Lehman Moment

What Is a ‘Lehman Second’?

The time period “Lehman Second” refers to a scenario by which the issues of 1 firm or one seemingly minor element of the financial system become so massive they change into everybody’s downside.

The time period is a reference to the 2008 chapter of Lehman Brothers, then the eighth-largest funding financial institution within the U.S. The chapter triggered an enormous inventory market downturn and put such strain on the remainder of the monetary trade that the federal authorities stepped in with a $700 billion program of bailouts and organized mergers to stabilize the monetary system.

And the issue was not restricted to the U.S. It unfold globally and have become the 2008 International Monetary Disaster.

Key Takeaways

  • A “Lehman Second” describes some extent at which one firm’s issues change into everybody’s issues.
  • The time period refers back to the late 2008 chapter of worldwide funding financial institution Lehman Brothers, which many see because the turning level when the issues of U.S. funding banks turned the world’s issues.
  • Following the chapter, the U.S. authorities stepped in with a large bailout bundle to rescue your complete monetary sector, particularly funding banks and insurance coverage corporations.
  • The contagion unfold, and have become the 2008 International Monetary Disaster.

Background

Within the early 2000s, banks and different monetary establishments started providing mortgages to debtors who traditionally wouldn’t have certified, akin to folks with poor credit score, individuals who may make solely a small down fee or those that utilized for loans past their means to pay. These loans had been known as “subprime.”

Banks had been in a position lend to those folks for 2 causes. First, banks created new funding merchandise into which they pooled the loans after which bought to traders, dramatically lowering their very own danger by passing it on. Second, housing costs had been rising steadily, so even when debtors couldn’t sustain with mortgage funds, they might simply promote at a revenue and repay the mortgage or just borrow extra in opposition to the now-higher market worth of the property.

When value rises started slowing, it turned harder for debtors to promote at a revenue or to refinance. Mortgage losses started to rise.

By early 2007, main subprime mortgage lender New Century Monetary filed for chapter. Shortly thereafter, massive numbers of mortgage-backed securities had been downgraded to high-risk, and extra subprime lenders closed.

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As traders started to shun subprime mortgage merchandise, lenders stopped writing mortgages for subprime debtors, which minimize demand for housing; this, in flip, triggered home costs to fall additional.

Debtors all of the sudden may now not merely promote or refinance, and when the worth of their properties fell beneath what they owed in mortgage funds, many merely walked away.

By the summer time of 2008, the Federal Nationwide Mortgage Affiliation (FNMA, generally often called “Fannie Mae”) and the Federal Residence Mortgage Mortgage Corp. (FHLMC, generally often called “Freddie Mac”), each quasi-government lenders, had incurred losses so massive they wanted to be bailed out by the federal authorities.

Lenders started making it much more troublesome for dwelling consumers to borrow, which pushed down housing costs even additional. With foreclosures climbing, much more properties had been provided on the market, rising provide in an already oversupplied market.

By early 2008, the issues started hitting the nation’s largest monetary establishments.

In March 2008, the Bear Stearns Cos. notified the Federal Reserve Financial institution that it might not have sufficient financing to satisfy its obligations. As one of many largest securities companies within the U.S., with belongings of almost $400 billion, Bear Stearns’ issues rattled the market.

The Fed provided financing to maintain Bear Stearns afloat, and when that didn’t work, it brokered a deal for Bear Stearns to merge with JP Morgan Chase, committing some $29 billion to make the deal occur. The bailout meant Bear Stearns averted default and chapter.

Six months later, Lehman Brothers Holdings, on the time the fourth-largest funding financial institution within the U.S. by belongings, filed for chapter.

Lehman’s Function within the Subprime Market

Like many massive monetary establishments, Lehman had piled into the subprime market. In 2003 and 2004, Lehman acquired 5 mortgage lenders, together with two that specialised in subprime lending, BNC Mortgage and Aurora Mortgage Providers.

Lehman’s actual property enterprise helped drive income in its capital markets unit, which climbed some 56% from 2004 to 2006. Lehman reported file income in 2005, 2006 and 2007, when it reported $4.2 billion internet revenue on $19.3 billion in income.

In February 2007, Lehman’s inventory value hit $86.18 per share, a file that gave it a market capitalization of almost $60 billion.

Lehman’s Demise

At the same time as Lehman continued to report file income, cracks started to appear within the U.S. housing market by which it was closely invested. Subprime mortgage defaults hit a seven-year excessive, whereas the Bear Stearns bailout spooked the market. Lehman exacerbated considerations in June 2008 when it reported a second-quarter lack of $2.8 billion.

Chapter Fallout

The S&P 500 fell some 5% on the day of the Lehman chapter submitting.

Shortly thereafter, a significant cash market fund that held massive quantities of Lehman debt introduced it might not have the ability to repay its traders all the cash they’d put in, inflicting a run on cash market funds, which prompted the Fed to step in to ensure cash market fund belongings.

Regardless of efforts to stabilize the market, lower than 48 hours after Lehman filed for chapter, the Fed was compelled to bail out world insurer American Worldwide Group (AIG). The S&P 500 fell an additional 5%.

A number of weeks later, with the contagion spreading, Congress handed the Troubled Asset Aid Program (TARP), which offered some $700 billion to stabilize the monetary system.

Have There Been Extra Latest Examples of a Lehman Second?

In late 2022, hypothesis started circulating concerning the well being of Switzerland-based world funding financial institution Credit score Suisse, which skilled a collection of scandals and losses that hammered its share value and raised investor fears of attainable insolvency.

Some likened the potential for Credit score Suisse failing to a Lehman Second as a result of measurement of the financial institution and its worldwide attain.

These are a few of the issues which have positioned Credit score Suisse in peril:

In early 2021, U.Okay.-based monetary providers firm Greensill Capital went underneath, leaving Credit score Suisse shareholders with a $3 billion loss because the financial institution had invested in Greensill. Only a month later, Credit score Suisse misplaced an additional $4.7 billion because of its involvement with Archegos Capital, and no less than seven Credit score Suisse executives misplaced their jobs.

In February 2022, Swiss officers charged Credit score Suisse with laundering cash for a Bulgarian cocaine trafficking ring, later discovered the financial institution responsible, fined it 1.7 million euros, and ordered it to pay 15 million euros to the Swiss authorities.

Extra not too long ago, the financial institution was accused of ordering hedge funds and different traders to destroy paperwork that linked the funds to sanctioned Russian oligarchs, resulting in investigations into the financial institution’s compliance with Swiss sanctions imposed within the wake of Russia’s invasion of Ukraine.

Credit score Suisse’s inventory fell from a pandemic-era excessive of $12.30 to beneath $5 by late October 2022, erasing greater than 50% of the financial institution’s market capitalization.

Credit score Suisse’s credit score default swap (CDS) charge additionally climbed from simply 1% to just about 6%. A CDS is basically an insurance coverage coverage in opposition to default on the mortgage, so increased charges point out the market thinks there’s a larger chance the financial institution could not have the ability to pay its money owed.

What Is a Mortgage-Backed Safety?

A mortgage-backed safety (MBS) is much like a bond. With MBS, banks bundle mortgages and promote them as a bundle to Wall Avenue traders. Mortgage-backed securities gained prominence within the early 2000s when mortgage originators started providing mortgages to debtors who usually wouldn’t qualify for a mortgage, then packaging these riskier loans and promoting them on Wall Avenue within the type of mortgage-backed securities.

How Many Banks Failed in 2008?

Greater than 500 banks failed between 2008 and 2015, in contrast with a complete of 25 within the previous seven years. Most had been small regional banks. The most important failures weren’t abnormal retail banks, nevertheless, however moderately massive, world funding banks that catered to institutional traders, akin to Lehman Brothers and Bear Stearns.

What Is Dodd-Frank?

Within the wake of the monetary disaster, in 2010 the U.S. authorities handed the Dodd-Frank Wall Avenue Reform and Shopper Safety Act, usually referred to easily as “Dodd-Frank.” The act prohibited lots of the riskier actions that created the disaster, elevated authorities oversight, and compelled funding banks to take care of bigger money reserves.

The Backside Line

The time period “Lehman Second” refers to a scenario by which the issues of 1 firm or seemingly one minor element of the financial system become so massive they change into everybody’s downside. The time period emerged from the late 2008 chapter of worldwide funding financial institution Lehman Brothers, which many see because the turning level when the issues of U.S. funding banks turned the world’s issues.

Following Lehman’s chapter, the U.S. authorities stepped in with a large bailout bundle to rescue your complete monetary sector, particularly funding banks and insurance coverage corporations. However the contagion unfold, and have become the 2008 International Monetary Disaster.