies.
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The Lehman bankruptcy represents a failure of America's banking
system and regulation. Lehman itself has become shorthand for a fatal
attraction by investors and banks alike to complex assets and
derivatives, a desire stoked by immense amounts of debt and
unencumbered by regulation and oversight. It's at the heart of what
still cripples finance today. No one, including governments, knows how
much toxic debt is out there, who holds it and how much it's actually
worth. After Lehman, frightened banks refused to lend to each other.
"The filing created a crisis in trust. It actually destroyed belief in the markets," says Harvey Miller, the Weil, Gotshal & Manges LLP
partner and widely acknowledged dean of the bankruptcy bar who became
Lehman's lead debtor counsel. "It was the spark that lit up the whole
fire."
Debate continues to rage over who or what is responsible for the
failure of Lehman and whether it could have been prevented. To some,
the unwillingness of Treasury Secretary Henry Paulson to save Lehman
was the financial equivalent of Neville Chamberlain standing by while
Hitler overran Czechoslovakia. In this view, Lehman was sacrificed on
the dubious altar of moral hazard and private sector responsibility.
A "horrendous" decision, said French finance minister Christine Lagarde.
To others, Lehman was so infirm and its management under longtime
CEO Richard Fuld so inept and unwilling to cede control, that the bank
couldn't possibly be saved. "Mr. Fuld's decisions drove the company
toward ruin, as his board stood idly by," New York State Comptroller
Thomas DiNapoli wrote in a bankruptcy motion demanding appointment of a
trustee. "Without question, Mr. Fuld's stewardship of the company was a
large factor in its demise."
Regardless, news of the impending bankruptcy wreaked havoc on global
markets before papers had even been filed. That day, Merrill Lynch
& Co. agreed to an acquisition by BofA. The next day, the Federal
Reserve pumped $85 billion into AIG. Later in the week, Lloyds TSB
Group plc announced it would acquire beleaguered HBOS plc, the first of
many forced financial couplings in Europe.
In the narrower context of bankruptcy, however, the system appears
to have worked remarkably fast, if not well. As a broker-dealer, the
Lehman operations themselves couldn't qualify for Chapter 11, but fell
under the auspices of a Securities Investor Protection Corp trustee. An
agreement quickly hammered out among the Federal Reserve, the
Securities and Exchange Commission, the SIPA trustee and Lehman in the
days after the filing allowed what Miller called "a prepack SIPA
proceeding."
Major Lehman assets were quickly sold out of bankruptcy, although
they fetched a small fraction of book value pre-bankruptcy. On Sept.
19, a U.S. Bankruptcy Court judge in New York approved a sale of
Lehman's New York headquarters and its North American investment bank
and brokerage operations to Barclays plc for $1.54 billion.
(Barclays had looked at buying Lehman pre-bankruptcy, but pulled out of
negotiations, the final blow to Lehman's survival.) The following week,
Japanese brokerage house Nomura Holdings Inc. agreed to pay $225 million for Lehman's Asia-Pacific assets. The next day, PricewaterhouseCoopers LLC,
the British-appointed receiver, announced Nomura had also captured
Lehman's European and Middle Eastern assets for what was described as a
nominal sum.
After a marathon eight-hour hearing on Lehman's sale to Barclays,
Judge James Peck overruled any objections and addressed the need for
speed. "I have to approve this transaction because it's the only
available transaction," he said. "This is not a question of due process
being denied," he added. To wait "would be reckless."
"The nature of the business, a financial institution, is different
from manufacturing, retail," says Miller, who argues that had the
Barclays sale not been completed so quickly, the 600,000-odd Lehman
clients could have found themselves unable to access their accounts.
"Financial institutions deal in money and money is fungible."
Miller points out that from Sept. 15 to Sept. 19, the value of
Lehman's assets depreciated by more than $20 billion. Because of the
filing, counterparties of Lehman's 2.5 million derivative contracts had
the legal option of quickly terminating the contracts if termination
was profitable or advantageous. According to Miller, "well in excess of
$75 billion, as high as $150 billion" worth of trades served notice.
In December, the estate sold 49% of Lehman's wealth management
division, Neuberger Berman, to management for $814 million.
Pre-bankruptcy, Lehman claimed Neuberger Berman was worth $5 billion to
$7 billion.
That said, the issue of Lehman's toxic assets, and their underlying
liabilities, can't be ignored. In a mid-January "state of the estate,"
restructuring firm Alvarez & Marsal LLC, which is managing
the Lehman estate, listed derivative trades and counterparties as a
major challenge to the estate winding down. So far, the document said,
more than 400,000 trades, both payables and receivables, were
terminated, reprsenting $14.3 billion receivables and $11 billion
payables.
About $43 billion in commercial and residential real estate assets
remain on the books. How much the Lehman estate will actually gain and
how much creditors can recover is another story. The markets remain
illiquid and depressed.
The Lehman bankruptcy may represent an inflection point in our
financial history, but that doesn't mean it's unprecedented. Grossman
is putting the finishing touches on a book that traces the evolution of
banking over the last two centuries. He likens the government's
decision to let Lehman fail but to save AIG to a series of moves in
19th-century Britain. The Bank of England refused to assist a brash and
anti-establishment bank called Overend, Gurney & Co., which failed
amid a bank run. Years later, Britain's central bank intervened to save
a much more politically connected Baring Brothers under the same sort
of circumstances. "None of this is new," says Grossman of what happened
last September. "Everything just moves much faster."
