Ethical Issues in the Collapse of Lehman Brothers Short Summary

Lehman Brothers Holdings Inc. used to trade on the NYSE under the symbol LEH as the fourth largest investment bank in the US. It provided global financial services in investment banking, fixed income sales, trading US treasury securities, investment management, private equity, and banking. But on September 12, 2008 it found itself under financial predicaments when it filed for bankruptcy. With $600 billion in debt, LEH stands as the largest bankruptcy in world history.

The company experienced an alienation of most of its clients, drastic losses in its stock, and loss of its assets when it got devaluated by credit rating agencies. This was mainly because Lehman Brothers had been taking excessive risks to the point that it became insolvent. Many argue that letting Lehman Brothers fail was one of the triggers of the financial crisis; the demise of Lehman Brothers accelerated the global financial crisis and sparked debate over ethical issues on Wall Street and in the financial industry in general.

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The Lehman Brother’s case highlights some of the negative ethical practices that affected the current financial crises in the United States. Consequently, exploring the Lehman Brothers case will not only give a clear image of how important ethics are in business but also steps to be taken to deal with them on large scale. The financial crisis put the whole world in jeopardy, thus understanding the moral aspects and the ethical implications of the matter helps in understanding how crucial ethics are for the success of any business.

The root of the Lehman Brothers problem came when they began doing mortgage loans. Before the global financial crisis, it was very beneficial for an investment bank to acquire a portfolio of mortgage loans from a commercial bank, because it relieved its debt on a balance sheet. The investment bank would then create mortgage backed securities (MBS,) packages of mortgages loans that were sold to investors. The investors would receive a return on their investments when the borrowers made their monthly mortgage payments.

Lehman Brothers would sell an MBS, which was also comprised of debt, to investors around the world. As long as mortgage payments came in, the investors would profit, as would the investment bank. Even if some defaults occurred, housing prices were going up, and the investment bank could count on the value of the home as collateral. Or so they thought… According to Larry Swedroe Lehman Brothers started taking on an obscene amount of leverage on a degree of 30 to 1, meaning that for every 30$ wager, they put only 1$ and borrowed the rest.

They were investing in the MBS mentioned above because they thought that these investments were safe and were backed by the market prices of houses at the time. The plunge of housing prices and the increasing number of defaults on subprime mortgages in 2007, conversely, meant that many individuals holding these mortgages did not make payments and the collateral that the banks held on those risky loans was not worth as much as it was during the height of the housing bubble. In some cases, the quantity of mortgage debt was even greater than the value of the home itself, which encouraged homeowners to default on their mortgages.

This caused MBSs to become “toxic assets,” which eventually led to a credit freeze in the United States and Europe. Basically the misjudgments of investment banks in their investment decisions, including their repeated violations of the basic banking principle not to borrow short-term and lend the proceeds long-term, transformed the housing crisis into a financial crisis. By failing to disclose full information about the MBS’, especially the debt they carried, and consequently, misleading investors, the Lehman Brothers found themselves under ethical infringement that eventually led to their fall.

When Lehman Brothers’ financial executives decided to use balance-sheet trickery in order to avoid full disclosure of their financial problems, they set themselves on a path towards failure in a financial market where perception is often crucial to ensure success. According to Attorney Tony Valukas, who led the investigation into the collapse of Lehman Brothers, they were shipping assets to London during difficult times to make loans appear like revenue. Surprisingly, the practice was technically legal and within the rules, but was it ethical?

There is a blur area between what’s legal and ethical. The blurred area was the gap that allowed many financial institutions to cause the global financial crisis, Lehman Brothers included. The collapse of Lehman Brothers was sudden and caught a lot of investors by surprise; consequently everybody tried to bail out as soon as they could. The market did not have enough time to digest the news, which led to panic. If Lehman Brothers had disclosed their financial standing clearly, they could have found a collaborative way to deal with the crisis with the different stakeholders of the company.

This process would have been smoother and the consequences would have been minimized. By not disclosing information to the public, Lehman Brothers made its downfall steeper. When their unethical practices came to light, everybody panicked and reacted accordingly. Worth mentioning is the culture at Lehman Brothers that rewarded risk taking; the company had a bonus system that compensated people for generating stellar returns when the company was performing very well, but when the company did poorly, employees never had to give money back.

This kind of culture that rewards high risk taking without punishing low return or losses sent a bad message to employees who perceived that there was no personal downside to taking risk. When the MBSs were adopted by Lehman Brothers their brokers accumulated as many as they could because they thought that the more they had, the more money they would make on them and if not they would still have their salaries. Secondly, the Lehman Brothers’ case was a great example of the good old saying “to put a lipstick on a pig. With their social responsibility programs, financial corporations might appear as though they are utilitarian, yet that’s far from the truth. Self-interest is one of the most important human motivator; many corporations exist solely to generate maximum profits for shareholders using all legal and ethical means. Lehman Brothers is a good example of one of those companies. Instead of adopting enlightened self-interest that recognizes that a company’s prime purpose is to make profits, Lehman Brothers knowingly decided to engage in legal practices that crossed the line of business ethics simply to make more money.

Lehman Brothers failed because of massive investments in subprime mortgage-backed securities notoriously misrated as “secure” by rating companies like Moody’s, Standard and Poor and Fitch. (Wolff) Before Lehman Brothers filed for Bankruptcy, the company appeared solvent to the general public and the auditing agencies; consequently nobody cared to question their ethical issues and their legal practices.

When it came to light that the company was insolvent and could never pay off its debt, that’s when all the unethical behaviors and misconduct of the company started being challenged. In the end, the company had no choice but to dissolve. Unlike many other investment banks, Lehman Brothers was not bailed out, there were concerns that the corporation was a (and rightly) “moral hazard. ” The government thought bailing out Lehman would encourage financial firms to engage in increased reckless behavior because they “know” they would be rescued by the government. The Federal Reserve made it clear that Lehman would not receive any federal money and instead encouraged other institutions to buy Lehman” (Johnson) Today Lehman Brothers sometimes blames its downfall to short-selling of the stock by traders; they claim that this led to an exponential downfall and alienated the long run investors who decided to sell their stock. Lehman Brothers’ investors however, blamed the company for being dishonest about the losses they were incurring.

Ethical issues have been at the forefront of business in the media and public consciousness ever since the accounting scandals at Enron, WorldCom etc…; but the lessons behind these scandals seem to have been less relevant. Ethical issues always come into light in times of recession when companies are struggling or when a scandal occurs, but during boom time nobody cares to question practices making the company successful. This has been the case in many scandals from the accounting scandals of Enron to the famous Monsanto Ponzi scheme.

From beginning to end, Lehman Brothers’ collapse is a classic example of how breaching and neglecting ethical issues can ruin a whole company. Had the company been ethical and honest in disclosing relevant information about the financial practices, the government could have been merciful and gave them credit to help them recover instead of filing for chapter 11 bankruptcy. Ethics play a huge role in business. In financial firms, perception is very crucial in the level of confidence the shareholders have in the company, thus ethical behavior is encouraged and should be promoted.

The ethical culture at Lehman Brothers endorsed high levels of financial leverage to increase returns and the latter combined with upside-only bonuses led employees to being dishonest, and untruthful in disclosing the information about solvency of the company. The upper-management failed to overlook that the transactions the company was engaging into were legal and ethical, but because of lack of an ethical culture that promotes good behavior and ethical conduct, nothing was done to prevent ethical issues from happening.

In conclusion, “Governments, enterprises and households have now become dependent on credit in most advanced industrial economies. Modern societies do not leave military security to private armies, or education to private schools, or control of the money supply to private banks” (Wolff) ; This being the case, the government has the responsibility to establish policies and regulations that ensure that cases like Lehman Brothers’ do not repeat themselves. The government needs to take back control of the market. It was the house bubble in 2007; it could be something else in the future.

Lehman Brothers failed its fiduciary duty, betraying both the public and the private trust; its case exposes big global private banking as unaffordable and untrustworthy. Although the reasons to let Lehman Brothers fail might not have been based on ethical issues, hopefully, the rest of the financial firms learned that being unethical is self-destructive.

Works Cited

* Johnson, Lindsay C. McAfee & Nichole. Major Financial Institutions in the Crisis: What Happened and Governments’ Responses. March 2010. 15 November 2012 <http://blogs. law. uiowa. du/ebook/uicifd-ebook/part-5-iv-major-financial-institutions-crisis-what-happened-and-governments%E2%80%99-responses>. * Wolff, Richard. Lehman Brothers: financially and morally bankrupt. 12 December 2011. 16 November 2012 <http://www. guardian. co. uk/commentisfree/cifamerica/2011/dec/12/lehman-brothers-bankrupt>. “Fallout From Lehman Brothers’ Collapse. ” Beijing Review 51. 39 (2008): 40. Academic Search Complete. Web. 17 Nov. 2012. * Swedroe, Larry. “Are You The Next Lehman Brothers?. ” Money 37. 12 (2008): 77. Academic Search Complete. Web. 16 Nov. 2012.

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