The collapse of Lehman Brothers was precipitated by the subprime mortgage crisis. Subprime lending involved making loans to borrowers who did not qualify for market interest rates. By 2008, 25% of subprime loans were delinquent or in foreclosure. Government policies in the 1970s and 1990s loosened lending standards and encouraged risky lending. Financial innovation like securitization and CDOs made the risks associated with subprime mortgages difficult to assess. In September 2008, JP Morgan demanded billions in collateral from Lehman, which Lehman could not pay, leading to its bankruptcy.

1. The Collapse of Lehman Brothers

2. Subprime Mortgage CrisisSubprime LendingMaking loans to borrowers who do not qualify for market interest ratesMarket worth an estimated $1.3 trillion in March 200725% of subprime loans were delinquent or in foreclosure proceedings as of May 2008

3. CausesGovernment PoliciesSpeculationFinancial Innovation

4. Government PoliciesGlass-Steagall Act - 1933Enacted as emergency response to 5,000 bank failures in Great DepressionCreated separation between commercial and investment banksRepealed in 1999, allowed commercial lenders to underwrite and trade mortgage backed securities and CDO’sCommunity Reinvestment Act - 1977Loosened lending standardsEncouraged predatory lending

5. SpeculationSpeculators began treating homes like stocksIn 2005 nearly 40% of homes purchases were not primary residencesLeft the market sometime in 2006

6. Financial InnovationSecuritizationPooling together and repackaging risky mortgagesCDO’s and MBSUnable to gauge the risk associated with these productsMany investment banks kept large amounts of MBS on balance sheet

7. EventsEarly summer 2008: JPMorgan is the clearing bank on behalf of clients who have exposure to Lehman Brothers trading. July 2008: The head of JP Morgan's risk department begins asking for collateral from Lehman Brothers Holdings.Early September 2008: Lehman Brothers still has not raised the capital it requires and at this point has approached several banks about possible mergers but there are no positive developments, or anything on the horizon to suggest that a merger could be in the offing. September 4 2008: Lehman Brothers Holdings is in real trouble at this point, this time, JP Morgan asks for another $5 billion in cash, concerned that any securities might not be worth their full face value. September 9 2008: Steve Black, head of capital markets at JP Morgan, knowing that Lehman has not paid the $5 billion from the week before, demands another $5 billion in cash to shore up its positions. JP Morgan receive just $3 billion from Lehman Brothers Holdings.

8. EventsSeptember 10 2008: Lehman Brothers goes ahead with its pre-announcement and conference call to analysts. They assure investors the firm is healthy despite all the reported liquidity issues and that the firm had delivering capital to JP Morgan to cover positions.September 11-12 2008: JP Morgan discovers that its initial $5 billion wasn't paid. It demands $8 billion immediately. Over those two days Lehman Brothers Holdings delivers the money.September 12 2008: Cable business channel CNBC, breaks the story that Lehman is attempting to sell itself, although no suitable offers are received.September 13/14 2008: The Federal Reserve tries to save Lehman Brothers through a private sector bailout, but this fails on the Sunday Evening.

9. Lehman Brothers Stock Price

10. Oversimplified ExplanationLehman Bros.Clearing AgentBanksMortgaged backed SecuritiesInvestors

11. Example$1002%$10$7$5Lehman Bros.Clearing AgentBanksMortgaged backed SecuritiesInvestors$102

12. Crisis$492%$10$7$5Lehman Bros.Clearing AgentBanksMortgaged backed SecuritiesInvestors$49$100 - $49 = $51The difference is the capital it has to raise to pay the investors

13. Conclusion… 13Combination of events

14. Subprime Mortgage Crisis

15. Government Policies, Financial Innovation, Speculation

16. Failure of Lehman similar to Bear Stearns

17. $40 billion in mortgage-backed securitiesIn Hindsight…Regulatory standardsRaising Lending StandardsBetter Judgment and Leadership14

18. Thank You!