On September 15, 2008, Lehman Brothers, a large investment firm based in the U.S., filed for bankruptcy. The Lehman Brothers Bankruptcy is one of the major events of the 2008 financial crisis. It was the largest bankruptcy in U.S. history and had lasting effects on the world economy.
In the early 2000s, Lehman Brothers became involved in loan origination, acquiring thousands of mortgages, many of which were considered “subprime,” because they were mortgages given to borrowers with high debt-to-income ratios and low credit scores. These mortgages were often given with variable interest rates, meaning the interest rate on the mortgage would change as the Federal Reserve (Fed) raised and lowered it. Banks all over the U.S., including Lehman Brothers were offering these subprime mortgages, creating a false sense of prosperity in the housing market. After obtaining these subprime mortgages, the banks would bundle them with better mortgages and sell them as bonds (called mortgage-backed securities) to other banks and investment firms.
From 2004-2006, the Fed raised the interest rate four points, leaving the borrowers of the subprime mortgages unable to make their mortgage payments. At the same time, home prices were falling, leaving the mortgagees unable to refinance or sell their homes to make their payments. By 2007, the default rate on variable rate mortgages was 29%. The more mortgages that defaulted, the less the mortgage-backed securities were worth, causing banks and investment firms to lose billions of dollars very quickly. Lehman Brothers was one such firm. When their losses were reported, their stock price plummeted. They declared bankruptcy and accounted for over $600 billion in debt.
The bankruptcy of Lehman Brothers was a landmark event in the 2008 financial crisis. It is estimated that American households lost about 26% of their wealth during the crisis. While many of these households never recovered from that loss, unlike the bankers and financial executives that caused the crisis. Richard Fuld, CEO of Lehman Brothers at the time of its collapse, made almost $500 million in the eight years leading up to the bankruptcy.
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