Crumbling Ethical Boundaries: Lehman Brother

For over 150 years, Lehman Brothers was synonymous with success and prestige on Wall Street.  The bank had grown to the status of being included in the bulge-bracket category, one enjoyed by only the largest and most profitable institutions.  However, by the time of September 10, 2008, Lehman’s stock stood at .21 cents, down 59.79 dollars from a year ago.[1]  Like many of the other banks, Lehman had benefitted from rise in housing prices that allowed for huge profits on mortgage loans.  The practice itself prior to the financial collapse seemed to be a noble one.  However, the firm was undone by its over-use of sub-prime mortgages.  This practice, of offering mortgage loans to individuals who have difficulty meeting the payment schedules, fell apart when the housing bubble burst.[2]  Lehman was overexposed in this regard, and by the time this was fully realized, the fate of the company had already been decided.  In this paper I will attempt to understand the decision making that went into this reckless spending, as well as examine whether or not these actions were done knowingly, or simply without proper research and risk management.  The fall of Lehman Brothers became symbolic of the entire financial crisis, as the once powerful firm was turned into a scapegoat for the misdeeds of many.  I will delve into the background of the company, as well as see if the actions of the company were truly unethical.

At the beginning of the 20th century, Lehman Brothers initially found success through the underwriting of securities, often partnered with another firm such as Goldman Sachs or JPMorgan.  They were especially successful in the consumer industry, where their underwriting of Sears, Roebuck and Co. and Woolworths were giant deals at the time.[3]  They eventually expanded their practices into aviation, commodities and media.  As the midpoint of the twentieth century passed, the business Lehman received from its retail clients continued to bolster their success on Wall Street, as they advised half of the top 20 retail companies in the US. Additionally, early investments in technology companies like Intel boosted profits through 1970’s.[4]  As the idea of private equity was born in the mid-seventies, M&A deals skyrocketed, leading banks like Lehman to get involved in advisory positions with other companies.

Lehman Brothers operated as what has been coined as a “shadow bank”, meaning they performed practices such as investment banking and structured investment vehicles without offering a basic personal banking program.[5]  For example, JPMorgan is a well-known investment institution, but they also have Chase Bank, a personal banking arm.  The same goes for Citigroup, with Citibank.  Examples of other shadow institutions include Goldman Sachs and Morgan Stanley.  Not only did Lehman offer the aforementioned investment services, they were also a major mortgage broker.

Before 1990, a sub-prime loan was almost unheard of.  Applicants underwent extensive background checks, and if their credit rating was under a certain number, then you didn’t receive a loan, bottom line.  However, around 2000 a credit bubble began to appear in the US.  As a wave of new capital entered the economy, more and more people became interested in purchasing their first house.  The increase in credit that started at the beginning of the 21st century spurred lenders to offer new sub-prime mortgages.  The ability of debtors to pay off their mortgages was completely predicated on the assumption that the housing market would continue to rise in value.[6]  Lehman has begun to see the profitability factor that came from the mortgages, and as a result overexposed themselves to potential losses; as the Wall Street Journal noted, “the firm established itself as a leader in the market for subprime-mortgage backed securities.”[7]  The firm had recklessly built up their MBS portfolio to the largest in the industry.  Keep in mind the well-being of these securities completely hinged on the sustainment of a strong housing market.  Meanwhile, at the same time that the MBS market was showing signs of trouble, CEO Dick Fuld used company capital to finance burgeoning private equity and real estate practices.[8]  While they didn’t know it yet, the firm could have used every liquid dollar available to them.  Instead, Fuld continued to expand, believing that the problem of MBS would not explode.

Explode it did.  As the housing bubble burst, a wide majority of the sub-prime mortgages Lehman had sold because illiquid.  When pressed to find a buyer, Fuld balked.  He refused an injection of capital from Berkshire Hathaway, and rejected deals with Goldman, Morgan Stanley and BofA.  Unbelievably, it appears as though Fuld believed Lehman could emerge of the crisis, even though a huge part of their business had essentially vanished before their eyes.  While the institution attempted to cover their losses by reporting profits in Q1 of 2008, the loss of 2.8 billion in Q2[9] signaled the beginning of the end for the firm.

As the weekend of September 13-14th began, employees were still holding out a bleak hope that the government would bail Lehman out.  When Bank of America chose to buy Merrill Lynch instead of Lehman, one more rope was cut from the bridge holding Lehman from insolvency.  While Barclays and Nomura bought small parts of the Lehman business, the main machine was shut down.  Lehman Brothers had succumbed to the largest bankruptcy in American history—613[10] billion.

When we look back on the financial crisis, it seems hard to believe that sub-prime mortgages could even be legal.  These were loans being offered to unqualified debtors, with the implicit knowledge that their success hinged on the strength of the housing market.  Obviously the successes of normal mortgages vary depending on housing strength, but nothing of this magnitude.  It is also amazing to think how short-sighted the bankers profit model was that it didn’t adequately take volatility into it’s structure.  When you look at this collapse from an ethical point, I came away with two main points: lack of accountability and poor executive leadership.

Lehman Brother was incredibly overexposed to losses from MBS at the time of the financial collapse.  Given the rigorous and prestigious reputation of hiring at a Wall Street firm[11], it seems impossible that this overexposure would have gone unnoticed within the firm.  And the fact that no one spoke up prior to the collapse suggests a culture that was more concerned about the employee than the client, or the financial system in general.  There has been much made of the profit-obsessed nature of investment firms, and how this culture contributed to the collapse.  It appears that this was also the case at Lehman.  There is no way this overexposure couldn’t have been noticed, and that no one could have seen the harm in using liquid company capital to finance their private equity and real estate divisions.  I believe that this is due a fear of potential punishment from the executives of the company, especially Dick Fuld, the CEO

Fuld was known as an authoritative figure who was overly aggressive even by investment banker standards.  Richard Swedberg, a professor at Cornell, went so far as to assert that,

“One reason why Lehman would later go bankrupt has to do with the fact that anyone who was perceived as a threat to Fuld was quickly eliminated—including a number of critics who early on realized that Lehman was headed for serious trouble.”[12]

I believe that when an executive is surrounded by people who are willing to challenge his or her decisions (to a certain point), a company runs most efficiently.  Fuld eliminated any people like that, and the company essentially was only run through him.  He grossly underestimated the effects that the loss of their MBS portfolio would have, and even after the effects were clear, he remained blindly confident that his firm would weather the storm.  His actions were completely unethical, and the worst part is he may not even have seen it that way.  By the time the sub-prime mortgages had fallen apart, he was too far gone to realize how wrong he had been.  Fuld became obsessed with the profit growth the firm had experienced in his time at the helm, and he allowed the ethical boundaries of the company to crumble.  Additionally, his lack of understanding of MBS and CDO’s caused him to underestimate the grave effects of their collapse, even when it was right in front of his nose.

Scholars and economists differ over Lehman’s role in the financial collapse.  Many people feel that the firm was the primary cause of the collapse, and that their loss on sub-prime mortgages made the overall loss too big to swallow.  Others feel that Lehman, along with Bear Stearns, were just the unlucky ones, and that if bailouts hadn’t occurred many other firms might’ve fallen.  As Jamie Dimon, CEO of JPMorgan put it, “large flaws in the financial system caused the meltdown…If it hadn’t been Lehman, something else would’ve been the straw that broke the camel’s back.”  Nevertheless, there is no doubt that the actions undertaken by Lehman were unethical.  The firm, especially it’s CEO Fuld, sacrificed ethics for profit.  And in the end, it killed at 150 year old firm.

[1] Nicholas, Tom, and David Chen. “Lehman Brothers.” Harvard Business Review. N.p., n.d. Web. <>. 4

[2] Nicholas, Chen 4

[3] Nicholas, Chen 8

[4] Nicholas, Chen 10

[5] “Shadow Banking System.” Investopedia. N.p., n.d. Web. 13 Nov. 2012. <;.

[6] Swedberg, Richard. “The Structure of Confidence and the Collapse of Lehman Brothers.” Cornell University Press (n.d.): 81. JSTOR. Web.

[7] Hudson, Michael. “How Wall Street Stoked the Mortgage Meltdown.” The Wall Street Journal [New York City] 27 June 2007: n. pag. Print.

[8] Swedberg, 88

[9] Fernando, Chitru S., Anthony D. May, and William L. Megginson. “The Value of Investment Banking Relationships: Evidence from the Collapse of Lehman Brothers.” The Journal of Finance 67.1 (2012): 247

[10] Chitru, May, Megginson 250

[11] Carney, John. “Why Is Wall Street So Addicted to Prestige Colleges.” CNBC. N.p., n.d. Web. <>.

[12] Swedberg, 83

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