Lehman Brothers
From Invertopedia, the encyclopedia of how things fail
Lehman Brothers was a 158-year-old Wall Street investment bank[1] that held about $700 billion of assets on about $25 billion of capital, funded largely by short-term repo loans it had to roll over every day[2]. When lenders lost confidence in September 2008, it filed for Chapter 11 on September 15 with $639 billion in assets and $613 billion in debt[1], the largest bankruptcy proceeding ever filed[2]. The court's examiner later found that it had used "Repo 105" trades to take about $50 billion of assets off its balance sheet at quarter-ends in 2008 so its leverage looked lower than it was[2][3].
Contents
The bet
In 2006, Lehman decided to grow aggressively, take on significantly more risk and raise its leverage[2]. When subprime mortgages went from problem to crisis in 2007, it chose to "double down" on a countercyclical strategy instead of pulling back[2]. Management told the board in March 2007 that "the current distressed environment provides substantial opportunities as in the late 1990s"[2].
The model only worked while lenders kept rolling over its daily funding[2]. Lehman knew the rating agencies watched its net leverage and liquidity numbers closely[2], and it believed that if those numbers looked good, confidence would hold long enough for markets to recover.
What happened
| 2006 | Lehman commits to an aggressive growth strategy with more risk and more leverage on its capital.[2] |
|---|---|
| Mar 2008 | Bear Stearns nearly collapses. Lehman is widely seen as the next bank that might fail, and SEC and New York Fed monitors take up residence at the firm.[2] |
| Jun 2008 | Lehman reports a $2.8 billion quarterly loss, its first since going public in 1994, and says its net leverage is under 12.5. About $50 billion of Repo 105 sits behind that number. Three days later it raises $6 billion.[2] |
| Sep 9 – 10, 2008 | Korea Development Bank ends talks on a partnership and the stock falls 45%. Lehman projects a $3.9 billion third-quarter loss and reports a liquidity pool of about $40 billion.[2] |
| Sep 12, 2008 | The stock closes at $3.65, down 94% since January 2. The liquidity pool holds less than $2 billion of assets it can readily turn into cash.[2] |
| Sep 14, 2008 | A rescue by Barclays falls apart when the UK regulator will not waive a shareholder vote. The government says it cannot fund a solution.[2] |
| Sep 15, 2008 | Lehman Brothers Holdings files for Chapter 11 at 1:45 a.m. The Dow falls 504 points that day.[1][2] |
| Sep 20, 2008 | The bankruptcy court approves the sale of much of the US brokerage business to Barclays.[2][4] |
| Mar 11, 2010 | Examiner Anton R. Valukas files a 2,200-page report in nine volumes that lays out Repo 105.[2][3] |
| Apr 2025 | The 30th distribution under the bankruptcy plan brings total payments to creditors to $129.4 billion.[5] |
The kill shot
Lehman held long-term, hard-to-sell real estate and mortgage assets with money it had to borrow again every morning. When lenders stopped trusting its numbers, the money left and there was nothing to sell fast enough to replace it.
The examiner put it plainly: Lehman's assets were mostly long-term while its liabilities were mostly short-term, and it had to borrow tens or hundreds of billions of dollars in the repo markets each day to open for business[2]. In 2008 that was more than $200 billion a day[2]. It could not shrink by selling, because the assets it had piled up were illiquid and their prices were falling[2].
So it shrank on paper. A Repo 105 was an ordinary short-term loan against securities, but because the collateral was worth 105% or more of the cash, Lehman booked it as a sale and the assets left the balance sheet for a few days around quarter-end[2]. At the end of the second quarter of 2008 that let Lehman report net leverage of 12.1 instead of 13.9[2]. Its own staff called it an "accounting gimmick"[2], and one email called it "basically window-dressing"[3].
The cash cushion was also thinner than reported. Two days after Lehman announced a $41 billion liquidity pool, it held less than $2 billion of readily usable assets[2]. The government concluded it had no authority to inject capital and that Lehman's assets could not support a big enough loan[2], so when the Barclays deal died on Sunday there was nowhere left to go[2].
Red flags ignored
- Long assets, overnight money. About $700 billion of mostly long-term assets on about $25 billion of capital, funded by loans that could be refused any morning.[2]
- Over its own limits. Lehman's monthly risk appetite exceeded its internal limit every month from July 2007 to February 2008, by as much as $708 million.[2]
- Leverage managed for the quarter-end photo. Lehman treated anything that moved net leverage by 0.1 as material. Repo 105 moved it by whole points, and it was disclosed to neither regulators, rating agencies, investors nor the board.[2]
- A whistleblower who went nowhere. In May 2008 senior vice president Matthew Lee alleged accounting improprieties. On June 12, 2008 he told Ernst & Young about the $50 billion of Repo 105. Neither management nor the auditor told the board.[2][3]
- A cash cushion that was not all cash. Lehman kept counting in its liquidity pool the cash and securities it had placed with clearing banks as "comfort" deposits, and by August 2008 substantial amounts of them had become actual pledges.[2]
The cost
Lehman entered bankruptcy with $639 billion in assets and $613 billion in debt[1], and about 25,000 employees worldwide were affected[1]. Its stock went from $62.19 on January 2, 2008 to $3.65 on September 12[2]. The day after the filing, the $62 billion Primary Fund money market fund said it had "broken the buck" because of its Lehman losses, and the government stepped in to rescue AIG[2].
Through the 30th plan distribution in April 2025, the Lehman debtors had paid creditors $129.4 billion, of which $96.4 billion went to third-party creditors; senior unsecured creditors of the holding company had recovered about 46.7%[5]. Payments have continued since; after the 32nd distribution, on April 2, 2026, holders of the holding company's senior notes had recovered about 46.8%[6]. Separately, the trustee liquidating the US brokerage had paid about 111,000 former customers more than $106 billion by July 2015, when it proposed a payout that would bring its unsecured creditors to 35 cents on the dollar[4].
The inversion
Never fund long, hard-to-sell bets with money that can leave overnight. If the numbers only look safe on the last day of the quarter, they are not safe.
What survived
Barclays bought much of the US brokerage business in a sale the bankruptcy court approved on September 20, 2008[2][4]. The holding company's plan took effect on March 6, 2012[5], and the first distribution, about $22.5 billion, went out on April 17, 2012[7].
The examiner found colorable claims against CEO Richard Fuld and CFOs Christopher O'Meara, Erin Callan and Ian Lowitt over misleading financial statements, and against auditor Ernst & Young[2]. Fuld's lawyer said he "did not know what those transactions were"[3]. In April 2015 Ernst & Young agreed to pay $10 million to settle the New York attorney general's suit over Repo 105, with no findings of wrongdoing according to the firm, on top of $99 million to settle an investor class action[8][9]. The attorney general called it the only action by a law enforcement authority tied to Lehman's collapse[8].
References
- ^ “Lehman files for bankruptcy, to sell units”. NBC News, September 15, 2008. The September 15, 2008 Chapter 11 filing, $639 billion in assets and $613 billion in debt as of May 31, about 25,000 employees, the firm's 158-year history from Henry Lehman's 1844 store, and Fuld's tenure.
- ^ “Report of Anton R. Valukas, Examiner, Volume 1 of 9 (In re Lehman Brothers Holdings Inc., No. 08-13555)”. U.S. Bankruptcy Court, S.D.N.Y., March 11, 2010 (Jenner & Block copy via Internet Archive). The primary record: $700 billion of assets on $25 billion of capital, daily repo funding of more than $200 billion, the 2006 growth decision and "double down", risk-limit overages, Repo 105 amounts and leverage with and without it, the materiality rule, Matthew Lee and Ernst & Young, the liquidity pool, the 2008 losses and stock prices, the weekend of September 12-14, the 1:45 a.m. filing, the aftermath, the Barclays sale order, and the colorable claims.
- ^ “Report details how Lehman hid its woes”. NBC News, March 11, 2010. The examiner's report: 2,200 pages in nine volumes, Repo 105 of about $50 billion, the "window-dressing" email, Matthew Lee, and the response from Fuld's lawyer.
- ^ “Lehman creditors' recovery may soon reach $7.8 billion”. Reuters (Jonathan Stempel) via Yahoo News, July 13, 2015. The brokerage trustee's recoveries: more than $106 billion to about 111,000 customers, the proposed 35 cents on the dollar for unsecured creditors, and Barclays' purchase of much of the brokerage.
- ^ “Lehman Brothers Holdings Inc. Quarterly Financial Report as of June 30, 2025 (Form 8-K, Exhibit 99.1)”. Lehman Brothers Holdings Inc. Plan Trust filing with the SEC, August 28, 2025. The latest totals: $129.4 billion distributed through the 30th distribution (April 2025), $96.4 billion to third parties, 46.7% recovery for senior unsecured creditors, and the March 6, 2012 plan effective date.
- ^ “Notice to Holders of Senior Notes of Lehman Brothers Holdings Inc.: April 2, 2026 Plan Distribution to Senior Noteholders”. Wilmington Trust Company, successor indenture trustee, April 2026. The 32nd plan distribution on April 2, 2026, bringing cumulative distributions on LBHI senior notes to 46.819% of the allowed claim.
- ^ “Lehman Brothers Holdings Inc. Form 8-K, Exhibit 99.1”. Lehman Brothers Holdings Inc. filing with the SEC, December 28, 2012. The first plan distribution of about $22.5 billion on April 17, 2012.
- ^ “Ernst & Young settles with NY for $10 million over Lehman auditing”. Reuters via Fortune, April 15, 2015. The $10 million settlement, no admission of wrongdoing, the $99 million class action, and the attorney general calling it the only law enforcement action tied to the collapse.
- ^ “New York Attorney General Eric T. Schneiderman announces settlement with Ernst & Young”. New York Attorney General's office, via Mondo Visione, April 15, 2015. The attorney general's description of Repo 105 and Ernst & Young's role, the $10 million settlement and the $99 million class action.