Lehman Moment

What Is a ‘Lehman Moment’?

The term “Lehman Moment” refers to a situation in which the problems of one company or one seemingly minor component of the economy turn out to be so large that they become everyone’s problem.

The term is a reference to the 2008 bankruptcy of Lehman Brothers, then the eighth-largest investment bank in the United States. The bankruptcy triggered a huge stock market downturn and put such pressure on the rest of the financial industry that the federal government stepped in with a $700 billion program of bailouts and arranged mergers to stabilize the financial system.

And the problem was not limited to the U.S. It spread globally and became the 2008 global financial crisis.

Background

In the early 2000s, banks and other financial institutions began offering mortgages to borrowers who historically would not have qualified, such as people with poor credit, people who could make only a small down payment, or those who applied for loans beyond their means to pay. These loans were referred to as subprime.

Banks were able lend to these people for two reasons:

• Banks created new investment products into which they pooled the loans and then sold to investors, dramatically reducing their own risk by passing it on.
• Housing prices were rising steadily, so even if borrowers could not keep up with mortgage payments, they could easily sell at a profit and pay off the mortgage or simply borrow more against the now-higher market value of the property.

When price rises began slowing, it became more difficult for borrowers to sell at a profit or to refinance. Mortgage losses began to rise.

By early 2007, leading subprime mortgage lender New Century Financial filed for bankruptcy. Shortly thereafter, large numbers of mortgage-backed securities were downgraded to high risk, and more subprime lenders closed.

As investors began to shun subprime mortgage products, lenders stopped writing mortgages for subprime borrowers, which cut demand for housing; this, in turn, caused house prices to fall further.

Borrowers suddenly could no longer simply sell or refinance, and when the value of their homes fell below what they owed in mortgage payments, many simply walked away.

By the summer of 2008, the Federal National Mortgage Association (FNMA, commonly known as Fannie Mae) and the Federal Home Loan Mortgage Corp. (FHLMC, commonly known as Freddie Mac), both quasi-government lenders, had incurred losses so large that they needed to be bailed out by the federal government.

Lenders began making it even more difficult for homebuyers to borrow, which pushed down housing prices even further. With foreclosures climbing, even more homes were offered for sale, increasing supply in an already oversupplied market.

By early 2008, the problems began hitting the nation’s largest financial institutions.

In March 2008, the Bear Stearns Cos. notified the Federal Reserve Bank that it would not have enough financing to meet its obligations. As one of the largest securities firms in the U.S., with assets of nearly $400 billion, Bear Stearns’ problems rattled the market.

The Fed offered financing to keep Bear Stearns afloat, and when that did not work, it brokered a deal for Bear Stearns to merge with JPMorgan Chase, committing some $29 billion to make the deal happen. The bailout meant Bear Stearns avoided default and bankruptcy.

Six months later, Lehman Brothers Holdings, at the time the fourth-largest investment bank in the U.S. by assets, filed for bankruptcy.

Lehman’s Role in the Subprime Market

Like many large financial institutions, Lehman had piled into the subprime market. In 2003 and 2004, Lehman acquired five mortgage lenders, including two that specialized in subprime lending: BNC Mortgage and Aurora Loan Services.

Lehman’s real estate business helped drive revenue in its capital markets unit, which climbed some 56% from 2004 to 2006. Lehman reported record profits in 2005, 2006, and 2007, when it reported $4.2 billion in net income on $19.3 billion in revenue.

In February 2007, Lehman’s stock price hit $86.18 per share, a record that gave it a market capitalization of nearly $60 billion.

Lehman’s Demise

Even as Lehman continued to report record profits, cracks began to appear in the U.S. housing market in which it was heavily invested. Subprime mortgage defaults hit a seven-year high, while the Bear Stearns bailout spooked the market. Lehman exacerbated concerns in June 2008 when it reported a second-quarter loss of $2.8 billion.

Bankruptcy Fallout

The S&P 500 fell some 5% on the day of the Lehman bankruptcy filing.

Shortly thereafter, a major money market fund that held large amounts of Lehman debt announced that it would not be able to repay its investors all the money they had put in, causing a run on money market funds, which prompted the Fed to step in to guarantee money market fund assets.

Despite efforts to stabilize the market, less than 48 hours after Lehman filed for bankruptcy, the Fed was forced to bail out global insurer American International Group (AIG). The S&P 500 fell a further 5%.

Several weeks later, with the contagion spreading, Congress passed the Troubled Asset Relief Program (TARP), which provided some $700 billion to stabilize the financial system.

Have There Been More Recent Examples of a Lehman Moment?

In late 2022, speculation began circulating about the health of Switzerland-based global investment bank Credit Suisse, which experienced a series of scandals and losses that hammered its share price and raised investor fears of possible insolvency.

Some likened the possibility of Credit Suisse failing to a Lehman Moment due to the size of the bank and its worldwide reach.

These are some of the problems that have placed Credit Suisse in peril:

In early 2021, U.K.-based financial services company Greensill Capital went under, leaving Credit Suisse shareholders with a $3 billion loss, as the bank had invested in Greensill. Just a month later, Credit Suisse lost a further $4.7 billion as a result of its involvement with Archegos Capital, and at least seven Credit Suisse executives lost their jobs.

In February 2022, Swiss officials charged Credit Suisse with laundering money for a Bulgarian cocaine trafficking ring, later found the bank guilty, fined it 1.7 million euros, and ordered it to pay 15 million euros to the Swiss government.

More recently, the bank was accused of ordering hedge funds and other investors to destroy documents that linked the funds to sanctioned Russian oligarchs, leading to investigations into the bank’s compliance with Swiss sanctions imposed in the wake of Russia’s invasion of Ukraine.

Credit Suisse’s stock fell from a pandemic-era high of $12.30 to below $5 by late October 2022, erasing more than 50% of the bank’s market capitalization.

Credit Suisse’s credit default swap (CDS) rate also climbed from just 1% to nearly 6%. A CDS is essentially an insurance policy against default on the loan, so higher rates indicate the market thinks there is a greater possibility that the bank may not be able to pay its debts.

The Bottom Line

The term “Lehman Moment” refers to a situation in which the problems of one company or seemingly one minor component of the economy turn out to be so large they become everyone’s problem. The term emerged from the late 2008 bankruptcy of global investment bank Lehman Brothers, which many see as the turning point when the problems of U.S. investment banks became the world’s problems.

Following Lehman’s bankruptcy, the U.S. government stepped in with a massive bailout package to rescue the entire financial sector, especially investment banks and insurance companies. But the contagion spread and became the 2008 global financial crisis.