Loading presentation...

Present Remotely

Send the link below via email or IM

Copy

Present to your audience

Start remote presentation

  • Invited audience members will follow you as you navigate and present
  • People invited to a presentation do not need a Prezi account
  • This link expires 10 minutes after you close the presentation
  • A maximum of 30 users can follow your presentation
  • Learn more about this feature in our knowledge base article

Do you really want to delete this prezi?

Neither you, nor the coeditors you shared it with will be able to recover it again.

DeleteCancel

Make your likes visible on Facebook?

Connect your Facebook account to Prezi and let your likes appear on your timeline.
You can change this under Settings & Account at any time.

No, thanks

THE HOW AND WHY OF LEHMAN BROTHERS COLLAPSE

No description
by

Karthik Manoharan

on 9 May 2014

Comments (0)

Please log in to add your comment.

Report abuse

Transcript of THE HOW AND WHY OF LEHMAN BROTHERS COLLAPSE

Anvesh Alluri, Katherine Breiding, Lijing Huang, Vishnu Ram Mahendran, Karthik Manoharan
CONCLUSION
ISE 563 TEAM 3C
RISK MANAGEMENT
AFTERMATH
The banks are still too big, too interconnected and too under capitalized

Prudential regulation authority and Financial conduct authority replaced the Financial services authority

The structure of the banking industry and the amount of the capital banks were changed

A level was set in the international agreement known as Third Basel Accord

Bankers reputation was damaged, with the real issue being culture and not capital

The bankers needed to remember their “institutional memory” and change their operation structure
$1.25
Friday, May 9, 2014
Vol XCIII, No. 311
MISTAKES
LEHMAN BROTHERS COLLAPSE
LESSONS LEARNED
THE HOW AND WHY OF LEHMAN BROTHERS COLLAPSE
The Sub prime Lending Caused by the Housing Bubble
The housing bubble of the mid 2000s led to feelings of increased economic conditions.
At the very height of the real estate bubble, Lehman kept financing large-scale commercial real estate deals
A sub prime mortgage is “a type of mortgage that is normally made out to borrowers with lower credit ratings
Sub prime mortgages made up to 23.5% of the entire mortgage market in 2006
Misuse of CDOs and Credit Rating
The loans were placed into packages of assets called Collateralized Debt Obligations (CDOs)

Bankers wanted potential investors to buy their CDOs, they wanted the CDOs to have high ratings, as some investors would only buy CDOs with a AAA (the highest) rating

The banks hired rating agencies, such as Moody’s, to evaluate the quality of the CDOs

Although 75% of debt securities were rated AAA, eventually 70% of them defaulted
Credit Default Swaps and Over leveraging
A credit default swap, or CDS, can be purchased by a lender to insure himself against a change in the borrower’s credit
Unlike most assets that can only be insured by the owner, CDSs could also be used by outside parties with no ownership to bet on or against CDOs that they thought would default
Between the fourth quarter of 2006 and first quarter of 2008, Lehman’s assets had increased by almost 50% to some $400 billion
Its leverage ratio was
30 to 1
Governmental Mistakes
Economic Stimulus Act passed in February 2008, set the mortgage limits higher for mortgage regulation companies such as Fannie Mae and Freddie Mac
The Federal Reserve, led by Hank Paulson, implemented a series of stress tests for Lehman Brothers in order to see if the company would be able to pay off their debts, which they failed
Paulson went on to pursue several investors, such as Bank of America, Barclay’s, international banks, and even Warren Buffet to try to find stability for Lehman
When Freddie Mac and Fannie Mae began experiencing problems of their own, Paulson’s attention turned to keeping those agencies afloat
Management Mistakes
"Too Big to Fail" mentality
Banking, lending, and financial firms did not see the plausibility of Lehman Brothers or any other large financial institution collapsing
Lehman Brother’s precarious situation became a catastrophe, as the financial industry came to a crash
CORE IDEA
Approach :

Understanding and quantifying all the possible financial risks

Set limits for all the identified risks. i.e. Define a Risk Appetite

Most importantly protect the firm against any huge losses
The idea of Risk Appetite represents how much the firm could afford to lose in a fiscal year measured at 95% confidence
VALUE AT RISK (VAR)
Lehman Brothers employed a complex model to calculate risks called Value at Risk (VaR)

VaR is an estimate of the potential decline in the value of the Firm’s trading portfolios due to “Normal” market movements over a one-day holding horizon at a 95% confidence level

Lehman Brothers blindly reacted to the results of the statistical formula (VaR) completely neglecting reality and the vulnerability of the bubble which was about to burst
THE FALLACY WITH THE IDEA
VaR is calculated by a statistical formula which is composed of multiple variables, some of which are volatility, leverage and diversity

VaR results were such that the risk was low in quiet markets and high in turbulent markets

VaR was based on mathematical assumptions; for example, with a confidence limit of 99 %, it implies that the losses would only occur when trading in the other 1%.

The fact that daily prices drive the VaR calculations the 1% was really significant and the management bore a blind eye to this fact
LEHMAN'S PERFORMANCE OVER THE YEARS
Historical VaR of Lehman

2001 - $14 million
2005 - $55 million
2007 - $124 million






Lehman Brother’s capital grew from 3.4billion to 22.5 billion in 2007, almost 650% growth in over 10 years
LESSON ONE
Targeted and timely fiscal and monetary policy intervention can shore up consumer demand, re-build private sector confidence that is critical to investment, and kick-start economic growth
LESSON TWO
Co-ordinated action among the major countries is needed to deal with a global financial and economic crisis
LESSON THREE
The financial sector requires exceptional regulatory oversight because a well-functioning financial system is critical to the performance of every other sector in the economy
LESSON FOUR
When firms are “too big to fail,” they can threaten the entire economic system
Six years after the 2008 financial crisis, the world economy is in much better shape, but it remains exposed to key risk factors: regulation of the financial sector globally and very large firms in financial trouble. Here, more serious policy action is still required.
INTRODUCTION
LEHMAN BROTHERS
Global Financial Services Firm
Fourth Largest Investment Bank in the US
At 1:45 AM on September 15 2008, the firm filed for chapter 11 bankruptcy
Lehman's Bankruptcy filing is the largest in the US history
BACKGROUND
Lehman Brothers started its journey as a small dry goods store
The firm moved to New York in 1858 to join Coffee Exchange and the New York stock exchange
In 1975 the firm merged with Kuhn, Loeb and Company to form at the time the fourth largest investment bank
The firm was then sold to American Express. In 1994, AMEX sold its retail brokerage and asset management operations to Primerica and it spun off Lehman Brothers Kuhn Loeb in an initial public offering, as Lehman Brothers Holdings, Inc
Since going public in 1994, the firm had increased net revenues over 600% from $2.73 billion to $19.2 billion in 2008 and had increased employee headcount over 230% from 8,500 to almost 28,600
THANK YOU !
Full transcript