Calculators

Another High Profile Victim

September 2008

Photo by Bloomberg News The shockwaves from the collapse of the US sub-prime mortgage market continue to reverberate around the world, claiming further high-profile victims. In a single September weekend, Merrill Lynch was unexpectedly taken over by Bank of America, while Lehman Brothers shocked the financial community by going bankrupt.

158-year-old Lehman Brothers had been in difficulties for a while, having amassed billions of dollars-worth of losses following the demise of the US sub-prime mortgage market. Lehman reported massive third-quarter losses earlier in September, and this news led already-nervous investors to dump shares in the beleaguered bank. Lehman subsequently filed for Chapter 11 bankruptcy protection after talks with potential buyers broke down. Interested parties had included Barclays and Bank of America, but both decided to walk away when the US Treasury refused to underwrite the deal with public funds. Despite helping to rescue Bear Stearns and bailing out mortgage giants Fannie Mae and Freddie Mac, the US government elected not to save Lehman Brothers, probably fearing that the American taxpayer is tiring of bearing the burden of rescuing shareholder-owned companies.

The failure of Lehman Brothers is likely to affect the many banks and pension funds that traded with the company. However, it could take some time for financial institutions to determine the extent of their exposure to Lehman, and this uncertainty will further undermine confidence in the financial system.

Unsurprisingly, investor sentiment was sent reeling by the news of Lehman’s collapse, and share prices dropped sharply. Nevertheless, central banks have moved swiftly to boost investor confidence: the Bank of England and the European Central Bank have pumped billions of pounds into the financial system, while the US Federal Reserve has relaxed the terms of its emergency lending scheme. Elsewhere, ten of the world’s largest banks have set up an emergency fund of US$70 billion, with the agreement that any one of them will be able to access up to one-third of the funds if they encounter problems with liquidity. The credit crunch is starting to reshape the face of Wall Street. Three of the top five American investment banks – Bear Stearns, Merrill Lynch and Lehman Brothers – have now succumbed; meanwhile, leading US insurer AIG is now 80% owned by the US Federal Reserve after they funded an US$85 billion loan to bail it out. Investors’ nerves, already stretched, are likely to remain firmly on edge for the time being.

Shirebrook Financial Services Ltd is authorised and regulated by the Financial Services Authority. The contents of this article do not constitute advice. Before taking any decisions, we suggest you seek advice from a professional financial adviser. All figures and data contained within this article were correct at time of writing.

Another High Profile Victim

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