The collapse of the housing market (bursting of the housing bubble) and its crucial impact saw the end of the five largest US investment banks. Goldman Sachs and Morgan Stanley switched under constraints to commercial banks. Merrill Lynch was acquired by Bank of America. Bear Stearns was taken over by JP Morgan Chase. Lehman Brothers crashed completely due to the same mistakes of too high leverage and an overreliance on unrealistic real estate assets. Because of the disastrous outcomes of this bankruptcy there was a lot of discussion about the decision of the Fed to let Lehman fall.
In this paper I will start to explain the failures of Bear and Lehman, then I will analyze these states of affairs and finally I will present my recommendations for the future.
The collapse of Bear Stearns and Lehman Brothers
In June 2007 two internal Bear hedge funds that had been heavily invested in mortgage securities were in trouble. To keep them afloat Bear poured $1.6 billion into these funds. Nevertheless, later the funds lost all their value and broke down. This circumstance had lead to the loss of the essential and very important trust between Bear and its customers.
In October 2007 Bear agreed to the necessary $1 billion capital investment of the Chinese government-controlled bank Citic Securities. After writing down $1.2 billion of its holdings in mortgages and mortgage-backed securities (MBS) off in the third quarter and $1.9 billion in the fourth quarter, Bear announced its first lost in history, an unexpected high deficit of $859 million. After rumors in the beginning of March 2008 that European financial institutions had stopped doing fixed income trades with Bear, many US fixed-income and stock traders decided to halt on their engagements with Bear. As there was more and more fear about a bankruptcy of Bear Stearns a fatal downward spiral started. Loads of firms exercised extreme caution in their dealings with Bear. An exodus of capital began. This concern had lead to a dramatically drop of Bear’s liquidity reserves. Moreover Bear was not able to stem rescue financing and therefore the only possibility was a strategic acquisition. To rectify this state of affairs the Fed decided to offer a short-term discount window for Bear.
On March 16, 2008 the major commercial bank JP Morgan Chase made a takeover bid of $2 per share, 1.5% of the share price the year before. To help facilitate the deal, the Federal Reserve approved a $29 billion credit line to JP Morgan Chase. Due to criticism from Bear shareholders and employees, Bear Stearns and JP Morgan Chase renegotiated the deal. After all, JP Morgan Chase purchased 95 million newly issued shares of Bear’s common stock at 10$ per share. In June 2008 JP Morgan phased out the Bear Stearns name and announced keeping 6,500 of the 13,500 employees.
Lehman Brothers, the Wall Street’s fourth biggest investment bank, faced similar problems like Bear. In 2008 Lehman was still holding large sums in subprime and other lower-rated mortgage tranches. Due to this affair and the continuing subprime mortgage crisis, Lehman incurred unprecedented losses. In the second quarter of 2008 Lehman announced a $2.8 billion deficit and was constrained to sell $6 billion of its assets. In the first two financial quarters Lehman’s stock price lost 73%. In August 2008 Lehman had to let 1,500 of its employees go. After reports that the state-controlled Korea Development Bank was considering to buy Lehman, its stocks lost 16% within one week. Furthermore the stock plunged 45% to $7.79 after information that the Korean bank stopped their talks with Lehman. Investors’ confidence continued to erode and Lehman reported a huge loss of $3.9 billion in the third quarter of 2008. Because of that Lehman was forced to sell the majority stake in its investment-management business.
To rescue the sliding Lehman, Timothy Geithner, at that time president of the Federal Reserve Bank of New York called a meeting on September 13, 2008. Lehman reported that it was negotiating with Barclays and Bank of America for a possible sale. But one day later the deal with Barclays had been discouraged by the Bank of England and the UK's Financial Services Authority. Moreover Bank of America’s intention ended as it acquired Merrill Lynch. On September 15, 2008 Lehman Brothers filed for chapter 11 bankruptcy.