The spectacular collapse of Lehman Brothers is perhaps the most dramatic banking failure in recent memory. The effects are still resonating throughout the financial industry, and its effects will be felt far into the future, even after the current credit squeeze evaporates. But how did such a large, and venerable financial institution such as Lehman Brothers so dramatically collapse, and why didn't anyone know it was about to happen?? The stark answer is that they did. The signs to the market were clear, but nobody acted early enough to avoid the worst banking failure since the Bearings Bank collapse in 1994.
The best way I can describe the situation is to outline, in the form of a timeline, what happened in the days and month leading upto the collapse of the company;
Early summer 2008: JPMorgan is the clearing bank on behalf of clients who have exposure to Lehman Brothers trading. The majority of these trading positions are money market funds and pension funds. JP Morgan also begins making intra-day loans to Lehman Brothers Holdings.
July 2008: The head of JP Morgan's risk department begins asking for collateral from Lehman Brothers Holdings as it becomes clear that Lehman's market exposure problems aren't going away and clients are getting more and more nervous. JP Morgan asks for $5 billion in July, but does not receive it until August. JP Morgan receives structured securities, which it considers difficult to value. When valued, JP Morgan decides that they are worth significantly less than $5 billion although it is quite unclear as to why JP Morgan accepted the structured securities. It is however, worth bearing in mind that Lehman has publicly stated at this time that it is looking for capital and that it wants to sell its investment management business.
Early September 2008: Lehman Brothers still has not raised the capital it requires and at this point has approached several banks about possible mergers but there are no positive developments, or anything on the horizon to suggest that a merger could be in the offing. The company anxiously moves to sell its investment management division to raise the by now, much needed capital, although the outlook for the company begin to take a more steep downward curve, as credit default swaps begin to spike.
September 4 2008: Lehman Brothers Holdings is in real trouble at this point, this time, JP Morgan asks for another $5 billion in cash, concerned that any securities might not be worth their full face value. JP Morgan's internal analysis shows that the initial $5 billion in structured securities received from Lehman Brothers, were now only worth a total of $1 billion. JP Morgan demands payment on behalf of money market fund clients who are demanding collateral on trades with Lehman Brothers. The money would never be recieved by JP Morgan...
September 9 2008: Steve Black, head of capital markets at JP Morning, knowing that Lehman has not paid the $5 billion from the week before, demands another $5 billion in cash to shore up its positions. JP Morgan recieve just $3 billion from Lehman Brothers Holdings. JP Morgan is getting more and more nervous: there are now mounting concerns that Lehman could go bankrupt if it doesn't urgently raise the required capital. Hours later, JP Morgan learns that Lehman Brothers is going to preannounce its losses and plans to raise capital. JP Morgan and Citigroup call an urgent meeting with Lehman Brothers asking them not to go ahead with the announcement as it would almost certainly spook the markets, and the expectation that sale of the investment management division would not be enough to raise the required funds. Lehman said it was worth $8 billion but Wall Street estimates were less than $3 billion. The firm needed around $4 billion in capital. No progress is made by the close of business.
September 10 2008: Lehman Borthers goes ahead with its pre-announcement and conference call to analysts. They assure investors the firm is healthy despite all the reported liquidity issues and that the firm had delivering capital to JP Morgan to cover positions. Deutsche Bank analyst Mike Mayo asks about the need to raise $4 billion in capital. Lehman's Chief Financial Officer says it doesn't need that much.
September 11-12 2008: JP Morgan discovers that its initial $5 billion wasn't paid. It demands $8 billion immediately. Over those two days Lehman Brothers Holdings delivers the money.
September 12 2008: Cable business channel CNBC, breaks the story that Lehman is attempting to sell itself, although no suitable offers are recieved.
September 13/14 2008: The Federal Reserve tries to save Lehman Brothers through a private sector bailout, but this fails on the Sunday Evening...
September 15 2008: Lehman Brothers Holdings files for Chapter 11 bankruptcy protection.