A flashback on Lehman Brothers: The biggest bankruptcy in American history!
Ahead of the 10th anniversary of the collapse of investment bank Lehman Brothers Holdings Inc., which paralysed global credit markets and helped trigger a downturn in economic activity known as the Great Recession.

September 15, 2008, was one of the darkest days in the history of Wall Street.
Some facts about Lehman Bros:
- Twenty-four countries fell victim to banking crises, and economic activity has still not returned to trend in most of them.
- Public debt in advanced economies rose by more than 30 percentage points of GDP.
- Average American will lose $70,000 in lifetime income because of the crisis.
- Three million people in the US lost their jobs and five million lost their homes.
- Some key euro zone economies still not back to their pre-crisis size despite a decade of stimulus.
- Some American people lost to the recession may never make it back to work.
In 2007 Fortune magazine ranked Lehman Brothers investment bank number 1 on its list of “most admired securities firms”.
Just a year later, on 15 September 2008, the financial world was shocked when Lehman, with $600bn of assets, filed for bankruptcy, causing chaos in financial markets: stock prices plummeted, credit flows froze, and markets feared that even larger financial institutions – from Morgan Stanley to Goldman Sachs and Citigroup – might fail.
The moment in September 2008 when the 150-year-old investment bank Lehman Brothers collapsed, precipitating the worst global economic crisis since the 1930s.
After failing to find buyers for the troubled financial giant, that was weighed down by risky debt holdings made up of at subprime mortgages, US authorities declined to offer a bailout and allowed the institution to fail.
Monday, September 15, 2008, at 1:45 am, Lehman Brothers filed for bankruptcy, taking the world by surprise leaving well over $600 billion in debt, as well as 25,000 employees in shock.
It was the biggest bankruptcy in American history. On Wall Street, the Dow Jones plunged 500 points, the largest drop since the attacks of September 11, 2001. Stunned traders streaming out of the building carrying boxes of their belongings became a symbol of the crisis.
From 2005 to 2007, at the height of the real estate bubble, when mortgages were given to many homebuyers who could not afford them, and then packaged into securities and sold off, Lehman Brothers bought several mortgage brokerages and posted record profits.
But in mid-2007, the losses began to build. The knockout punch came nine months later, March 16, 2008, with the near bankruptcy of another investment bank, Bear Stearns.
Here is an explainer on the global financial crisis:
Good people with good jobs wanted houses to live. They followed the simple, tried and tested method. They went to a bank and asked for a loan. The bank obliged. Many people who were capable of repaying the loans bought houses. They paid their installments on time and everything looked fine. This was the time when the real estate market was on a boom. Also, the general notion about the real estate market is that it never goes down.
Now, the investment banks wanted to make some money. They bought these loans from the banks and bundled them together and sold them in the market in the form of Collateralised Debt Obligation (CDO). In the early phase, loans that were held by people who were capable of repaying it made the major chunk of a CDO. An investment bank would go to a credit rating agency and get these CDOs a good rating before putting them up for sale in the market. So here is the picture. Some capable people took loans from banks to buy houses. Banks sold these good loans to investment banks for a good fee. Investment banks bundled few hundreds of these loans and asked the credit rating agency for a good rating and got it. Now there is a product called CDO ready to be sold in the market. Since a CDO had the stamp of rating agencies, investors bought them with the hope that they would get a good yield out of the investment.
The demand for CDO was rising in the market as these CDO were nothing but a bundle of home loans, and it was assumed, everyone pays their home loan. So the risk was low. Seeing the rise in demand for CDOs, the investment banks went to the banks and asked for more loans they could buy. The banks got greedy and started giving loans to people without verifying their income or credit history. Now, this came to be known as sub-prime loans. And these loans had adjustable rates. Meaning that in the initial years, the interest rates would remain low. but later the rates would spike. But the home buyers had no idea about it. They were happy that they were getting homes to live. After giving loans to people with questionable credit history, the banks sold these loans to the investment banks. The same process of bundling and selling it in the form of CDO was repeated. Everyone was making money.
The insurance company too wanted a piece of this housing market boom. So there comes a company that says it would sell insurance on CDO. Simply put, an investor invests in CDO but thinks it might not give good returns. That investor can go to an insurance company selling insurance on that CDO. So the investor will pay a monthly premium to the insurance company and in case the CDO fails, the insurance company would pay the investor his money. This was known as credit default swap. So insurance companies, too, began making money.
Now, in the second quarter of FY07, the adjustable rates on sub-prime loans, or the risky loans, started to kick-in. The people who had questionable income history were unable to repay the loans and hence the defaults started. The houses on which the loans were not paid went to the bank. The bank auctioned it to get its money back. This would have worked had it only happened with only a handful of houses. Since the banks had given out sub-prime loans to a lot of people, there was just far too many houses to auction and not many willing buyers for them.
With an abundance of such houses and not many buyers, the real estate prices started coming down. This led to another unfortunate situation. A good person with a home loan became unwilling to pay his loan back because they value of his house had gone down but he was still paying more as he had a loan. As the loans started defaulting, the values of CDO, which is nothing but a bundle of home loans, also went down. As the value of CDO came down, investors lost their money. The investment banks had far too many worthless CDOs to sell but no buyers for it. The banks had too many bad loans to sell to the investment banks, but no takers. And yes, seeing the value of CDOs going down, the investors who had insurance against it, sought returns. The insurance companies had to pay the money to those investors.
The banks had no money, the investment banks were clueless about what to do with CDOs, and the insurance companies were paying the price of their greed in the form of returns. Moreover, people lost jobs and their homes. The entire financial system came to a standstill as the bank had no money to function or give to others. The stock of banks went to zero on the exchange. They filed for bankruptcy and shut their door.
How the RBI dealt with the Lehman crisis:

It was about a decade ago, on Sept. 5, 2008, that D Subbarao took over as the governor of the Reserve Bank of India. An experienced administrator, Subbarao was new to the world of central banking.
On Sept. 15, Lehman Brothers filed for bankruptcy.
Subbarao’s meetings turned into fire-fighting sessions. The induction turned into a rite-of-passage of sorts for the new governor.
In the three months that followed, the RBI had to keep markets ticking, tackle rumours of a run on ICICI Bank Ltd., address a liquidity squeeze across the mutual fund and NBFC sectors and, eventually, cut interest rates sharply to dull the domestic growth impact of the global financial crisis.
Ring-fencing the operation of Lehman Brothers in India was the first step. To do this, the top management of Lehman worked directly with RBI officials and ensured that it went smoothly.
Indian banks had limited exposure to the toxic securities that had led to a freezing-up of western markets. But there was some lingering concern that India’s relatively more global banks like ICICI may have an exposure.
Rumours started to swirl and the credit default swaps of ICICI spiked. One thing led to another and concerns of a possible run on the bank emerged. Those rumours needed to be stopped in their tracks.
Both the government and the RBI acted immediately. On Sept. 30, the following statement was released.
“It is clarified that the ICICI Bank has sufficient liquidity, including in its current account with the Reserve Bank of India, to meet the requirements of its depositors. The Reserve Bank of India is monitoring the developments and has arranged to provide adequate cash to ICICI Bank to meet the demands of its customers at its branches/ ATMs.” ~ RBI Statement
It moved to the health of the Mutual Fund sector, which was facing a genuine liquidity squeeze. On Oct. 15, the RBI put in place a special line of liquidity which would provide up to ₹20,000 crore for mutual funds.
Later, special liquidity facilities were put in place for NBFCs, housing finance companies and the Small Industries Development Bank of India.
The global economy is no longer the same place 10 years after the collapse of Lehman Brothers.
Ten years after Lehman, IMF’s Christine Lagarde warns fallout from financial crisis far from over.
“We have come a long way, but not far enough. The system is safer, but not safe enough. Growth has rebounded but is not shared enough,” she added.
“As I have said many times, if it had been Lehman Sisters rather than Lehman Brothers, the world might well look a lot different today,” Lagarde said.
Female leaders would be “more prudent, less inclined to the kinds of reckless decision-making that provoked the crisis.”
Lagarde suggests. IMF research, she says, concludes that boards of banks and financial supervision agencies with more women have greater stability.
Source: IMF Blog | The Economist | Bloomberg | Reuters | The Guardian | Daily Mail | AFP | The Washington Post | Business Standard
