Collapse of Lehman Brothers in 2008

a) Describe the collapse of the Lehman Brothers in 2008. Some institutional
investors were concerned that Lehman Brothers might have been overstating its
earnings in 2007 and early 2008. Explain why more complete and accurate
disclosure by banks and other financial institutions may help to resolve financial
problems.
Lehman Brothers’ collapse in 2008 was primarily due to the factors, like, over-
leveraging, sub-prime lending, pathetic long term investment and investment in risky
enterprise/asset.
According to New York Times’ report in March 11 2010, Lehman temporarily
shuffles $50 billion of assets off its books in the months before its collapse in
September 2008 to conceal its dependence on leverage, or borrowed money.
As far as disclosure norms are concerned, complete and accurate disclosure norms
would bring transparency and accountability in the organisation. It would also
improve corporate governance in the organisation due to above said measures.
Regulator needs to devise proper mechanism to maintain complete transparency in the
functioning of financial institutions. Even if, single entity able to cheat genuine
investors, it will erode the investor’s confidence severely and bank will lose the trust
of common investors.
b) During the credit crisis in the 2008 – 2009, banks were criticized for restricting
their credit. Do you think banks should be allowed to restrict their credit during
the credit crisis? Why or Why not?
It would be appropriate to say that Bank should adopt more cautious approach when
providing credit facility to any organisations or individuals. Banks need to do proper
due diligence before going ahead and granting credit to any individual or entity. It
would be advisable to say that rather than restricting credit facility to all types of
customer, bank should go on case to case basis and only after thorough investigation,
credit should be granted to any entity, so that, Bank’s capital remained protected and

paid back with its interest. Restricting all kind of credit facility would hamper growth
to an economy and will hurt genuine credit seekers. It should be done to those
selective credit seekers, who do so, to commit fraud on financial institutions/bank. All
cannot be levelled as fraudsters.
c) Explain why the credit crisis caused concerns about systemic risk.
Systematic risk occurred due to macroeconomic reason and generally not related to
one company or organisation. It affects entire market segment, hence difficult to
avoid. It can only be hedge, only to certain level, through proper asset allocation in
debt, government bond, bank fixed deposits, etc.
Any credit default or crisis could lead to systematic risk because it affects sentiment
of entire market segment. Credit crisis or any such crisis if spread to whole economy,
could become systematic risk, where, market sentiment and its cascading effect plays
major role. Same thing happened in Lehmon brothers’ case.
d) During the credit crisis, the government was attempting to prevent failures of
banks. Explain why the moral hazard problem may have received so much
attention during the credit crisis. Explain why regulators might argue that the
assistance they provided to Bear Stearns was necessary.
Lehmon brothers was said to be practicing moral hazard by risking the investment of
common home buyer or those investing their money in real estate business expecting
better return, but in turn, company (Lehmon brothers) knowingly, putting these
common investor money in highly risky asset class and endangering their principal
amount too. Here, Lehmon brothers, engages in risk-taking behaviour, based on a set
of expected outcomes where another person or entity bears the costs in the event of an
unfavourable outcome. So, this is the clear cut case of moral hazard by Lehmon
brothers.