WTF Did Lehman Brothers Actually Do? — Transcript

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1. 0:00Everybody thinks they know the story of Lehman  Brothers. At its heights, it was the fourth
2. 0:05largest firm of its kind in America and managed  hundreds of billions of dollars in assets across
3. 0:11the world. But less than a year after recording  its best ever year, it was gone. In the early
4. 0:17morning hours of Monday, September 15th, 2008,  the firm's chief legal council sent an email
5. 0:24officially declaring bankruptcy in the Southern  District of New York. It was and still is the
6. 0:30largest bankruptcy in history and it marked  the climax of the global financial crisis. In
7. 0:37the hours that followed, the markets had their  worst day since the 9/11 attacks in 2001 and the
8. 0:43panic spread across the entire global economy,  taking the world from an economic downturn into
9. 0:48a full blown crisis. Now, you already knew  this, but something that's normally missing
10. 0:54from these oversimplified headlines is what  actually happened in the months between Lehman
11. 0:59Brothers recording record profits and failing so  spectacularly. Lemans is another classic case of
12. 1:05City Boys trying to make too much too fast. Optimism at Lehman Brothers one day after the
13. 1:10investment bank filed the biggest bankruptcy in  US history and news Barclays is buying the bulk
14. 1:16of the company. A pivotal moment in the financial  crisis. Letting Lemans go under caused panic on
15. 1:23the markets. Suddenly, no bank was safe.  Hold long before the dramatic collapse of
16. 1:28Lehman Brothers last week. To highlight just how  much is misunderstood about the rise and fall of
17. 1:36Lehman Brothers, here's a question for you. What  was Lehman Brothers? If you are brave enough,
18. 1:43leave your answer in the comments below. It wasn't  a bank. It wasn't a hedge fund and it wasn't a
19. 1:48stock broker and it wasn't a private equity firm.  For the sake of simplicity, most industry insiders
20. 1:54just called it an investment bank. Because of its  history, even though by the time of its collapse,
21. 2:00that was just one tiny, almost inconsequential  part of the entire business. The firm was started
22. 2:06in 1847 by the well, what the Lehman Brothers. Far  from its eventual place amongst the elite firms
23. 2:13of Wall Street, Henry Leman actually opened a dry  goods store in rural Alabama. 3 years into running
24. 2:20the shop, his brother Emmanuel joined him and the  business name changed to H. Leman and Bro. Yes,
25. 2:26they little bro-ed him. 3 years after  that, the pair's third brother, Mayor,
26. 2:32also joined the business, so they gave up on the  constant renames and decided to just call it Leman
27. 2:37Brothers. But spoiler alert, this would not be the  last time the firm changed its name. Even these
28. 2:43humble beginnings of selling convenience goods to  cotton plantations revealed something that would
29. 2:49be a common trend throughout the company's entire  history. They were not tied down to a single
30. 2:55business model. They would happily move into  any industry where there was money to be made.
31. 3:00For example, the brothers quickly realized that  they could make more sales with cotton plantation
32. 3:06owners if they just accepted raw cotton  in exchange for their merchandise instead
33. 3:11of currency. They of course had to resell this  cotton on the open market, but they could normally
34. 3:16do that at a significant markup over what they  got from the farmers. Eventually, they realized
35. 3:21that trading cotton was far more profitable  than running their shop. So, they closed it
36. 3:25down and became full-time commodities dealers.  By 1858, just 8 years into their operations,
37. 3:32the center of the cotton trade had moved to the  upandcoming port city of New York since that was
38. 3:37where most transatlantic shipping originated. By  this time, Henry, the original Lehman Brother,
39. 3:42had passed away from yellow fever. So, the two  remaining operated separate offices, one in New
40. 3:48York and the other back in Alabama. Unfortunately  for this new trading business, just 3 years later,
41. 3:55New York and Alabama had uh something of a  disagreement. But not even the American Civil
42. 4:01War could keep the Lehman brothers down for long.  The conflict and the eventual abolition of slavery
43. 4:07radically reshaped the market for cotton, and they  were there and ready to profit off it in a big way
44. 4:13by helping to form the New York Cotton Exchange.  basically the NYC only for cotton. As old school
45. 4:21as this sounds, the cotton exchange actually still  operates in New York City to this day. Lehman
46. 4:27Brothers also branched out into trading other  commodities like coffee, tea, and orange juice
47. 4:32and got a taste of the finance game by extending  loans to help rebuild their home state of Alabama
48. 4:38after the war. So at this point, Lehman Brothers  had been a convenience store, a cotton kajit,
49. 4:45a market maker, and an alternative lender. But  it wasn't until 50 years after its creation that
50. 4:51it finally became an investment bank. You see, the  big boss man over at How Money Works wants to make
51. 4:58it really clear that investment banking actually  means something specific and it's not just a
52. 5:04catchall term for finance bros. Now, what that is  is admittedly a little bit confusing. Investment
53. 5:10banks are not banks, and by definition, they don't  invest in anything either. You need to instead
54. 5:16replace the word bank with middleman. A blood bank  is a middleman between blood donors and patients
55. 5:22who need it. A food bank is a middleman between  food depositors and people in need of a meal.
56. 5:27And a bank bank is really just a money bank being  the middleman between depositors and borrowers.
57. 5:35So, an investment bank is an investment middleman  connecting people who want to make investments
58. 5:41with businesses that need to raise money. By 1899,  Lehman Brothers was making a small fortune being
59. 5:47the middleman between commodities producers and  consumers. So, they figured the next best step was
60. 5:53middlemaning entire companies. That same year,  they underwrote the initial public offering of
61. 5:58the international steam pump company. Underwriting  basically meant that Lehman Brothers looked at the
62. 6:04company, deemed that it was fit for investment,  and guaranteed that if enough shares didn't sell
63. 6:08on the public market, they would personally buy  them. If things went badly, this liability could
64. 6:14have been enough to wipe out half a century's  worth of business operations. Fortunately for
65. 6:20the brothers, this IPO was a huge success with all  of the offered shares selling out within the day.
66. 6:26In the process, it made Lehman Brothers more  money in fees than they would make in an entire
67. 6:32year of trading. A small side note is that the  International Steam Pump Company would also go
68. 6:38on to make the elevators in the Eiffel Tower, and  its founder, Benjamin Guggenheim, was a member of
69. 6:43the family that commissioned the world famous art  museums that still operate across the world today.
70. 6:49Tragically, he would never see these public  marvels because in 1912, he was amongst those
71. 6:54who died at sea when the Titanic sank on her  maiden voyage. Over the next 20 years, the
72. 6:59Lehman Brothers and their firm slowly transitioned  away from trading commodities and more towards
73. 7:05trading companies. They underwrote several of the  biggest IPOs of the time, including Sears, Macy's,
74. 7:11Goodrich, and Studebaker. often partnering  with another upandcoming firm by the name
75. 7:16of Goldman Sachs. By teaming up to underwrite  company offerings, they could spread the risk
76. 7:23and share in the reward while always making sure  they had a consistent stream of business. That was
77. 7:29until 1929 when the market crash and subsequent  Great Depression slashed stock market activity.
78. 7:37For a business that now almost exclusively relied  on listing other businesses on the stock market,
79. 7:42this could have been yet another death blow. But  the firm, ever adaptable, decided that it would
80. 7:48take this time to get into a new business, venture  capital. Venture capital is a type of finance
81. 7:55where wealthy investors will take a stake in very  new businesses to give them the money they need to
82. 8:01get their idea off the ground. In the 1930s, this  was almost unheard of. businesses were started by
83. 8:07people who had the means to fund early operations  themselves. And only after years of operation
84. 8:13would normal investors consider coming in. But  Lehman Brothers saw potential, especially during
85. 8:18the Great Depression. There were hundreds or  thousands of talented people out of work who had
86. 8:23good ideas, but no money to make them a reality.  Business lending had all but stopped after several
87. 8:29banks had collapsed. So Lehman Brothers had a  golden opportunity. By being the first investors
88. 8:35in a business, they could get a huge stake for  very little upfront investment. If the business
89. 8:40was a success, it could make returns hundreds of  times greater than the original investment. It was
90. 8:46very risky, of course, but by finding talented  entrepreneurs with no other opportunities, they
91. 8:53could be confident knowing that their winning bets  would cover dozens of losers and then some. In the
92. 9:00process, they've also increased social mobility  by offering opportunities to people who otherwise
93. 9:05would have struggled to get them, even if that was  just a happy little side effect. Today, venture
94. 9:12capital is a mainstay of modern business. But back  then, this really was a revolutionary concept,
95. 9:18and it kept them making money even while Wall  Street went into hibernation. All right. So far,
96. 9:24Lehman Brothers has been a corner store, a cotton  trader, a commodities dealer, a market maker, an
97. 9:29investment bank, and a venture capital firm. But  it didn't stop there. After the Second World War,
98. 9:36the firm eventually started doing well, a little  bit of everything. It had divisions for all of
99. 9:41these financial services, and it basically treated  them each like competing companies. Bonuses would
100. 9:46be showered on the divisions that made the most  money, and entire floors were routinely fired if
101. 9:52they didn't perform. This was a great way to  motivate some people, but it ultimately made
102. 9:57for a pretty toxic work environment. Teams didn't  want to cooperate with one another, and in many
103. 10:03cases would actively try to sabotage the other so  they could stay on the good side of management.
104. 10:10In the 1970s, this earned the company a nickname,  The Devil's Casino, a nod to the excessive
105. 10:17risk-taking and backstabbing that happened within  the company's glistening skyscraper. There were
106. 10:22enough stories to fill a book, and they did.  It's a very interesting read, so like always,
107. 10:26we will leave a link to it below. In an interview  20 years later, the company's M and A chairman
108. 10:33said that Lehman Brothers had an extremely  competitive internal environment, which ultimately
109. 10:38became dysfunctional. That salty executive  just so happened to be Steven Schwarzman,
110. 10:45who would leave the company soon after to start  Blackstone, the largest private asset manager in
111. 10:51the world today. This fragmented company was good  at making money for the people who worked for it.
112. 10:56But with so much disarray between departments,  nobody even knew what the company really did,
113. 11:01apart from make money by moving money around. The  problem was that a lot of teams figured they could
114. 11:08make more for themselves by going out and starting  their own firms rather than operating under this
115. 11:14confusing mess of an organization. In a way,  it had become the buzzfeed of finance, slowly
116. 11:20bleeding talent and profitable operations until  1984 when it was acquired by American Express.
117. 11:27For the next 10 years, the Devil's Casino was  reduced to a name alongside Shearsen and Hutton,
118. 11:33forming Shears, Lehman, Hutton, and American  Express Company. A bit of a mouthful and not
119. 11:39a particularly effective operation. The strange  abomination of a company basically did two things.
120. 11:45work as a retail brokerage and get into scandals.  Whether it was check fraud or financing the Boston
121. 11:52mafia, the shears and Hutton part of the business  had some uh difficulties to put it nicely.
122. 11:59Eventually, this became too much for American  Express to bother dealing with. So, in 1984,
123. 12:04it spun off the companies and Lehman Brothers was  once again free to set its own destiny under the
124. 12:10stewardship of a maverick new CEO. Over the next  14 years, it would be home to the greatest rise
125. 12:18and fall in American financial history. So, it's  time to learn how history works to unravel how
126. 12:24Lehman Brothers century and a half of business  adaptability collapsed within 9 months. Today's
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141. 14:00chapter of Lehman Brothers long and diverse story  was defined by a single man, Dick Fuld. Now, apart
142. 14:08from having the worst name in financial history,  he was an incredibly interesting gentleman. He
143. 14:15temporarily pursued a career in the Air Force,  but never made it to service. Fuld allegedly got
144. 14:20into a fist fight with another cadet and was  expelled from officer training. After that,
145. 14:25he got his first job at Lehman Brothers at the age  of 23 and just well never left. He was there for
146. 14:32the company's glory days as the Devil's Casino,  and by his own recollection, he really enjoyed
147. 14:37the fast pace and competitive atmosphere. On  the other hand, he hated the period in which
148. 14:41the company was split up, merged, and mixed in  with American Express. During this period, he
149. 14:46diligently worked his way up the corporate ladder,  trading fixed income securities, but always felt
150. 14:51like he had missed out on Lehman Brothers best  years. He also openly considered the executives
151. 14:58who had left the firm at that time to start their  own operations traitors, and this would be really
152. 15:04important once he was handed the reigns. By the  time American Express offloaded Lehman Brothers,
153. 15:10Fuld was the obvious choice for CEO. He had been  with the firm for a long time. He had well and
154. 15:16truly bought into the company's vision and he was  running one of the few profitable departments the
155. 15:21firm had left. After gaining control, Fuld wanted  to bring back the company's glory days and set out
156. 15:28on a mission of rapid expansion. The firm borrowed  aggressively and rebuilt multiple departments from
157. 15:34the ground up. When they couldn't start something  from scratch, they would buy out other firms and
158. 15:38bring them inhouse. By the 2000s, they once again  had a department that operated like a hedge fund,
159. 15:44an investment banking division, a private  equity office, an asset management arm,
160. 15:49and a growing department with providing mortgage  origination and packaging services. Lehman
161. 15:54Brothers had seen how profitable mortgagebacked  securities were as a financial product and took
162. 16:00the idea to a new level. They purchased Aurora  Loan Services and BNC Mortgage so they could
163. 16:07make their own loans before packaging them up and  selling them to institutional investors who wanted
164. 16:13the supposedly predictable returns. Every time  they did this, they would earn a healthy fee and
165. 16:19quickly the small department became a nice little  money maker for Lehman Brothers, which was looking
166. 16:23to diversify in any way it could. By all accounts,  Dick F was actually quite a competent CEO. Outside
167. 16:31of overseeing such a massive and rapid comeback,  he also expanded operations internationally,
168. 16:37opening offices in Europe and Asia to offer  a growing list of services to a growing list
169. 16:42of clients. It wasn't like he was blessed with an  easy tenure either. He guided the company through
170. 16:48the Asian financial crisis in 1997, the dotcom  crash, and the attacks on 9/11. Lehman not only
171. 16:55felt the shock of the market crash after these  events, but the company's global headquarters at
172. 17:01the time was in three world financial center. This  was not one of the directly targeted buildings,
173. 17:07but it was still damaged by falling debris beyond  the point of being habitable. So, the entire
174. 17:12company was temporarily set up in 40 different  locations, including the Sheran Manhattan Hotel.
175. 17:19Lehman Brothers booked every room to convert into  office space for its growing investment banking
176. 17:26team until they could find a new permanent global  headquarters. Now, even during the good times,
177. 17:33this rapid reexpansion didn't come without  some growing pains. The thing with having so
178. 17:39many departments under one single firm is that  it's hard to tell who should and should not be
179. 17:45working together. When the investment banking  division of a company like Lehman takes on a
180. 17:50company as a client, they need to see a lot  of detailed financial information that isn't
181. 17:54yet publicly available. That kind of information  would be really useful to the trading division,
182. 18:00which could buy or sell a company's stock based on  this privileged information to gain an edge in the
183. 18:05market. This is of course insider trading, which  is illegal, but it's much harder to track when it
184. 18:12happens within a single firm. Lehman Brothers was  eventually fined for this behavior alongside most
185. 18:18of the other big banks on Wall Street and it  led to a new rule where the investment banking
186. 18:23division of these firms had to be kept completely  separate from all other operations. At this point,
187. 18:30you might have noticed that the Lehman Brothers of  the early 2000s was starting to sound a lot like
188. 18:35the Devil's Casino era of the late 1970s. And  so naturally, the company could have developed
189. 18:41the same problems. Fuld had learned from these  mistakes, though. He demanded loyalty from all
190. 18:48of his executives, threatening to destroy their  financial careers if they dared to leave the firm
191. 18:54without his blessing. But he went even further  than that. Most bonuses were not paid in cash,
192. 19:00but rather shares in the company that could only  be sold after a lockup period. If an employee left
193. 19:06before they could sell their stocks, they would  forfeit that bonus. But if the firm was doing
194. 19:10well, they would get a new bundle of locked up  stocks every year indefinitely, keeping them on
195. 19:16the treadmill. Restricted stock bonuses are common  today in finance and tech roles, but they really
196. 19:22got their start on Wall Street in the early 2000s.  Now, to play devil's advocate for a second here,
197. 19:28Dick Fuld, either out of devotion or delusion,  held himself to the same kind of standards of
198. 19:35complete loyalty to the firm. He was reportedly  paid more than half a billion dollars during his
199. 19:41tenure as CEO, and most of that came in the form  of stock bonuses. But instead of selling these
200. 19:47shares as soon as he could to free up cash,  he kept most of his wealth tied up within
201. 19:52Lehman Brothers itself. According to secondhand  reports from people close to him around this time,
202. 19:58he would often also buy more shares in Lehman,  often on margin. As a financial professional,
203. 20:06he surely knew that having his employer also  be the majority of his personal wealth was an
204. 20:13incredibly ill-advised position to be in, but he  did it anyway, either to show his subordinates
205. 20:19how much he believed in the company or because  he genuinely did. It's up to you to decide which
206. 20:24one is scarier. The other big change he made was  just making Leman a good place to work. Beyond
207. 20:32the life-changing money that could be made at the  firm, by most accounts, people seemed to generally
208. 20:37enjoy working there. It was still competitive  and high stress, but strong performers were given
209. 20:41their dues, and people who made mistakes were not  immediately punished, as was the culture elsewhere
210. 20:46on Wall Street. In 2007, the company announced  that it had had its best year ever. It had made
211. 20:52a profit of over $4.2 2 billion on revenues of  more than $19 billion and now managed a pool of
212. 21:00assets worth $640 billion. This all came from  a company that just 13 years earlier was sold
213. 21:09off by American Express because it simply  wasn't worth dealing with. Unfortunately,
214. 21:15while most of the executives were celebrating,  the company's fate had ultimately been sealed.
215. 21:20There was one other problem with diversifying  the company so broadly so quickly. Every new
216. 21:26department in the firm carried with it risks  which could sink the entire ship. Dick Fuld's
217. 21:32aggressive expansion ambitions meant that all of  these operations were consistently pressured to
218. 21:37take on more risk to help the company maximize  returns and grow faster. Of course, one of those
219. 21:43departments was subprime mortgage bonds. It's a  common misunderstanding that the firm had gone all
220. 21:49in on these products by the time of its collapse.  In reality, Subprime Mortgages only accounted for
221. 21:553% of the firm's total revenue in 2007. However,  even that relatively small operation was operating
222. 22:02in such a volatile way that it carried more than  enough risk to blow up the entire firm. You see,
223. 22:09Lehman Brothers may have had over $600 billion  in assets at this time, but that number by itself
224. 22:15doesn't mean anything unless you consider the  debt. The actual equity in the company was only
225. 22:21around $22 billion on a good day. Everything  else was made up of debt. And here's the thing,
226. 22:28asset prices can rise and fall, but debt stays  constant until it's paid off. Borrowing so
227. 22:35aggressively had let the firm grow and maximize  returns during the good times. But even a small
228. 22:40hiccup could have put the entire global enterprise  into negative equity territory extremely quickly.
229. 22:47A more relatable real world example would be  someone putting a 3% down payment on an investment
230. 22:53property. If property prices increase by 10%  they have more than quadrupled their money. But
231. 22:59if prices fall by just 3% they have lost all of  their money. and they still owe interest. This is
232. 23:07exactly the position that Lehman Brothers was in.  And that small mortgage bond department was like
233. 23:13a hand grenade amongst the clockwork. The actual  profit that Lehman Brothers made by giving out
234. 23:19loans to regular people and then packaging them up  to sell to institutions actually wasn't very big.
235. 23:25So to generate good enough returns to keep  Dick Fuld happy, the department borrowed a
236. 23:30lot of money so they could handle more loans at  any given time. This was seen as relatively low
237. 23:36risk for two reasons. The first was that the  bank wouldn't actually own these mortgages for
238. 23:41very long. Between the time they made a loan and  the time that it was packaged up with thousands
239. 23:45of other loans and sold off to something like  a pension fund was typically around 1 month if
240. 23:51they were doing their job right. The second reason  they didn't see a problem with taking on so much
241. 23:56debt to get the money to give out mortgages was  because they were mortgages. In the absolute worst
242. 24:02case scenario, it was assumed that they could  get their money back by foreclosing on people's
243. 24:07homes and selling those houses to in turn repay  their lenders. But the key factor here is these
244. 24:13are essentially just mortgages. So that has  allowed us to push the leverage considerably
245. 24:18beyond what you might be willing or allowed to  do in any other circumstance. thereby pushing
246. 24:23the risk profile without raising any red flags. But by mid 2008, it was becoming clear that both
247. 24:30of these assumptions were just wrong. The hot  real estate market was starting to falter because
248. 24:36even with easy lending to anybody who wanted it,  there was only so much that people could afford.
249. 24:42Another common misconception about the collapse of  Lehman Brothers is that this is where the global
250. 24:48financial crisis started. In reality, the economy  was already in a technical recession for a full
251. 24:5412 months before this. The Fed had raised interest  rates again after dropping them to 1% after 9/11.
252. 25:01In fact, interest rates were below inflation for  almost 3 years, below the rate of inflation. Now,
253. 25:12how do you think about this? So, when you're  looking at a house, can I afford this house?
254. 25:15Can I afford the payments? Obviously, those  payment streams are determined by the level of
255. 25:20interest rates. And when interest rates are low,  you're going to buy a bigger house. You're going
256. 25:25to buy in a better neighbourhood. You're going  to buy cherry cabinets and granite countertops
257. 25:29because you can afford it. After rates went  up again, this debt just simply caught up with
258. 25:35people. This slowed home sales and lowered house  prices, which meant that there were no longer any
259. 25:41guarantees that selling a home would completely  cover its mortgage. The other problem was that big
260. 25:46investors were starting to lose their appetite for  mortgage-backed securities. So Lehman Brothers was
261. 25:52forced to hold on to them for longer and longer,  basically getting high on their own supply.
262. 25:58It was also revealed that in an attempt to  make money, Lehman was keeping a lot of the
263. 26:03riskiest and therefore highest yielding bonds for  itself because when everything was going well,
264. 26:09they were paying as much as 12% interest where  the firm could borrow money for as little as 4%.
265. 26:15Lehman Brothers under Dick Fuld was a rocket  ship, but rocket ships are just controlled
266. 26:21explosions that are always right on the edge of  catastrophic failure. By September, the firm had
267. 26:28an inventory of bad loans that it couldn't  sell. And without being able to sell them,
268. 26:33it couldn't meet its debt repayments the next day.  Operationally, it was still exactly the same firm
269. 26:39it was 9 months earlier. But now, instead of  producing record profits, it was functionally
270. 26:45insolvent. On Friday the 12th of September,  leaders from all of the major banks on Wall
271. 26:51Street were called to the Fed headquarters in New  York City, just a few blocks away from Lehman's
272. 26:56new head office. Dick Fuld was not invited. They  were there to discuss what to do with the firm,
273. 27:03which couldn't afford to open its doors on Monday  morning. A few months earlier, Bear Sterns had
274. 27:09been bailed out in a joint agreement with the  government and JP Morgan Chase. Like Lehman, Bear
275. 27:15was an institution that got caught in the trap of  trying to do everything and ran into trouble when
276. 27:20the bad parts of their business sank everything  else. JP Morgan and its new CEO, Jaime Diamond,
277. 27:26saw the opportunity to buy up the good parts  that still made money and let the government
278. 27:30deal with the toxic debt bomb that was left over.  Naturally, at a time when people were already
279. 27:36starting to lose their homes, this made people  furious. So when Lehman found itself in the same
280. 27:43position 5 months later, the political support  wasn't there anymore, especially since there was
281. 27:48now an election just a few weeks away and nobody  was winning any votes by supporting Wall Street.
282. 27:54Uh the news from Wall Street has shaken  the American people's faith in our economy,
283. 28:00a situation with Lehman Brothers  and other financial institutions.
284. 28:03We have to explain that this affects Main Street,  not just Wall Street. To this day, financiers,
285. 28:09bankers, economists, and worst of all, politicians  argue if it would have been better to bail Lehman
286. 28:15out to prevent a wider panic. But did we learn any  lesson from it? Well, not really. We are now more
287. 28:23in debt than we ever have been before. We kept  interest rates too low for too long, and financial
288. 28:30firms are figuring out new and creative ways to  lend money to people who have no business paying
289. 28:35it back. Before Leman became American history,  it was shaped by it. It lasted so long because
290. 28:42it adapted to the times and maybe learned that  doing one thing well is better than trying to do
291. 28:48everything. Go and watch this video next to learn  how the same mistakes caused every economic crisis
292. 28:54for the last 2,000 years. And don't forget to  subscribe to keep on learning how history works.