Five years ago, the investment banking firm Lehman Brothers filed for Chapter 11 bankruptcy protection. Although not the first of the larger investment banking firms to go bankrupt in the financial implosion, Lehman’s extensive interactions throughout many areas of the capital markets caused waves of concern to wash across the global financial markets.
The firm could trace its financial transaction roots back to the mid-1800s. Lehman’s history included involvement in the trading of cotton and fundraising for the early railroads.
Lehman’s extremely highly leveraged balance sheet meant it could not easily absorb shocks to its creditworthiness. At the time of Lehman’s bankruptcy filing, the firm indicated it had assets worth $639 billion and total obligations of $768 billion. These obligations included extensive borrowings from other banks and bonds it had issued in the fixed income markets.
A multitude of factors contributed to the collapse of Lehman Brothers. Extensive holdings of subprime loans and a variety of lower-rated residential mortgage securities resulted in substantial losses as those markets declined. The values of most of these securities were plummeting as confidence these borrowers could repay their mortgages diminished.
Following the collapse of Lehman Brothers, the stock market reacted violently. Volatility in the stock market significantly increased. By November 2008, the stock market had fallen to a new six-year low. It wasn’t until March 2009 that the stock market hit its last low point.
With the demise of Lehman, many other global financial institutions were either directly or indirectly affected. Liquidity in many financial markets evaporated. For many financial institutions, this liquidity is like the oil in a car engine. As a result of the liquidity concerns in the financial markets, the U.S. Treasury took a number of actions to pump funds into the system in an effort to keep the transactions moving.
Looking back five years, the difficulties experienced by Lehman Brothers, Bear Stearns and many other financial institutions have resulted in some meaningful changes. Off balance sheet financing and its close cousin shadow banking have been brought somewhat into the light. Balance sheet leverage has decreased at most financial institutions, allowing them to be better positioned for inevitable future shocks to the system.
In place of these past risks, new risks are likely forming. Although it is always difficult to forecast future events, the ongoing very low interest rate environment is likely sowing seeds of some sort of future bubble. Growth in student loan balances is also concerning. It is likely the next financial difficulties will not look like those of the most recent past.
Kirby Brown is the CEO of Beneficial Financial Group in Salt Lake City.