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Recession is a general slowdown in economic activity over a period of time.

It is interesting to note that Recession is infact Depression at its nascent stages and Recession leads to Depression after a sustained decline in the economic activity.

There is a hint of euphemism associated with the coining of the term Recession which is almost synonymous with the term Depression.

Now it is widely believed that it was the collapse of the Lehman Brothers which lead to a global economy slowdown during the fag end of the last decade. Once Lehman Brothers went backrupt, morgages dried up and the stock markets plummeted.

How come one bank going bankrupt lead to a series of catastrophic consequences ???

Lehman Brothers was established in the year 1850 at Montgomery, Alabama, United States by Henry Lehman. Before declaring bankruptcy, Lehman Brothers had business expansion in varied dimensions of banking such as Investment Banking, Equity and Fixed Income Sales, Research and Trading, Investment Management, Mergers and Acquisitions, Private Equity and Private Banking etc.Richard Fuld was the reigning Chairman and CEO before the bank went bust.

When Fuld took this position in 1994, one share of Lehman Brothers cost $4 and in the year 2007 it cost $82.  The bank’s turnover in 2004 was close to $11.5 billion and in 2007, it almost doubled.

How did the bank make so much of money ???

It was done by investing in some highly lucrative, complex  and yet risky products. Post 9/11, the tax rates were slashed and mortgage terms were regulated. Bush’s vision of ‘Own Homes’ frenzy caught up. People were tempted into lucrative and cheap introductory rates and banks were willing to offer loans to risky clients. There had been a steady increase in property rates in the United States ever since the Second World War but house prices reached extraordinary levels after 9/11 when the interest rates were slashed and in mid 2006, the property rates reached new heights.

Lehman Brothers made a profit of close to $4 billion, in 2008,  primarily due to home ownership and property. There was a sense of belief in the financial markets in the 2007 that nothing could go wrong and people at the helm of affairs were so experienced that any risk undertaken could lead only one way…. UP  !!

This confidence lead Lehman Brothers to borrow more money. It was borrowing $44 to every $1 that it owned whereas for some other banks the ratio was close to 20:1. This activity is termed as Leverage.

Lehman Brothers used this money in the property business and it had invested around $60 billion in property by 2007. When property rates increase, leverage rake in profits, thus they multiplied profits and Lehman Brothers registered a profit of close to $4 billion in 2008.

It also happens to be true that, when property rates decrease, leverage rake in losses, they multiply losses and this is what eventually happened.

A growing number of people, who were initially attracted to the low introductory interest rates failed to keep up with the ever increasing interest rates. Repossession of homes started and the property prices fell. This is termed as the Sub Prime Crises.

Share prices of Lehman Brothers started a downward trend and a week before bankruptcy there was a huge fall in the share prices and it evenually reached 3 cents.

The second largest bank in US, The Bank of America, was expected to steer this large ship out of shallow waters but this did not happen and when The Bank of America got into a strategic partnership deal with Merill Lynch, it was all but over for Lehman Brothers.

The presidential elections were on and US goverment was not interested in giving a bail out to an ailing bank at the cost of taxpayers money.

The inevitable took place and Lehman Brothers filed for bankruptcy on Sept 15, 2008. 

When markets closed, on that day, the Dow Jones had gone down by a little over 500 points. The confidence in the market slumped and a lot of complex global associations which Lehman Brothers was a part of took a beating. Banking operations such as payroll and inventory management at various top companies, which had nothing to do with financial banking, were hit and the repurcussions instigated a downward economic trend across the globe.

Could recession have been avoided ???

Things might have ended up in a different way, had US Govt intervened and instigated a bail out of Lehman Brothers , but it was impossible to foresee such an economic impact. More than the tangible elements, it was the confidence, in markets across the globe, which were hit and eventually lead to the economic slump.