π Bankruptcy of Lehman Brothers
Core Lesson: Systemic risk, financial contagion
π Overview
| Attribute | Detail |
|---|---|
| Subject | Finance |
| Core Lesson | Systemic risk, financial contagion |
| Source | HBS / Top MBA Case |
π°οΈ Background
On September 15, 2008, Lehman Brothers β the 4th-largest US investment bank with 158 years of history β filed for the largest bankruptcy in US history ($639B in assets). Lehman had leveraged its balance sheet 30:1 into mortgage-backed securities and CDOs. When the housing bubble burst, Lehman faced massive losses, a liquidity crisis, and ultimately no buyer or government rescue.
β The Central Problem
Why did the government rescue Bear Stearns and AIG but not Lehman? Key issues: (1) Excessive leverage and concentrated risk in MBS/CDOs, (2) Lehmanβs use of Repo 105 transactions to temporarily remove $50B from its balance sheet each quarter-end, (3) The moral hazard debate β should central banks rescue failing institutions?, (4) Systemic contagion β Lehmanβs failure froze global credit markets instantly.
π Analysis
Lehmanβs 30:1 leverage meant even a 3-4% decline in asset values wiped out equity. CEO Dick Fuld refused to raise capital or accept dilutive offers early (Korean Development Bank walked away). When Bear Stearns was rescued in March 2008, markets assumed Lehman would be too. Treasury Secretary Hank Paulson decided to let Lehman fail to avoid moral hazard β but the contagion was catastrophic. Within 48 hours, money market funds broke the buck, commercial paper markets froze, and global interbank lending stopped.
π Key Lessons
- Leverage amplifies both returns and risk β at 30:1, even small losses are fatal
- Systemic risk means individual firm failures can cascade through the entire financial system
- Moral hazard cuts both ways β not rescuing Lehman was principled but created more damage than a rescue would have
- Quarter-end window dressing (Repo 105) masked the true state of the balance sheet
π Discussion Questions
- Was Paulson right to let Lehman fail? What were the alternatives?
- How did 30:1 leverage make Lehman so fragile? What leverage ratio would have been safe?
- What role did the credit rating agencies play in failing to downgrade Lehman earlier?
οΏ½οΏ½ Connected Concepts
Capital Structure, Corporate Governance, Investment Banking Overview, Capital Markets Overview, Monetary Policy