Here’s why the Lehman Brothers collapse was such a watershed moment

Nick Sundich Nick Sundich, October 24, 2023

The Lehman Brothers collapse in September 2008 was one of the major triggers for the global financial crisis. This event sent shockwaves through the entire world economy, leading to a widespread economic downturn and plunging many countries into recession.

But why did the failure of just one company have such far-reaching consequences? To understand this, we need to look at the role of Lehman Brothers in the financial system and the events that led up to its collapse.

 

Who was Lehman Brothers and why did it collapse?

Lehman Brothers was a leading investment bank, with a history dating back to 1850. Just prior to the GFC it was 158-years old, had 25,000 employees and over $600bn in assets. It was heavily involved in the subprime mortgage market, which collapsed in 2007-8 due to rising defaults on home loans.

As a result, Lehman Brothers suffered significant losses and struggled to raise capital. In the months leading up to its collapse, there were multiple attempts to rescue the company, but ultimately they all failed. The US government refused to offer itself as a lender of last resort and no buyer could be found (it had searched for buyers). One day later, there was a US$85bn bailout for AIG, the insurance company responsible for issuing the bulk of the Credit Default Swaps that infected the global financial systems. This was too late to prevent wide-scale damage.

 

Why the Lehman Brothers collapse was a big deal

When Lehman Brothers filed for bankruptcy on September 15th, it was the largest bankruptcy in U.S. history. This had a domino effect on other financial institutions, as they all had significant exposure to Lehman Brothers and its assets. The sudden collapse of this major player in the financial system caused a loss of confidence among investors and triggered a credit freeze, as banks became wary of lending to each other.

Furthermore, the collapse of Lehman Brothers also highlighted the fragility of the entire financial system, which had become increasingly interconnected through complex financial instruments. As more companies started to reveal their own subprime losses, investors began to panic and withdraw their investments, leading to further market turmoil.

 

Global shockwaves

The shockwave caused by the collapse of Lehman Brothers rippled through different sectors of the economy. Stock markets plummeted, businesses struggled to access credit, and consumers faced difficulties obtaining mortgages and loans. The effects were felt globally, as many countries had invested in the U.S. housing market and held assets backed by Lehman Brothers.

In response to this crisis, governments around the world implemented various measures, such as bailouts and economic stimulus packages to stabilize their economies. The collapse of Lehman Brothers served as a wake-up call for regulators and financial institutions to reassess their risk management practices and take steps to prevent similar crises in the future. It was also tough for the employees who lost their jobs – but many of them managed to salvage their careers.

 

Investors remain scarred

Cast you mind back to the collapse of Silicon Valley Bank (SVB) earlier this year. There was substantial unrest in financial markets, which saw 2 further banks collapse and the US government quickly step in to guarantee deposits. Yet, investors sold off many companies unfairly – some that had money with SVB, others that had nothing to do with the bank at all.

This shows that investors remember the Lehman collapse very well and could be spooked by anything close to a wide-scale crisis happening – because of how Lehman was a sort of domino effect for the GFC.

 

Conclusion

In conclusion, the collapse of Lehman Brothers was a perfect storm of events that exposed the vulnerabilities and weaknesses in the global financial system. Its failure not only caused a shockwave through the economy but also sparked an ongoing debate on how to prevent such crises from happening again.

 

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