The Lehman Panic — An Avoidable Crash

Abstract

The bankruptcy of Lehman Brothers Holdings, the fourth largest US investment bank, in mid-September 2008 triggered the most severe financial panic and crash in a century. Lehman had been an aggressive buyer of mortgage-related securities; the firm used the money that it obtained from selling its own short term IOUs to buy long-term mortgages. Every investment bank is highly leveraged, but Lehman was at the extreme end of the spectrum in terms of its leverage; its assets were more than thirty times its capital. At times, Lehman’s leverage may have been as much as forty times its capital; at the end of each quarter, Lehman engaged in ‘window dressing’ so that its reported leverage appeared smaller than the leverage that it had had in the previous several months.