The anatomy of the crisis
The second part of the multi-part series on the 10th anniversary of the collapse of Lehman Brothers looks at how some large banks and their CEOs fell
The second part of the multi-part series on the 10th anniversary of the collapse of Lehman Brothers looks at how some large banks and their chief executive officers fell.
The first tremors of the global financial crises could perhaps be traced back to when the Federal Home Loan Mortgage Corporation (Freddie Mac) said in February 2007 that it would no longer buy risky subprime mortgages, nor would it invest in related securities.
Within two months, New Century Financial Corporation, a leading player in the subprime mortgage segment, filed for bankruptcy. A string of financial institutions followed and in August, 2007, another key lender American Home Mortgage Investment Corporation filed for bankruptcy. The ripple effect was felt across the Atlantic too and in the UK, the Bank of England got permission to provide liquidity support to Northern Rock, one of the country’s largest mortgage lenders the next month.
All this happened before the Lehman crisis unfolded. India at the time seemed relatively insulated. However, the cauldron continued to boil, and financial firms had to turn to stronger hands with alarming regularity.
Freddie Mac, which buys loans from banks and resells them, thereby making it easier for banks to provide mortgages to more homebuyers, was incorporated in 1970 to provide competition to Fannie Mae, which too operates in the same area. Over the years, loans often went to people who couldn’t afford them, which are termed subprime loans.
Bank of America Corporation announced in January 2008 that it would acquire mortgage lender Countrywide Financial Corporation. By February, the UK Treasury had taken over Northern Rock.
The next month came the fall of Bear Stearns with preparations commencing for JPMorgan Chase to acquire the firm. Bear Stearns was one of the country’s largest investment banks, many of whom had exposure to subprime loans which were turning sour. The company had grown under its chief James Cayne, who was credited with the bank’s rise through the 1990s and well into the period before the financial crisis. Subsequently, Cayne was also blamed for its fall because of his hands-off managing style, with accusations of him playing bridge and golf as the crises unfolded.
There was more to come, but meanwhile, the US market regulator Securities and Exchange Commission was doing what it could to stem the flow. It temporarily prohibited naked short-selling in the securities of major financial players including Freddie Mac and its sister firm Fannie Mae in July.
But this didn’t really help. Other firms soon fell by the wayside, taking their executives with them. This included marquee names such as Lehman Brothers’ CEO Richard Fuld Jr, who became famously reclusive after the crises that cost him his firm, called the ‘gorilla’ for his indelicacy in handling people.
Another top executive John Thain, the chief executive of Merrill Lynch, continued to live the high life even as the financial crises unfolded. He oversaw redecoration to his office, a reception area and two conference room for over a million dollars, including a $35,000 toilet.
The middle of September saw two key events. Financial services firm Bank of America (BofA) announced that it would be buying Merrill Lynch. The firm, which had been a major player in the subprime market, had made significant losses, but was able to find a ready investor in BofA.
Lehman Brothers had hoped to sell off a stake in its investment unit to raise capital and use the funds to take care of some of its toxic assets, with possible asset sales by September 10, 2008. But investors weren't convinced and the shares continued to plummet. However, unlike in the case of JPMorgan’s acquisition of Bear, which the US government had agreed to support, it refused to provide such a lifeline in Lehman’s sale. As a result, possible suitors were reluctant to step in. Barclays on September 13 attempted to enlist Buffett's help in taking over the bank, but it didn't work out. After a weekend of negotiations, the 158-year old company ultimately filed for bankruptcy.
Lehman’s Fuld, who retained a large fortune, later set up another financial services firm, albeit on a smaller scale. Merrill’s Thain too moved on after his firm was acquired.
JPMorgan’s Jamie Dimon was one chief who managed to avoid the worst of the crisis as he avoided the traps of the subprime crises, managed to grow his company and also lasted longer than his less fortunate peers. His bank snapped up other firms and he emerged as a key spokesperson for the financial services sector even after the crises. Among his wins were the acquisition of Washington Mutual’s banking operations ten days after the Lehman bankruptcy.
Others key events included the Wachovia Corporation’s October acquisition by Wells Fargo. Wachovia until recently was one of the top five banking organisations in the country. Then followed the bailouts. And they were no longer restricted to banks. November 17 saw insurance firms looking for bailouts. The auto companies including General Motors and Ford followed the next day. It was only after global central banks pumped in unprecedented liquidity into global markets, that the storm was finally calmed.
Next: How the crisis impacted markets globally and in India