Corporate Malfeasance in Lehman Brothers - Term Paper Example

College Collapse of Lehman Brothers Introduction Following a $620 billion estimated debt, Lehman Brothers Holdings Inc. filed for bankruptcy protection under the auspices of Chapter 11 of the U.S Bankruptcy Code in September 2008. According to Cramer, Lehman’s predicament was perpetuated by corporate malfeasance, shadow banking, naked short selling, high risk lending and the untimely subprime mortgage crisis. These factors led to the collapse of the corporate giant, thus, setting forth a global credit crunch and a liquidity crisis which scale was nothing short of unprecedented. It was one of the leading global financial services firms in the world, hence, its demise almost took the U.S and global economy down with it. The company was experiencing a mass exit by clients, dramatic fall in stock value and asset devaluation. Their bid for bankruptcy protection was the largest in the world history. Corporate Malfeasance Corporate malfeasance is a legal concept that denotes the art of falsely manipulating accounts such that the financial position of a company appears stable and progressive. Following their collapse, top executives of former corporate giants, such as WorldCom, Enron and AIG, faced civil suits and criminal charges with allegations of corporate malfeasance. Corporate malfeasance was one of the leading causes for the collapse of Lehman in light of the financial crisis of the late 2000. James Cramer calls the Lehman’s malfeasance case ‘financial engineering’ (Cramer 2). He believes that with the knowledge of top officials, CFOs and CEO Dick Fuld, the accounting department manipulated the financial records in a bid to make the company appear more venerable to attract investors and retain clients. Lehman’s financial engineering had gone on for a few years amid growing worries among top officials that the company was over-leveraged. The advice of chief financial officers and other top officials spearheaded the ‘financial engineering’ gimmick through counterfeit records to hide Lehman’s vulnerability to collapse (Taibbi 98). Sources retrieved from the Wall Street Journal indicate that CEO Fuld was aware of the imminent collapse. He was manipulated by a clique of shadowy bankers and top investors who wanted to be overnight billionaires by urging him to make money-losing decisions. Corporate malfeasance did not go far. The truth eventually emerged and Lehman’s estimated $619 billion debt was exposed. This was after the audit report of a court-appointed financial examiner was released. Fuld had admitted in writing that he had commissioned the financial engineering gimmick as a systematic ploy of buying the company more time. This was by creating “a materially misleading picture of the firm’s financial condition in late 2007 to 2008” (Cramer 2). Lehman’s accounting gimmick dubbed ‘repo 105’ allowed the sale of company securities through a signed obligation to re-purchase them after a while so that they can do so at a lower price. This would temporarily remove such asset securities from the balance sheet. Likewise, the untimely sale of securities allowed the influx of liquid cash into the bank thus effectively lowering financial coverage ratios. These subtle and corrupt financial gimmicks were done behind closed doors keeping investors and other stakeholders in the oblivion (Sorkin 8). The US Housing/ Subprime Mortgage Crisis Economic experts link Lehman’s predicament to the bursting the housing or real estate market bubble in the U.S in the summer of 2008. The untimely subprime mortgage crisis was another leading cause for the collapse of Lehman Brothers Inc. In 2007, the real estate market in the U.S had registered a remarkable progress amid the housing bubble. Housing prices soared, reached the elastic limit and Wall Street began to experience a huge increase in home foreclosure rates and equally high subprime mortgage delinquencies. Subsequently, securities backed by mortgages declined significantly. The steep decline made re-financing very difficult. Subprime mortgages lost their value. The number of investors willing and able to purchase mortgage-backed debt, reduced dramatically (Williams 90). According to a Wall Street analyst, in 2007, Lehman underwrote mortgage-backed securities accumulating an $85-billion portfolio. Lehman's stock rebounded, as global equity markets reached new heights (Nocera 12). This provided an opportunity for Lehman to cut their massive mortgage portfolio but it did not do so, which, in retrospect, turned out to be its downfall as the mortgage was about to burst leading to record losses and numerous collapses of major financial lenders. In the last quarter of 2007, Lehman recorded persistent losses in each quarter forthwith. Naked Short Selling At the time Lehman was filing for protection under Chapter 11 of the US Bankruptcy Code, former CEO Fuld attested that there were instances of naked short selling. Naked short selling involves the premature sale of an asset without procuring security or ensuring that such security is procurable. Naked short selling is done unconventionally in anticipation of a price fall. This exposed the company to a risk in the event that the asset prices went up. There were allegations in the Economist that the CFOs manipulated stock prices in order to profit from naked short selling of company’s assets. James Cramer writes that short selling contributed to the downfall of Lehman since the company never allowed a steady increase in stock value in bid to buy time for them to profit from the repurchase of the assets (Cramer 2). High Risk Lending, Shadow Banking and Bankruptcy The most obvious reason that triggered the demise of Lehman is the fact that it had overrated the U.S real estate market in face of the housing or mortgage bubble. The flourishing market had prompted the bank to engage in a series of unwarranted activities such as high risk lending to real estate moguls in anticipation of high returns. At the height of the housing bubble, Lehman recorded billions of dollars worth of profit from the sale of unsecured mortgages to real estate gurus. They profited from risky loans (Lawrence 76). Another key cause of Lehman’s demise was shadow banking. This refers to engaging in covert banking activities in collaboration with key (shadowy) players in the banking industry. Shadow banking involves the intentional withholding of certain information that clients, investors, stakeholders and the public ought to know (Lawrence 76). Top officials at Lehman called it ‘plausible deniability’ arguing that ‘what you don’t know can’t hurt you.’ They filed tax returns and other income assessments like any other financial agents but systematically withheld crucial accounting information such that the projected financial position was materially altered. It was impossible to tell, for instance, the true value of the firm. Likewise, they neglected to mention how they made their money or the capital they had at their disposal. Another concern was that, stakeholders and prospective investors were misled by the fraudulent manipulation of accounts, which definitely influenced their investment plan (Dillian 7). The bank never indicated their capacity to lend money along with the amount they were taking in form of leveraged security and whether that amount would secure repayment of mortgages. Failure to disclose was a systematic way of perpetuating fiduciary malfeasance and naked short selling. The bursting of the US real estate bubble later in 2007 led to the dawn of the global credit crunch. In March 2008, Lehman stock fell by 47 %. Investors were concerned that Lehman would be the next Wall Street loser following the near-demise of Bears Stearns. In the next quarter, Lehman announced a $2.8 billion loss. The downward trend was evident and this led to efforts to salvage the company. Negotiating took over in a series of deliberations with Barclays PLC and Bank of America, the acquisition bid did not materialize (Daigle and Arnold 9). Lehman also suffered yet another major blow. Credit-default swaps on Lehman’s debt suffered a 66 % spike along with a 44 % decline in company stock. The U.S government was reluctant to bail out the company, which remains unclear to date (Auletta 78). Lehman Brothers Holdings Inc. filed for bankruptcy protection under the auspices of Chapter 11 of the bankruptcy code in September 15 2008, thus leading to a decline of over 45 billion dollar of its market price. Conclusion The untimely collapse of Lehman Brothers Holdings took the world by storm. The former powerful firm suffered a major blow following the bursting of the U.S housing bubble and nearly brought the US and global economies down with it. As the largest bankruptcy bids in the history of the planet, the demise of Lehman Brothers was the initial indicator of the economic regression of the late 2000s. Corporate malfeasance was one of the leading causes for the collapse of Lehman in light of emerging studies into the financial crisis of the late 2000s. Similarly, there were allegations in the Economist that the CFOs manipulated stock prices in order to profit from naked short selling of company assets. Finally, the most obvious reason that triggered the demise of Lehman is the fact that they had overrated the U.S real estate market in face of the housing/ mortgage bubble. The flourishing market prompted the bank to engage in a series of unwarranted activities, such as high risk lending to real estate moguls in anticipation of high returns. Works Cited Auletta, Ken. Greed and Glory on Wall Street: The Fall of the House of Lehman. Random House: 2009. Print. Cramer, James. “Lehman’s Lessons Learned: One Year Later, What the Collapse of the Banking Colossus Has Taught Us.” New York Times, 13 Sep. 2009. Print. Daigle, R. J., and V. Arnold. Lehman's Shell Game: Poor Risk Management. New York: SAGE, 2000. Print. Dillian, Jared, Street Freak: Money and Madness at Lehman Brothers: A Memoir. New York: Simon and Schuster, 2011. Print. McDonald, Lawrence G. Colossal Failure of Common Sense: The Inside Story of the Collapse of Lehman Brothers. London: Crown Business, 2009. Print. Nocera, Joe. "Lehman Had to Die So Global Finance Could Live" New York Times, 11 Sep. 2009. Print. Sorkin, A. Ross. Too Big to Fail: The Inside Story of How Wall Street and Washington Fought to Save the Financial System and Themselves. Viking Adult: 2009. Print. Taibbi, Matt. "Wall Street's Naked Swindle." Rolling Stone, October 2009. pp. 50–59. Print. Williams, Mark T. Uncontrolled Risk: The Lessons of Lehman Brothers and How Systemic Risk Can Still Bring Down the World Financial System. New York: Simon and Schuster, 2011. Print. Read More