The World After Lehman Brothers

In the decade since the investment bank sank, what lessons have been learnt and is the world more dangerous now than in 2007?

- Vivek Kaul

Lehman Brothers, the fourth largest investment bank on Wall Street, filed for bankruptcy in the southern district court of New York at 1.45 am on Monday, September 15, 2008. In April that year, while speaking at a conference, hedge fund manager David Einhorn had said investment banks were dangerous because half the money they made was used to give high salaries and bonuses to employees. And employees had strong reasons to increase the leverage of their trades, in the hope of making more money, and thus getting higher bonuses. The average bonus in the securities industry in New York (more popularly referred to as Wall Street) had gone up from around $60,900 in 2002 to $191,360 in 2006. In 2007, it fell to $177,830.

These high bonuses, Einhorn said, were risky. He substantiated his argument with the example of Lehman Brothers. If calculated properly, the firm had had a leverage of 44:1. This meant, for every dollar of its own money, the firm had borrowed $44 to spruce up the returns on its trades. Hence, even a 1 percent fall in the value of its investments would have wiped out half of its equity, and pushed the leverage to almost 80 times. “Suddenly, 44 times leverage becomes 80 times leverage and confidence is lost,” Einhorn said.