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Lehman Brothers declares bankruptcy

Year: 2008

Month Day: September 15

On September 15, 2008, the venerable Wall Street brokerage firm Lehman Brothers seeks Chapter 11 bankruptcy protection, becoming the largest victim of the subprime mortgage crisis that would devastate financial markets and contribute to the biggest economic downturn since the Great Depression.

Lehman Brothers History

At the time of its collapse, Lehman Brothers was the country’s fourth-largest investment bank, with some 25,000 employees worldwide—but it began as a humble dry goods store founded by German immigrant Henry Lehman in 1844 in Montgomery, Alabama.

After Henry’s brothers Emanuel and Mayer joined him in 1850, the business became known as Lehman Brothers.

In 1994, American Express—which had acquired the firm a decade earlier—spun Lehman Brothers off in an initial public offering (IPO). Under the leadership of CEO Richard Fuld, the investment firm began to expand its offerings in the aftermath of the 1999 repeal of the Glass-Steagall Act, which had barred affiliations between commercial banks and investment banks and their activities.

In this newly deregulated financial industry, Lehman Brothers increased its involvement in proprietary trading (or trading with the firm’s own money to make a profit for itself), securitization, derivatives, asset management and real estate.

Subprime Mortgages

The housing boom of the early to mid-2000s saw Lehman and other Wall Street firms become heavily involved in collateral debt obligations (CDOs) and mortgage-backed securities (MBSs).

Lehman also expanded into loan origination, acquiring five mortgage lenders between 2003 and 2004, including some specializing in subprime mortgages, which were given to borrowers with weaker credit who ordinarily wouldn’t have been able to obtain a mortgage.

As housing prices began to fall rapidly in mid-2006, many subprime borrowers began to default on their payments, revealing the risky nature of these debts.

Despite these warning signs, Lehman Brothers continued to originate subprime mortgages and increase its real estate holdings after housing prices went into decline, and by the end of fiscal year 2007 the firm held some $111 billion in commercial or residential real-estate-related assets and securities (more than double what it had held at the end of the previous year).

Signs of Trouble

Due to the weakening real estate market, as investors and ratings agencies expressed serious doubts about these types of assets, due to their lack of liquidity in the market, they began to lose confidence in Lehman and its investment banking peers.

Bear Stearns, one of Lehman’s closest competitors, was the first to go under, narrowly avoiding bankruptcy with a sale to J.P. Morgan Chase (backed by the federal government) on March 16, 2008. In the aftermath of Bear’s sudden collapse, rumors circulated that Lehman Brothers would be the next to fall.

Like Bear and other investment banks, Lehman’s reliance on short-term funding deals known as repurchase agreements, or “repos,” to raise the billions of dollars it needed to run business operations each day made it especially vulnerable to any crisis in investor and market confidence.

Lehman sought to reassure its investors, raising $6 billion in equity in June 2008, despite reporting its first loss since going public in 1994.

Then on September 10, the firm announced that it expected $5.6 billion in write-downs (reductions in the estimated or nominal value of an asset) for its “toxic” assets and a $3.93 billion loss for the third quarter. In addition, Lehman said it planned to spin off $50 billion of toxic assets into a separate publicly held corporation.

Largest Bankruptcy in U.S. history

In response to this announcement, the major ratings agency Moody’s threatened to downgrade Lehman’s debt ratings, and on September 12, Federal Reserve Chairman Timothy Geithner, Treasury Secretary Henry Paulson and others met at the Fed in New York to discuss the firm’s fate.

Despite concerns about the consequences a Lehman Brothers collapse would bring, the federal government and representatives of the administration of President George W. Bush ultimately refused to bail out another investment bank.

Hopes of a sale to another bank fell short as well: One prospective buyer, Bank of America, decided to buy Merrill Lynch instead, while British regulators blocked a last-ditch deal to sell Lehman to Barclays of London.

Out of options, Lehman Brothers declared bankruptcy early on the morning of September 15. The firm declared $639 billion in assets and $613 billion in debts, making it the largest bankruptcy filing in U.S. history.

That day, the Dow Jones Industrial Average plunged more than 500 points, its steepest decline since reopening after the 9/11 terrorist attacks. Lehman’s collapse sent financial markets into turmoil for weeks, leading many to question the federal government’s decision to let the bank fail.

After Lehman’s bankruptcy filing, Barclays agreed to purchase the firm’s North American investment banking and capital markets businesses, saving some 10,000 jobs.

As James Peck, the judge who approved the deal, put it in court: “I have to approve this transaction because it is the only available transaction. Lehman Brothers became a victim, in effect the only true icon to fall in a tsunami that has befallen the credit markets. This is the most momentous bankruptcy hearing I’ve ever sat through. It can never be deemed precedent for future cases. It’s hard for me to imagine a similar emergency.”

Sources

Lehman Brothers Bankruptcy, Yale School of Management.
A Brief History of Lehman Brothers, Reuters.
William D. Cohan, House of Cards: A Tale of Hubris and Wretched Excess on Wall Street (New York: Doubleday, 2009).
“Judge approves Lehman, Barclays pact,” Reuters, September 19, 2008.
“4 Reasons Why Lehman Failed,” The Atlantic, September 7, 2010.

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Bear Stearns collapses, sold to J.P. Morgan Chase

Year: 2008

Month Day: March 16

On March 16, 2008, Bear Stearns, the 85-year-old investment bank, narrowly avoids bankruptcy by its sale to J.P. Morgan Chase and Co. at the shockingly low price of $2 per share.

With a stock market capitalization of $20 billion in early 2007, Bear Stearns seemed to be riding high. But its increasing involvement in the hedge-fund business, particularly with risky mortgage-backed securities, paved the way for it to become one of the earliest casualties of the subprime mortgage crisis that led to the Great Recession.

Housing boom goes bust

In the early to mid-2000s, as home prices in the United States rose, lenders began giving mortgages to borrowers whose poor credit would otherwise have prohibited them from obtaining a mortgage.

With the housing market booming, Bear Stearns and other investment banks became heavily involved in selling complex securities based on these subprime mortgages, with little regard for how risky they would turn out to be.

After peaking in mid-2006, housing prices began to decline rapidly, and many of these subprime borrowers began defaulting on their mortgages. Mortgage originators started feeling the effects of the crisis first: New Century Financial, which specialized in subprime mortgages, declared Chapter 11 bankruptcy in April 2007.

In June, Bear Stearns was forced to pay some $3.2 billion to bail out the High-Grade Structured-Credit Strategies Fund, which specialized in risky investments like collateralized debt obligations (CDOs) and mortgage-backed securities (MBSs).

The following month, the firm revealed that the High-Grade fund and another related hedge fund had lost nearly all of their value due to the steep decline in the subprime mortgage market.

Bear Stearns collapses

For the fourth quarter of 2007, Bear recorded a loss for the first time in some 80 years, and CEO James Cayne was forced to step down; Alan Schwartz replaced him in January 2008.

Barely two months later, the collapse of Bear Stearns unfolded swiftly over the course of a few days. It began on Tuesday, March 11, when the Federal Reserve announced a $50 billion lending facility to help struggling financial institutions. That same day, the rating agency Moody’s downgraded many of Bear’s mortgage-backed securities to B and C levels (or “junk bonds”).

Unlike a regular bank, which can use cash from depositors to fund its operations, an investment bank like Bear Stearns often relied on short-term (even overnight) funding deals known as repurchase agreements, or “repos.”

In this type of deal, Bear offered bundles of securities to another firm or an investor (such as a hedge fund) in exchange for cash, which it would then use to finance its operations for a brief period of time.

Relying on repos—which all Wall Street investment banks did to some degree—meant that any loss of confidence in a firm’s reputation could lead investors to pull crucial funding at any time, putting the firm’s future in immediate jeopardy.

Taken together, Moody’s downgrade and the Fed’s announcement (which was seen as an anticipation of Bear’s failure) destroyed investors’ confidence in the firm, leading them to pull out their investments and refuse to enter into any more repo agreements.

By Thursday evening, March 13, Bear had less than $3 billion on hand, not enough to open its doors for business the following day.

J.P. Morgan Chase cuts a deal

Schwartz called on J.P. Morgan Chase, which managed the firm’s cash, to ask for an emergency loan, and told the Federal Reserve chairman, Timothy Geithner, that his firm would go bankrupt if the loan didn’t come through.

The Fed agreed to provide an emergency loan, through J.P. Morgan, of an unspecified amount to keep Bear afloat. But soon after the New York Stock Exchange opened on Friday, March 14, Bear’s stock price began plummeting.

By Saturday, J.P. Morgan Chase concluded that Bear Stearns was worth only $236 million. Desperately seeking a solution that would stop Bear’s failure from spreading to other over-leveraged banks (such as Merrill Lynch, Lehman Brothers and Citigroup) the Federal Reserve called its first emergency weekend meeting in 30 years.

On Sunday evening, March 16, Bear’s board of directors agreed to sell the firm to J.P. Morgan Chase for $2 per share—a 93 percent discount from Bear’s closing stock price on Friday. (Subsequent negotiations pushed the final price up to $10 per share.) The Fed lent J.P. Morgan Chase up to $30 billion to make the purchase.

Harbinger of the Recession

The unexpected downfall of the nation’s fifth largest investment bank, founded in 1923, shocked the financial world and sent global markets tumbling.

As it turned out, Bear Stearns would be only the first in a string of financial firms brought low by the combination of income losses and diminishing confidence in the market.

In September 2008, Bank of America Corp. quickly purchased the struggling Merrill Lynch, while venerable Lehman Brothers collapsed into bankruptcy, a stunning failure that would kick off an international banking crisis and drive the nation into the biggest economic meltdown since the Great Depression.

Sources

Kate Kelly, Street Fighters: The Last 72 Hours of Bear Stearns, the Toughest Firm on Wall Street (New York: Portfolio, 2009).
William D. Cohan, House of Cards: A Tale of Hubris and Wretched Excess on Wall Street (New York: Doubleday, 2009).
A Timeline of Bear Stearns’ Downfall, The Motley Fool, March 15, 2013.
“How subprime killed Bear Stearns,” CNN, March 17, 2008.
Timeline: A dozen key dates in the demise of Bear Stearns, Reuters, March 17, 2008.

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Stock market crashes on Black Tuesday

Black Tuesday hits Wall Street as investors trade 16,410,030 shares on the New York Stock Exchange in a single day. Billions of dollars were lost, wiping out thousands of investors, and stock tickers ran hours behind because the machinery could not handle the tremendous volume of trading. In the aftermath of Black Tuesday, America and the rest of the industrialized world spiraled downward into the Great Depression.

During the 1920s, the U.S. stock market underwent rapid expansion, reaching its peak in August 1929, a period of wild speculation. By then, production had already declined and unemployment had risen, leaving stocks in great excess of their real value. Among the other causes of the eventual market collapse were low wages, the proliferation of debt, a weak agriculture, and an excess of large bank loans that could not be liquidated.

Stock prices began to decline in September and early October 1929, and on October 18 the fall began. Panic set in, and on October 24—Black Thursday—a record 12,894,650 shares were traded. Investment companies and leading bankers attempted to stabilize the market by buying up great blocks of stock, producing a moderate rally on Friday. On Monday, however, the storm broke anew, and the market went into free fall. Black Monday was followed by Black Tuesday, in which stock prices collapsed completely.

After October 29, 1929, stock prices had nowhere to go but up, so there was considerable recovery during succeeding weeks. Overall, however, prices continued to drop as the United States slumped into the Great Depression, and by 1932 stocks were worth only about 20 percent of their value in the summer of 1929. The stock market crash of 1929 was not the sole cause of the Great Depression, but it did act to accelerate the global economic collapse of which it was also a symptom. By 1933, nearly half of America’s banks had failed, and unemployment was approaching 15 million people, or 30 percent of the workforce. It would take World War II, and the massive level of armaments production taken on by the United States, to finally bring the country out of the Depression after a decade of suffering.

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First stock ticker debuts

Year: 1867

Month Day: November 15

On November 15, 1867, the first stock ticker is unveiled in New York City. The advent of the ticker ultimately revolutionized the stock market by making up-to-the-minute prices available to investors around the country. Prior to this development, information from the New York Stock Exchange, which has been around since 1792, traveled by mail or messenger.

The ticker was the brainchild of Edward Calahan, who configured a telegraph machine to print stock quotes on streams of paper tape (the same paper tape later used in ticker-tape parades). The ticker, which caught on quickly with investors, got its name from the sound its type wheel made.

The last mechanical stock ticker debuted in 1960 and was eventually replaced by computerized tickers with electronic displays. A ticker shows a stock’s symbol, how many shares have traded that day and the price per share. It also tells how much the price has changed from the previous day’s closing price and whether it’s an up or down change. A common misconception is that there is one ticker used by everyone. In fact, private data companies run a variety of tickers; each provides information about a select mix of stocks.

READ MORE: Wall Street Timeline

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Martha Stewart is released from prison

Year: 2005

Month Day: March 04

On March 4, 2005, billionaire mogul Martha Stewart is released from a federal prison near Alderson, West Virginia, after serving five months for lying about her sale of ImClone stock in 2001. After her televised exit from the facility, Stewart flew on a chartered jet from nearby Greenbrier International Airport to New York, where she would serve out her remaining five-month home confinement on her 153-acre Bedford, New York, estate.

On December 21, 2001, Stewart sold about 4,000 shares of ImClone Systems, a company run by her friend Sam Waksal that develops cancer-therapy drugs. The next day, the company’s stock tanked after news broke that ImClone s newest cancer drug, Erbitux, had been rejected by the FDA. Waksal, who also sold stock before the drug’s rejection was made public, was arrested on charges of insider trading and later sentenced to more than seven years in prison. When questioned about her sale of the stock in June 2002, Stewart denied any insider knowledge and said that the stock was sold based on a previously made agreement with her stock broker, Peter Bacanovic of Merrill Lynch. The next month, Bacanovic was suspended by Merrill Lynch when investigators were unable to confirm that such an agreement actually existed. In September 2002, the Department of Justice began to investigate Stewart’s stock sale and alleged insider trading. Less than a year later, she was indicted on charges of securities fraud and obstruction of justice and subsequently resigned as chairman and CEO of the company she founded, Martha Stewart Living Omnimedia, though she remained on the company’s board. Stewart’s trial began in February 2003.

Days into the trial, Bacanovic’s former assistant, Douglas Faneuil, testified that he had been ordered by Bacanovic to inform Stewart that she should sell her ImClone stock. Soon after, a friend of Stewart s testified that Stewart told her she knew Sam Waksal had been trying to sell the stock before dumping her own shares. Though the judge dropped the securities fraud charge against Stewart in February for lack of evidence, she was convicted on all remaining counts of conspiracy, obstruction of justice, and making false statements on March 5, 2004. Public opinion polls at the time showed that many Americans believed Stewart should serve prison time; others thought Stewart had been unfairly targeted by overaggressive prosecutors.

On July 16, 2004, Stewart was sentenced to five months in prison and five months of home confinement, in addition to being fined $30,000 and given two years probation. She could have received up to 16 years in prison. Stewart requested to serve her time immediately and was sent to the minimum-security facility in West Virginia known as “Camp Cupcake” on October 8, 2004.

Despite fears that Stewart’s legal battle might devastate her financial empire, Martha Stewart Living Omnimedia’s stock price climbed dramatically during her incarceration, with values quadrupling by the time of her March 2005 release. During her subsequent home confinement, Stewart was forced to wear an electronic ankle bracelet to monitor her movement and was able to leave home for only 48 hours each week and only to go to work. Immediately upon completion of her sentence, she began work on two new NBC television shows: a primetime spin-off of the reality series The Apprentice and a daytime variety show, Martha.

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Wall Street informer, Martin Siegel, hatches insider trading scheme

Year: 1982

Month Day: August 24

On August 24, 1982, Martin Siegel meets high-powered stock broker Ivan Boesky at the Harvard Club in New York City to discuss his mounting financial pressures. Boesky offered Siegel, a mergers-and-acquisitions executive, a job, but Siegel, who was looking for some kind of consulting arrangement, declined. Boesky then suggested that if Siegel would supply him with early inside information on upcoming mergers there would be something in it for him. In January 1983, although little information had been exchanged, Boesky sent a courier with a secret code and a briefcase containing $150,000 in $100 bills to be delivered to Siegel at the Plaza Hotel.

Over the next couple of years, Siegel passed inside information to Boesky on several occasions. With Siegel’s inside tips, Boesky made $28 million dollars investing in Carnation stock before its takeover. But his success began to fuel investigative inquiries by both the press and the Securities and Exchange Commission. Rumors that Siegel and Kidder, Peabody & Co. were involved in illegal activities began floating around.

Despite the pressure, Siegel and Boesky met at a deli in January 1985, where Siegel demanded $400,000. This time, the cash drop-off was made at a phone booth. Siegel, who was apprehensive about his relationship with Boesky, decided to put an end to it after he had received his money. Still, he continued to trade inside information with other Wall Street executives.

In 1986, the illegal schemes, which by then included many of the biggest traders in the country, came crashing down. Arrests were made up and down Wall Street, and Boesky and Michael Milken, the junk bond king charged with violating federal securities laws, were no exception.

Siegel turned out to be one of the few cooperative witnesses for the government and virtually the only one who showed remorse for his role in the fraud, causing him to be ostracized on Wall Street. Nevertheless, he did fare better than the others: Milken received a 10-year sentence and Boesky received 3 years, but Siegel was only required to return the $9 million he had obtained illegally. The entire incident came to symbolize the era of unfettered greed on Wall Street in the mid-1980s.

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New York Stock Exchange resumes bond trading

Year: 1914

Month Day: November 28

On November 28, 1914, the New York Stock Exchange (NYSE) reopens for bond trading after nearly four months, the longest stoppage in the exchange’s history.

The outbreak of World War I in Europe forced the NYSE to shut its doors on July 31, 1914, after large numbers of foreign investors began selling their holdings in hopes of raising money for the war effort. All of the world’s financial markets followed suit and closed their doors by August 1.

By the end of November, however, American officials had decided to reopen the NYSE because it was thought that bond trading, albeit with a set of restrictions designed to safeguard the American economy, could help prevent the financial ruin of the belligerent countries by raising money for the war effort. Trading of stocks didn’t resume until December 12, 1914, when the Dow Jones Industrial Average (DJIA)—the most important of various stock indices used to gauge market performance—suffered its worst percentage drop (24.39 percent) since it was first published in 1896. This precipitous fall underlined the risky nature of business during the first months of the war, when nobody knew exactly how long the conflict would last or exactly what role the then-neutral U.S. would eventually end up playing.

Although the stock market would remain volatile–including a 40-percent drop in the DJIA from late 1916 to early 1917–World War I was a clear turning point in the realm of international finance. In its wake, New York would replace London as the top investment capital and the NYSE would become, for better or worse, the undisputed barometer of the world’s economies. The NYSE did not close its doors for any extended period of time again until the terrorist attacks in New York and Washington on September 11, 2001, when trading was suspended for three days.

READ MORE: Wall Street Timeline

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