Lehman Brothers: A License to Fail with Other People’s Money

Abstract

The bankruptcy of Lehman Brothers Holdings, Inc. (“Lehman”) is the largest bankruptcy ever filed, with losses to investors, both small and large, totaling billions of dollars. In January 2008, Lehman Brothers, heavily invested in by pension plans such as the California Public Employees’ Retirement System and the New York State Teachers Retirement Plan, traded at a high of over $65 per share. At that time, Lehman reported record numbers of nearly $60 billion in revenue and more than $4 billion in earnings. However, a mere eight months later, Lehman’s stock was trading under $4 per share, and on September 12, 2008, Lehman filed for Chapter 11 bankruptcy.The Bankruptcy Court appointed an Examiner to investigate and report on Lehman’s business affairs, with particular regard to “any fact ascertained pertaining to fraud, dishonesty, incompetence, misconduct, mismanagement, or irregularity in the management of the affairs of the debtor, or to a cause of action available to the estate.” The Examiner’s findings, taken at face value, reveal that the legal system that allowed Lehman’s failure will permit similar failures in the future because, for the most part, Lehman’s actions did not violate the law.This report explores Lehman’s risk management in a declining market and the valuation of its assets. Lehman, after recognizing the magnitude of the economic crisis, doubled-down on its risk, dramatically increasing the amount it was prepared to lose, while also disguising the declining value of its assets. These acts were not inadvertent, but rather were deliberate violations of internal risk limits and conscious overvaluations of its assets.