The Pride - Issue 4 - Winter 2021 - Magazine - Page 18
F EAT U R E
BEHIND THE HEADLINES
The Lehman Brothers collapse, and why it still matters 10 years on
September 2018
marked the 10th anniversary of the
collapse of Lehman Brothers (Lehmans).
It was billed at the time as “high finance’s
darkest hour”, “the crash of a titan” and
“a colossal failure”; what the banks –
and global economies – subsequently
lost in assets, the media made up for
in headlines. But this was a rare case
of the press not hyperbolising – it’s now
acknowledged as the defining moment
of the credit crunch.
How did it all go so wrong?
US investment bank Lehmans was
deeply plugged into the global financial
system via a complex network of
contracts, deals and partnerships.
It had “leveraged up” – borrowing
money to invest in rising assets. This
helps to magnify returns when the
going is good, but also amplifies losses
when markets fall. Lehmans had put a
lot of faith in the US property market
– which had been booming thanks to
low interest rates and therefore cheap
borrowing costs – including commercial
real estate and had significant interests
18 - THE P R I DE - Issue 2 Winter 2018
in subprime mortgages (subprime is the
non-too gentle term for homeowners
who are at a high risk of default).
When rates rose, many of those
“subprime” homeowners struggled to
keep up with their mortgage payments
and defaulted. Aggregate demand for
houses subsequently dropped. Having
leveraged itself substantially, when
the investments in which Lehmans had
trusted their money plummeted, it quickly
went from owning more than it owed to
owing more than it owned. Lenders shut
their doors to Lehmans, potential buyers
balked at the prospect of taking on all
that risk, the US Government didn’t
come to the rescue, and so arrived the
biggest corporate bankruptcy in history.
Of course, things had looked grim
prior to Lehmans’ downfall. Words like
“credit crunch” and “subprime bubble”
had been floating around since 2006.
But the bank’s failure – and President
George W Bush’s refusal to bail it out –
triggered a chain reaction.
European banks had borrowed and
dealt in American money markets before
the crisis, inadvertently taking on the
poisoned assets which led to Lehmans’
demise. The day after the bank’s
collapse, shares in the UK’s biggest
mortgage lender HBOS dropped 34 per
cent as the market opened. By midday,
the FTSE had dropped by around 400
points. Three days later, HBOS was
rescued by Lloyds, and the FTSE was
trading below 4,000 (having previous
bounced around at the 6,000 mark).
Investors, understandably spooked,
pulled their cash from the stock market.
Consequently, funds were forced to sell
the shares they owned in businesses
to reimburse investors. Markets fell
and faith in the global banking system
plummeted – to the point where savers
worried that banks would literally run
out of money.
And then governments stepped in,
lending taxpayers’ money to banks.
This was enough to calm the market
storm and keep economies functioning,
but much, much more was to come.
Emergency bank bailouts, record
low interest rates and extraordinary
measures from Central Banks were just
the beginning of the road to recovery.