Extended-form Case Study

Strategic risk management: the case of Lehman Brothers

Published on June 30, 2016   11 min

Other Talks in the Series: Hot Topics

0:00
Hello, my name is Pat McConnell. And in this session, I'm going to talk about the topics of strategic risk in general and the failure of Lehman Brothers in particular.
0:11
Bankruptcy of Lehman Brothers in 2008 was a critical event in the global financial crisis. It exposed serious fault lines in the structure of the global financial markets and led to widespread economic disruption. But how did Lehman, a company with over 150 years of experience as a successful investment banker, reach such a precarious position? The official examiners report into Lehman's bankruptcy by Anton Valukas runs to some nine volumes and 2,100 pages and explains in great details the events that led up to the demise of the firm.
0:47
On September 15, 2008, Lehman Brothers, successful US investment bank, filed for bankruptcy with the largest failure of a bank in history to that point and it precipitated but did not cause what became known as the global financial crisis. The immediate cause of Lehman's insolvency was that the firm was overly exposed to the US commercial and residential property markets, and when the housing bubble burst in 2007, Lehman Failed. At the time, Lehman was sitting on a large warehouse of securities, so called Collateralized Debt Obligations or CDOs, the value of which were falling rapidly as a result of rating agency downgrades. However, the bankruptcy, the examiner concluded that it was the firm's flawed strategy that was the ultimate cause of the failure.
1:37
The underlying reason for Lehman's failure goes back to a change in the firm's corporate strategy in 2006 from which the board headed by the charismatic chairman and CEO Dick Fuld decided to shift what was called a moving or securitization business to a storage business, with the firm making and holding longer term riskier investments. In addition to making fee income from its traditional investment banking activity such as mergers and acquisitions, Lehman's management wanted to use its own capital to speculate in the markets. For our purposes, however, it's sufficient to note that in 2006 Lehman's management developed a new strategy which was fully endorsed by the Lehman Board. But this flawed strategy resulted in the bankruptcy of Lehman's. Only two years later in 2008, Lehman's board fully endorsed this growth strategy, which was presented as a 50% increase in what was called the risk appetite limit, which Lehmans claimed they needed to compete. Although the strategy was without controversy, inside the firm the Chief Risk Officer at the time Madelyn Antoncic argued for a much lower limit but was overridden by senior management, eventually leading to her replacement as Chief Risk Officer. However, the risks inherent in this strategy, so called strategic risks, were not fully disclosed to the board nor were they properly mitigated by management.
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Strategic risk management: the case of Lehman Brothers

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