Reasons Behind Lehman Brothers Bankruptcy

Reasons Behind Lehman Brothers BankruptcyUndoubtedly, the complexity and unpredictability of the external surround-market forces/stakeholders influenced the way and manner Lehmans CEO, Mr Ric hard Fuld be squanderd. He composite himself and his composition into unethical practices due to so legion(predicate) expectations on them. The market competition was getting very fierce, so he had to bend the rules in erect to keep his organization profitable.Market complacency, weak monetary regulations, lack of transparency and poor internal pecuniary control policy led to the demise of Lehman Brothers. Mr Fuld take the omnipotent view of anxiety only if told the U.S Ho spend of Representatives Committee on Oversight and Government Reform that the collapse of his firm was totally out of his control-i.e. emblematic approach. This indicated a weak moral culture/ maturation at the preconditional level. His ethical inclination indicated a utilitarian approach which involves decision making based on favorable anticipated outcomes.Clearly, the fall of Lehman Brothers was a preventable man- do disaster. He enshrined a very poor risk forethought culture in the organization by offering passing leveraged Mortgage Backed Securities. Even if Mr. Fuld felt the scotch tides were beyond his control as he proclaims, he should experience at least sold the company early enough the way Merrill Lynchs CEO smartly did. But his ego as soundly as poor management insight took a better part of him.Lehman never engaged in real Corpo treasure affable Responsibility, rather what they did was philanthropy with ulterior motives in object. They never issued a CSR report of any kind depicting lack of transparency and accountability.There is no denying the hard and bitter truth that we are experiencing a orbicular financial recession with many a nation counting their losses. We are in fact passing play by means of possibly the worst global consultation crisis since the Great Dep ression. Given that the world is flatter and with advancing technology, global financial markets are now integrated consequently making an otherwise bailiwick financial market a global phenomenon. By a straightforward click of a button, billions of dollars can seamlessly traverse national boundaries at the speed of light.Sadly, this global financial meltdown originated in USA due to the widespread subprime mortgage defaults, stinting recession is affecting all the major players of world economy.By folk 2008, the commendation crunch, which started nearly 2006, had alarmingly ballooned into Wall Streets biggest crisis since the Great Depression as hundreds of billions in mortgage-related investments went sour mighty investment banks that once ruled high finance empyrean crashed.In the midst of this conundrum, accusing fingers are been pointed at different quarters virtually blame the regulatory authorities over complacency and blind-faith, while some blame the private and inve stment banks over greed, poor corporate governance/practises and investment decisions. The worst hit directly were the insurance companies, investment banks, Hedge store operators, Large Mortgage Lenders such as Lehman Brothers, Merrill Lynch, nurse Stearns, Fannie Mae, and Freddie Mac etc.The United States government has been battling to starve off what has surely snowballed into a global economic recession by acquiring national mortgage giants Fannie Mae, Freddie Mac, AIG as wellhead as midwiving Bear Stearns Cos Incs sale to JPMorgan Chase. Bank of America took over Merrill Lynch. date these bailouts were going-on, a blind eye was turned on the struggling fourth largest investment giant- Lehman Brothers.Consequently, the Lehman brothers filed for failure on September 15, 2008 as a result of the feed refusing to bailout them out or at least backstop their toxic assets.1.1 CASE ISSUESThe case issues discussed areThe interior and External EnvironmentWe shall evaluate how these environments interacted with Lehman Brothers.managerial moralityReactions are bound to be elicited as organizations continue to interact with their environments. Hence we shall attempt to assess how Lehman Brothers behaved and reacted in accordance with ethical theories and standards.Corporate Social ResponsibilityLehman Brothers Social Responsibilities as well as their attendant consequences shall be evaluated.PART A2.0 THE INTERNAL AND EXTERNAL ENVIRONMENT OF LEHMAN BROTHERS2.1 The External EnvironmentOrganizations do non operate in a vacuum because they derive their ultimate existence from the environment. Environmental factors whether specific or broad-based, influences an organizations strategy for survival and profitability. Lehmans external environment consists of its stakeholders such as Mortgage financiers, Hedge Funds, Pension Funds, Government Regulators, Commercial Banks, Investors, Credit Rating Agencies, employees, Home Owners, Small and Large companies, etc. See d epend below for a schematic diagram of Lehmans overall environment. Figure 1GLOBAL ECONOMICSDEMOGRAPHICS POLITICAL/LEGALTECHNOLOGICAL SOCIOCULTURALSuppliersPressure GroupsLEHMAN BROTHERSCustomersCompetitorsHow suspicious and complex is Lehman Brothers environment?Below is the Uncertainty matrix used to evaluate how the external environment affected Lehman Brothers. Figure 2ENVIRONMENTAL UNCERTAINTY matrixSource Robbins, Bergman, Coulter, Management 4e, 2006, Pearson Education, AustraliaDue to the case and nature of business, Lehman Brothers falls at heart the cell block 4 which connotes a dynamic and unpredictable environment characterised with many components and a high need for knowledge. Hence, Lehman stands the chance of been influenced by the external environment which may reduce the influence of its managerial decisions and interventions.Lehman Brothers broader environment as it affected their activities, behavior and outcomes are discussed under the following sub-headings using the Political/Legal, Economical, Socio-cultural and Technological convinces, blighter analysisPolitical/LegalLehman Brothers which was formed some 158 years ago was initially involved in assisting large corporate firms such as Sears, Roebuck and F.W. Woolworth, etc raise capital to expand their businesses. During the 1930s, the Lehman Brothers diversified into strictly Securities business when the U. S government forced all financial institutions to choose between commercial banking and Securities.Lehmans portfolio deepened following the repeal of the Glass-Steagall Act in 1999, during the Clinton administration. The act prohibited banks from place on Wall Street, thus shielding consumers from riskier transactions. Once that protection was abolished, Lehman was able to gamble and it became among the largest issuers of Mortgage-Backed Securities making its share price to climb from its 1994 price of $5 to $86 in 2007.As a result of Lehmans desperate attempts to compete fie rcely with its core rival, Morgan Stanley for market share, it employed several under-arm tactics that exposed it to several bitter brushes with the law amounting to multiple litigations (See attachment 1). This further hurt its corporate image by brewing fear, panic, dis think amongst its stakeholders resulting in it been abandoned during its time of need.Lehman would have been saved respectable as Fannie Mae, Freddie Mac, Bear Stearns and AIG under the current political climate, but there were outstanding issues involved e.g. the federal Reserve picked out big holes created by the toxic assets in Lehmans isotropy sheet coupled with their refusal to come out clean to the public. Instead, Treasury and Federal Reserve bosses, Messrs Henry Paulson and Ben Bernanke reckonively, preferred to save others because they felt that allowing these (Fannie Mae, Freddie Mac, Bear Stearns and AIG) to fail would have resulted in a cataclysmic cascade of events that will consume not only in th e U. S economy but the Worlds. Moreover, Mr Paulson never believed it was right to use taxpayers money to save Lehman. Whether this was a right decision remains to be seen as the Lehmans bankruptcy has inevitably crippled global financial markets worldwide.EconomicThe macro instruction and Micro-economic environment which Lehman Brothers operated played a vital intention in its demise. Indeed, what basically happened to Lehman was typically a simple economic case of supply outstripping demand.After the terrorist attacks of September 11, 2001, the Fed greatly lowered pastime rates in other to stimulate economic growth and prevent deep recession. Expectedly, the largest Wall Street firms began reacting to this Federal Reserve policy of extremely low rates at which money was borrowed by purchasing billions of dollars of subprime mortgage loans. These were most managely bought from nonbank mortgage companies, which borrowed money from companies like Lehman in order to make loans and quickly resell them to Wall Street.Bear Stearns and Lehman Brothers almost monopolised this market as other players like Merrill Lynch were late arrivals to the highly leveraged/risky subprime lending and securitizing business. Lehman offered bulk loans to nonbank lenders, also purchasing mortgage products and then turning them into Asset Backed Securities (ABS), and then exchange these bonds to end investors basically make up of the insurance companies, Hedge Funds, Pension Funds, Local Governments and foreign banks.The Securities and Exchange Commission escalated the already worsening economic situation in 2004 by load-bearing(a) these investment banks through the relaxation of the pre-existing limits on leverage. Expectedly, the leverage ratios of the five largest independent investments banks hit the rooftop (Labaton, 2008). Lehmans greedy internal financial policy did not stand by matters at all, as it offered potentially dangerous leverage ratios as much as 301, asset-to-e quity ratio (Table 6, see appendix 2). Given this scenario, any 3% drop in measure of assets completely blows out the entire value of equity thus rendering the company bankrupt. Nevertheless, Lehman grew rapidly, playing a dominant spot in the securitisation market and the leveraged lending businesses posting quarter after quarter of record earnings from 2004 to 2007.Even after the economy had recovered, the U.S Fed notoriously unploughed interest rates low which made mortgage payments even cheaper and affordable thus greatly reducing the likelihood of defaults to barest minimum. Therefore, demand for homes began to escalate, sending prices up. In addition, megs of homeowners seized the luck of rate drops to refinance their existing mortgages. As the industry became saturated (as virtually bothbody now owned a home), coupled with the never-ending competitive rivalry among lenders, the smell of the mortgages went down resulting in the eroding of underwriting standards.For the fear of inflation due to excess liquidity in the markets, Fed started increasing interest rates which eventually made mortgages already owned, worth less than the amount for which they were initially purchased due to higher payments. This sent widespread panic across all stakeholders which to loss of confidence and trust in financial markets trail to mortgage defaults and subsequent foreclosures. With this ugly scenario playing out, coupled with the Lehmans increasing inability of meeting its debt obligations, investors lost confidence in its stocks resulting to bankruptcy with close $613 billion in debt.Socio-culturalThese are factors such as behaviours, beliefs, values, demographic trends as they affect organization. A majority of Lehmans workforce belong to the generation Y. generation Y are generally lifestyle oriented, tech-savvy, ambitious, impatient, etc. Because they generally flock to where the money is, Lehmans top management continued to do everything in its power to g o for its best brains. With the continuous availability of low interest funds, change in consumer taste became the norm. An individual who otherwise wouldnt have been able to afford a dramatics now had access to owning more than one house. This made the public adopt the culture tending towards investment rather than consumerism which affected other real sectors of the economy. This change in consumer taste favoured Lehman initially because of increase in mortgage demands. Soon Lehman had no borrowers for its mortgage products because everybody now had a house and with the increase in interest rates, foreclosures became apparent because the real weak financial status of its borrowers became obvious.TechnologicalAdvancement in technology played a very double-edged sword role at Lehman Brothers. It brought about drastic reduction in the cost of creating mortgages. The growth of the internet coupled with easier availability of information about potential borrowers by the simple click of the mouse button, encouraged it to rely more heavily on convenient sources of information, such as credit scores and ratings, rather than on the more labour intensive time tested methods. It also made searching for a new set of borrowers easier and less costly, mortgage offerings using bulk tele glide by sending tools.On the other hand, these noveltys created what economists call an agency problem. Since the mortgage originator was no longer going to hold the mortgage to maturity, but rather was going to immediately sell it to a securities firm and collect its fees upfront, it did not have a strong inclination to conduct a thorough appraisal of the loan.2.2 The Internal EnvironmentThe internal environment of any organization basically symbolizes its culture, nature, commonly shared values and beliefs (Robbins S., et al, 2006). Companies will react to same circumstances differently due to the differing cultures that distinguish them. Furthermore, an organizations internal stren gths and weaknesses as well as opportunities and terror, SWOT can play a vital role in its success or failure.2.2.1 Lehmans lastLehmans CEO, Mr Richard Fuld in my opinion is viewed as an omnipotent leader because he single-handedly turned the fortunes of the company around when he assumed office in 1994. He ran the organization like a warfront where he enshrined a very strong culture amongst his subjects.His colleagues even nicknamed him Gorilla because of his imposing stature on the firm as nobody not even outsiders dared challenge his ideas, policies and decisions. This behaviour was not unexpected because Lehman has had a long history of hostilities, in-fighting and coup de tat within its ranks which had cost it its independence in 1984.Since we already know that the internal environment of an organisation is all about its culture, behaviour and reaction as to how it sees the external environment. For the scope of this report, we may not dwell so much on the positive culture o f Lehman rather we shall take a critical look at how its culture might have played a role directly or indirectly in its demise using the seven dimensions of culture.Usually, attention to details is very much of needful skill financial institutions must possess. But due to the competitive landscape and greed on the part of senior management, ethical details were ignored regarding the type of mortgage loans that were issued. Background checks werent performed to de nameine the credit worthiness of its mortgage borrowersInnovation and Risk allowance accountXHigh innovation/High risk tolerance culture as evidenced in their highly leveraged mortgage securities offering which came through several complex financial innovative packagesOutcome orientationX-Outcomes/result-oriented culture that focuses more on results rather than how they were achieved. This attitude made it lose sight on the illiquidity of the market during the impending crisis because of blind greed Short term performance reward culture throughout the firm not minding if these loans would survive in the long term or notStabilityX rattling strong/stable culture of lets maintain the status quo which resulted in their inability to adapt to the current financial situations.People orientationX-Poor and ineffective conversation culture from top management to the bottom. Senior execs never took feedbacks from employees in the field seriously While senior management compensated themselves with cash allowancees, other employees were issued bonuses generally in stock options and bonds. Lack of recognition for outstanding performance especially if it came from a lower employee A culture of lack of transparency among the senior executives. They never communicated the true nature of their liquidity to their employees and other stakeholdersAggressivenessXOverly aggressive culture in which they tried to bully, falsify and outsmart the market but got their fingers burnt.Team orientationXNon collaborative compet itions which dampened employee morale. The atmosphere was like that of a collegiate, people formed cliques and cartels. There was teamwork, but competition was basically on a personal level because of rewards that may accrue from individual performanceThe above listed cultural adoptions by Lehman went a long way in tarnishing their image before its global stakeholders which made it difficult for it to be trusted and rescued when its state of insolvency became apparent. Table 2.02.2.2 SWOT Analysis of Lehman BrothersSWOTDESCRIPTIONStrengths-Lehman has a robust financial base with liquidity in excess of $42 billion as at Aug., 2008 which is capable of withstanding severe financial stresses (Scott S., Tanya A., 2008). It also has a strong licence across its core investment banking, trading, and investment management businesses. Cutting-edge IT infrastructure is one of Lehmans strengths which it exploited maximally in the acquisition of customers more efficiently (see PEST analysis). Strong knowledgeable and skilled workforce Strong culture which is one of team-work, collaboration and knowledge sharing as evidenced by the rotation of workers around departments at least every two yearsWeaknesses-Poor managerial decisions which led to the inability or otherwise outright refusal to see the financial dangers coming. -Poor risk management and internal controls which led to its finances being exposed to risk of been wiped out within days. Strong culture which resulted in sluggish adaptability to the changing financial situations within and without the organization.Opportunities-The U.S Federal Treasury kept interest rates low for prolonged periods which made mortgage acquisition/repayments even cheaper and affordable which increased the patronage that accumulated to investment banks, Lehman Brothers inclusive. Securities and Exchange Commission relaxed limits of financial leverage which gifted Lehman with the opportunity to offer more highly leveraged mortgage back ed securities to its investors. But these seeming respectable opportunities turned out to be a curse in disguise.Threats Stiff competition coming from Morgan Stanley, Goldman Sachs, and Merrill Lynch in the hunt for new mortgage clients leading to the drastic reduction in the quality of mortgage instruments issued. More and more leverage was issued in other to remain competitive and remain profitable. The worst threat came from the Federal government backed Fannie Mae and Freddie Mac which had exclusive access to government subsidy (very low interest rate loans) making them issue the lowest rate mortgages thereby dominating the mortgage market. This then forced other players to issue even lower rates in order to stay in business. -Short selling of its stocks by brokers on the floor of the exchange which made the value fall freely thereby escalating investor anxiety resulting in loss of confidence. Negative market sentiments concerning its possible collapse due the earlier collapse of Bear Stearns, bailouts of Freddie Mac and Fannie Mae.Summary of the SWOT AnalysisNo doubt, Lehman is an indeed very large bank. With its robust financial war chest, experienced/diverse workforce and cutting-edge IT/IS at its disposal, it still went under. Lehman failed to utilize its strengths/opportunities to strategic advantage. Stiff competition, financial regulation laxity as well as poor management made it issue highly leveraged risky Mortgage Backed Securities, MBS which eventually wiped out its liquidity due to massive defaults in mortgage repayments which came as a result of increased interest rates to checkmate rising inflation.PART B3.0 MANAGERIAL ETHICSThese are situated down standards of conducts or moral judgements used in the discharge of business. More importantly, it refers to the rules and principles that define right and wrong conduct. It is the ultimate duty of the manager to effectively communicate and implement ethical issues within an organization.Lehman B rothers adopted the utilitarian view of ethical motive, in which decisions were made based on outcomes and/or consequences. They concerned themselves with making enough internet to satisfy the greedy yearnings of the top few at the top hierarchy of management not minding if their activities were detrimental to the welfare of others. This was clearly seen in the way mind boggling bonuses was dished out to the CEO, Mr. Fuld and other top management executives. According to Mr. Fulds report to the Federal Committee on Oversight and Government Reform, over $30 million was paid to him as bonuses. He also claimed that during the fruitful years, 2004-2007, an astonishing $16 billion was disbursed as bonuses out of which he alone grossed over $260 million.Below is a table showing a list of variables as they affect Lehmans ability to behave the way it did.Table 3.03.1 Factors affecting Lehmans ethical behaviourFactors affecting Managerial EthicsCommentsState of moral development (managers)S ince the ethical behaviour of managers is the single most vital factor that influences employee decisions (Robbins S., et al, 2006), we shall focus on the state of moral development of Lehmans CEO, Mr Fuld R. He operated at the preconventional level since his actions (selling highly leveraged Mortgage Backed Securities at all cost) were hugely inclined to the rewards and bonuses he and his cronies would get.Personality/Values (ego strength/ locale of control)Values which represent personal convictions of what is right and wrong (Robbins S., et al, 2006) go a long way in influencing ethical behaviour. Mr Fuld has a very strong personality (ego strength) always believing that whatever he does is the right thing. Even at the collapse of Lehman, he never accepted business for his actions and/or inactions. When he was alerted about what financial crisis they were in, by an insider, he waved it off. He also believes he has the ultimate power to control both his destiny as well as that of others (internal locale of control)Organizational Culture/Design-For the fact that Mr. Fuld took Lehman from rag to riches, he was seen as a demigod who was above the law. Hence, he was not subject to the organizations code of ethics and conduct. The organizational design/structure adopted a Top-Bottom management style of leadership. It enshrined a strong master-subordinate relationship which stifled information and knowledge sharing as no employee dare alert top management on their wrongly adopted strategies Lehmans culture is such that encouraged risk taking and constant innovation which later proved to be its undoing. The emphasis on individual achievement above group/team achievement encouraged employees as well as management to go extra lengths even if its unethical to perform e.g. the more mortgage clients you get, the more your bonus and recognition which was further boosted by its culture of short-term performance appraisals.Issue Intensity Greatness of harm Lehman brother s never believed their actions (highly leveraged MBS) would have deleterious effects on its overall stakeholders after all, it believed its investors had being hedged against dangers through the Credit Default Swaps, CDS being issued by American Insurance Group, AIG-Consensus of wrong Nobody dared oppose Mr. Fulds decisions, the very few that did were summarily sacked. So there was no basis for consensus of wrong here.-Probability of harm Lehman believed the probability of foreclosures was minimal because of the seemingly prolonged low interests rates which created a lot of liquidity in the economy immediacy of consequences Mr. Fuld in his opinion believed that even if theres an eventuality of foreclosures, economic downturn and/or write downs, it would be for a short while because historically crises does occur every few years and the markets would always heal itself-Proximity to victims Lehman pushed its mortgage customers far off using its distanced subsidiary, Aurora Loan Ser vices as the issuer of its mortgages. This, it used to distance itself from its customers. By so doing, most people never knew the subprime mortgages were being offered by Lehman in order to maintain a clean public image and avoid responsibility for any untoward adverse effects of its unethical actions-Concentration of effect Lehman ignored how concentrated the effect of foreclosures that would arise from its subprime mortgage sales would have on the national as well as global economy. They failed to see the broader picture of a likely global economic downturn. That necessitated their continuous unethical/risky financial actions. destinationMr. Fuld of Lehman Brothers acted unethically in most of his decisionsFrom the complex interplay of several factors that affected Lehmans unethical behaviour in the table above, we shall take a closer look at some of the ethical issues faced at Lehman Brothers below with a view to comparing opposing views on their conducts.Table 4.0 Opposing argu ments concerning Lehmans managerial ethical decisions. estimable issuesArguments forArguments againstSale of risky/highly leveraged Mortgage Backed SecuritiesSmall percentage appreciation in value can translate to explosive profits for its isotropy sheet and investors alikeLittle decrease in value potentially wipes out the entire credit of the company rendering it insolvent. It is unethical to use investors hard earned monies to venture into greedy and risky ventures under whatsoever guise.Constant financial products reengineering and innovationThis creates potential attraction for new customers as well as retaining the existing onesCauses confusion as to the understanding of the potential risks these products- offers portends.Unscrupulous bulking or bundling of mortgagesThis otherwise smart strategy helps to dilute the toxic effect of under-performing mortgage securities by lumping them with the good ones thereby creating a positive appearance leading to AAA ratings by rating agen ciesThis strategy deceived many investors by underplaying the actual value and safety of their stock holdings leading them to be taking by surprise when their stocks became worthlessGenerating mortgage demands packaging them, and then reselling them back to Wall Street and the investing public for large profits when in reality, there werent real buyers for themThis was a way to create profits out of nothingThis is an unethical attempt to manipulate the natural forces of demand and supply. Hiding behind their phony subsidiary, Aurora Loan Services to propagate falsehood contributed to the housing market bubble burst when it became spare there was no more demand for these mortgagesUnderwriting loans to questionable lenders e.g. FAMCO, Delta Funding Corp., etc and assisting them in cheating borrowers thereby violating consumer protection laws (Graham R., 2008, see bibliography)NAThis led to widespread erosion of global investor and public confidence in the company which further contri buted in its bankruptcy.Mr Fulds non-equity incentives were astronomical exceeding the 85th percentile. Furthermore, his bonuses grossly exceeded the normal industry average of bonus= base salary x Two. Mr. Fulds bonuses were five times his base salary (Nell M., 2008, see bibliography)NAThis compensation practice doesnt align in favour of shareowner interestsPART C4.0 CORPORATE SOCIAL RESPONSIBILTYThis is a broad term which is used to describe an organizations business activities as it affects the well-being of its stakeholders- customers, investors, employees, communities and the environment within which it operates. It is the justifiable ethical standard for which all of an organizations operational activities are measured (Davidson, P. Griffin, R, 2005). Achieving financial success in a manner that honours ethical values and respect people, communities, and the local environment is what defines CSR.An effective CSR program is one that is not mainly based on philanthropy or good will but rather on creating productive relationships with stakeholders who represent various social, financial and environmental concerns.Lehman Brothers adopted the hand of management approach to CSR in which it strongly believes in the advancement of its corporate economic interests as well as the protection and enhancement of the quality of life of its stakeholders. The conscience and practise of an organizations management is often a subject of frequent moot globally. Is it compulsory that an organisation must protect and improve the welfare of its specific and remote stakeholders? Well, the scope of this report is not to argue in favour of or against this motion but to analyse where Lehman got it wrong as regards to CSR.Lehman engaged in several philanthropic (socially responsive) activities all over the world where they had their businesses. Lehmans CSR spanned through the economic and sound levels terminating at the ethical level. Lehman used its philanthropy to avoid legal actions both from the government and its stakeholders while making sure its activities stayed within the ambit of the law. It engaged in philanthropy (in a socially responsive way) in my opinion because it did what it did just to create more global awareness (Public Relations for financial gains) (economic CSR) as well as to fulfil the general expectations society members place on corporations (ethical CSR). See Bibliography (URL link) for comprehensive details of their charity works.Corporate Social Responsibility goes beyond just philanthropy. CSR means accountability towards a firms various stakeholders e.g. shareholders, employees, customers, local and international communities, etc. Unfortunately, Lehman and Bear Stearns produced no CSR report of any s