The Fall of Lehman Brothers

The story

Lehman Brothers had a long history. In 1844, a German immigrant named Henry Lehman opened a dry goods store in Montgomery, Alabama. His brothers joined him, and by 1850 the business was called Lehman Brothers. Over the next century and a half it grew into a Wall Street investment bank that survived railroad failures, the Great Depression and many market crashes. By 2008, it was the fourth-largest investment bank in the United States, with about 25,000 employees.

In the early 2000s, home prices in America were rising fast, and lenders were making loans to many borrowers who could not really afford them, called subprime mortgages. Lehman jumped in. In 2003 and 2004, it bought five mortgage lenders, including some that specialized in subprime loans. It bundled loans into investments to sell, and it also kept many of them. Even as home prices started falling, Lehman kept increasing its real estate bets. By the end of 2007, it held about $111 billion in real estate assets, more than twice as much as a year before.

Like other investment banks, Lehman paid for its investments mostly with borrowed money, much of it short-term loans that had to be renewed constantly. That worked only as long as lenders trusted Lehman. In March 2008, a rival bank, Bear Stearns, ran into trouble and was sold to JPMorgan Chase with backing from the government. Many people wondered who would be next.

Lehman tried to calm the worry. In June 2008, after its first quarterly loss as a public company, it raised $6 billion from investors. But on September 10, it announced a loss of about $3.9 billion for the quarter and $5.6 billion in write-downs, meaning it admitted some of its assets were worth much less than it had said. Lenders and trading partners began pulling away.

That weekend, government officials, including Treasury Secretary Henry Paulson, met with bank leaders at the Federal Reserve Bank of New York to look for a rescue. Bank of America chose to buy Merrill Lynch instead. A deal with the British bank Barclays fell apart when British regulators would not approve it in time. The government decided not to put its own money in. Early on Monday, September 15, 2008, Lehman filed for bankruptcy, listing about $639 billion in assets and $613 billion in debts. That day the Dow Jones stock index fell more than 500 points. Within weeks, credit markets froze, and Congress passed a huge rescue plan for the banking system.

Later, a court-appointed examiner, Anton Valukas, studied what went wrong. His 2010 report described an accounting move called Repo 105 that let Lehman temporarily shift about $50 billion off its books at the end of a quarter, making it look less indebted. He found enough evidence for possible legal claims against some former executives and Lehman's auditor, though that was not a court ruling. CEO Richard Fuld said he did not know about the transactions. Federal prosecutors and the SEC ultimately brought no charges against Lehman's leaders.

The lesson reaches far beyond Wall Street. Being old and famous is not protection. When a business depends on borrowed money and on everyone's confidence, it must be honest about its risks, because trust can vanish almost overnight.