Five questions (not so) silly about the fall of Lehman Brothers

How can such an important bank collapse? Why did the authorities not save her? All the elements to understand the implications of this historic event.
 | 14.09.2018 at 14:25
 • Updated
14.09.2018 at 14:47

By Mathilde Damgé

                                                                                                                On September 15, 2008, a major US banking group collapses to the surprise of all connoisseurs of Wall Street: Lehman Brothers Holdings Inc., 27,000 employees, is placed under the protection of Chapter 11 of the state law States on bankruptcy.
How can such an important bank collapse?
She had gone through the American civil war, two world wars and the crash of 1929; the Lehman Brothers bank collapses in a weekend, more than a century and a half after its creation. An event that did not happen completely by chance: in the 1990s, the bank took full advantage of the liberalization of financial markets and the deregulation initiated in the United States more than a decade ago.
It takes bigger and bigger risks and gets into the business of increasingly complex financial products. Problem: to finance their speculative activity and guarantee their profits, banks must constantly seek external financing. With a low starting bet, it was possible to risk a lot.
This is called leverage; Lehman Brothers was one of the highest: in 2007, with $ 1 in capital, the bank borrowed $ 30. A technique that can amplify gains as losses: if the bet is lost, 1 million dollars bet lost 30 million. In the third quarter of 2007, the fifth Wall Street investment bank is expected to announce an asset write-down of $ 5.6 billion.

          Lehman Brothers, new victim of "subprime"

Why did the authorities not save her?
"A few days before the bankruptcy, I understood that the Secretary of the Treasury [Henry Paulson] and the US government felt they had neither the political capacity nor the support of Congress to save Lehman Brothers with public money, recalls Jean -Claude Trichet, then governor of the European Central Bank (ECB). In previous weeks, congressional Republicans had vigorously criticized the rescue of Freddie Mac and Fannie Mae, the US mortgage guarantee agencies.
Still, the amazement after the announcement, Sunday, September 14 in the evening, the release of Lehman Brothers by the US federal authorities is total. The French Minister of Economy Christine Lagarde, who has since become Director of the International Monetary Fund, reacts in these terms: "Oh cow! …"

The next day is a black Monday in the markets: the defeat of the US bank plunges the stock markets. Whoever will become the next year President of the United States, Barack Obama, compares the crisis to that of 1929. On Thursday, Nicolas Sarkozy strives to reassure the French: "This is a solemn commitment that I take tonight: whatever happens, the state will guarantee the security and continuity of the French banking and financial system. The goal: to avoid a general panic and a rush of savers at the counters to withdraw their savings.
The subprime crisis, what is it?

The US housing bubble, born from the deregulation of credit, bursts in 2006: interest rates (variables) rise, borrowers are strangled by their debt. Conceded by credit companies with little regard for households not always solvent, and despite a compliant rating of official agencies (Standard & Poors, Moody's …), the "subprime" begin to reveal their true face, that of a gigantic scam.
The houses are worth nothing, creditors can not even pay on the resale of homes. Except that in the meantime subprimes have been transformed (securitized) into complex financial products, themselves bought by banks all over the world; the risk is thus spread over the entire planet.
Some investors like Lehman will pay this error at a high price, but banks like Goldman Sachs have achieved excellent results in 2007 speculating for their own account on the decline in the mortgage market.

When did the crisis begin exactly?
The first signs of a crisis appear when the real estate market across the Atlantic begins to slow down. But the beginning of the crisis is historically located in Europe: on August 9, 2007, BNP Paribas freezes three Luxembourg subprime funds, a signal that investors in these funds will not be able to recover their stake.

        The roll of
          the subprime crisis in France

On August 22, Lehman Brothers closes its subprime subsidiary, BNC Mortgage. The difficulties of Northern Rock and its rescue by the British government follow, the purchase of Bear Stearns, in great difficulty, by its rival JPMorgan, successive announcements of losses of Lehman …
The anxiety, already growing, among investors turns into panic at the time of the fall of Lehman. First signs of market distrust, the rates at which banks lend themselves to money explode, a surge in the rent of money that soon has repercussions on the loans that banks grant to businesses and block the 'real economy'.
Another consequence is the decline of investors towards values ​​considered less risky: commodities, whose prices are rising. In 2008, the FAO index (Food and Agriculture Organization of the United Nations, which measures the monthly change in international prices of a food basket) climbed in one year by 50%, and even 87% for cereals, causing a wave of food riots in Haiti, Egypt, Indonesia …
2007-2017: at the heart of the crisis that changed the world
   The biggest financial crisis of the 21st century – at this point – began in the summer of 2007. A year before the bankruptcy of the US bank Lehman Brothers on September 15, 2008, no one wanted to see that the largely created economic bubble by real estate speculation was about to explode. Ten years later, Europe is recovering from the cataclysm that plunged the global economy into recession and triggered the European debt crisis.
In 2007, the warning signs of the bankruptcy of Lehman BrothersChefs of States, central bankers, high-level civil servants … How they lived the crisisAfter Lehman Brothers, what lessons for finance? How the subprime bubble triggered the crisis of European debtsWhen the crisis undermines economic certaintyThe seeds of the next crisis
What has changed since?
The crisis has revealed a culture of unbridled risk within banks and the guilty lightness of some regulators. Since then, they have tried to turn things around; sales of "subprime" are by far the biggest reason for fines for the last ten years for banks.
In Europe, "countercyclical cushions" have been put in place to anticipate a future crisis. In concrete terms, it is a question of increasing banks' regulatory capital during a period of growth, in order to be able to reduce it in times of crisis.
But there is still household to do, with another 600 billion euros of bad loans out of bank balance sheets, especially in Italy. "We must also put in place the guarantee of bank deposits across the euro area, a promise that has never been finalized," said economist Hélène Rey, member of the High Council for Financial Stability.
On the other side of the Atlantic, after a restructuring of the sector with liquidation and express marriage, it is time for the return of the old demons; New President Donald Trump has made deregulation one of his priorities, leaving the door open to lobbies and the loosening of the Dodd-Frank Act, voted in 2010 and which frames credit.
As for the remuneration of players in this universe of speculation, if the European Union has imposed a ceiling – since 2014, the amount of the bonus must not exceed that of the fixed – the traders of the big banks of New York are not limited by such a device. This year, they earned an average bonus of $ 184,220, the highest level since the peak of 2006.

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