Four Years Since The Lehman Brothers Collapse

24 Sep

Four years ago, Lehman Brothers, a Wall Street investment bank collapsed. The shockwaves are still reverberating through the global financial system. The collapse of Lehman Brothers was the Pearl Harbor moment of a financial crisis that almost brought down the entire U.S. and Global financial systems.

The eurozone’s inherent weakness has been ruthlessly exposed, while here in Britain the crash ensured the death of a discredited regulatory architecture. By the end of 2012, a new regime in the UK will put responsibility for financial stability back in the hands of the Bank of England. 

Many still debate the blame for the collapse. People bought homes they couldn’t afford, peddled by lenders who knew (or should have known) that the loans were destined to fail. Stock Markets sucked up these loans and sold them off in bundles to investors.

Everyone should have known better. At the top of this list were the government regulators who are supposed to protect the economy from these Stock Market excesses, but who instead sat and watched as a global bubble built of rotten subprime loans kept expanding.

Financial institutions, each indebted to the next via complex financial products whose value outstripped that of the banks themselves, threatened to topple like dominoes.

After regulators forced the shotgun wedding of the investment bank Bear Stearns to JPMorgan Chase in March 2008, the Federal Reserve Bank of New York and the Securities and Exchange Commission sent teams of observers to Lehman Brothers to gather information and monitor the company’s condition. Like Bear Stearns, Lehman Brothers had invested heavily in mortgage bonds.

Instead of sharing their findings, as they had agreed to do, they did not. Had they shared information, they would have discovered that Lehman’s statements about the robustness of its liquidity were false, according to an independent examiner appointed by the bankruptcy court to determine what had gone wrong at Lehman.

When it finally became clear in the week before Lehman fell apart that disaster was imminent, regulators claimed that they didn’t have the tools to prevent its collapse. Lehman’s lawyers warned that an unplanned bankruptcy would lead to “armageddon.” Regulators let it fall, only to watch in horror as the entire financial system began to unravel, and lending of all sorts came to a halt.

It is impossible to say how the last four years would have unfolded had regulators, upon discovering Lehman’s failings, sounded warnings earlier about the instability of the nation’s largest banks. It is also not clear whether an orderly unwinding of Lehman from world financial markets would have significantly altered future events.

But here is a safe bet, economists and financial crisis scholars say: The financial system hasn’t yet been purged of greed, irrational exuberance or wilful misconduct. Another crisis will come.

Are regulators now better equipped to sniff out and prevent a disaster in advance (and/or manage the collapse of a major bank if they don’t)?

The risks to the financial system of a bank collapse have only grown. That’s because the banks themselves are even bigger than they were four years ago.

Size is no insulation against a full-fledged panic. The biggest banks are tied together through an endless series of loans, bets, side bets and even bets on whether each other’s financial products,investments that they don’t even own, will succeed or fail. 

Banks have the cushion to weather a storm as the government will prop them up.

Balance sheets were ravaged and in the UK both HBOS and Royal Bank of Scotland had to be bailed out with more than £65bn of taxpayers’ money just weeks after Lehman’s fall from grace. 

As Lehman staff filed out of their Canary Wharf tower for the last time, any sympathy soon evaporated at the sight of their office gear stuffed into boxes stamped with the logos of Chateauneuf-du-Pape and Cristal champagne.

Within six months, thousands of protestors overran the City of London, staging furious protests targeting London’s once-proud financial sector. 

Today’s banking landscape, at least in Britain, looks very different. Lenders must hold much higher cash buffers to absorb future financial shocks, while the City have been forced to rein in executive pay.

The Independent Commission on Banking is considering some form of split between investment and retail banking to accompany the regulatory shake-up.

As far as the safety of Britain’s banks goes, Investec analyst Ian Gordon thinks we’re on the right path.

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