Why has Lehman Brothers collapsed?
Monday, September 15, 2008 at 02:57PM Lehman Brothers collapse: Q&A
By Harry Wallop, Consumer Affairs Correspondent
Last Updated: 4:38pm BST 15/09/2008
Q. Why has Lehman Brothers collapsed?
A. It was one of the most exposed banks to the US sub-prime mortgage market. It did not give out mortgages to ordinary American citizens. Rather, it bought up billions of dollars worth of these loans from US banks, re-packaged them, and sold them on to global investors.
It also invested heavily in property, both commercial and residential. With the US housing market in free-fall these re-packaged loans and its property portfolio have plummeted in value. In June to August last year, the bank said it would write off $700 million (£390 million), from its balance sheet as a result.
In the same three months this year, this figure soared to $7.8 billion (£4.34 billion). The bank tried to sell itself but no one – including the UK's Barclays – was willing to take on these "toxic" assets.
Q. Could others follow Lehman Brothers?
A. Yes. Merrill Lynch, one of the most venerable Wall Street firms, has been bought out by the Bank of America to save it going under. AIG, the world's largest insurance company is also running short of funds, it is understood. It is almost certain another major financial institution will collapse.
Q. Why does it matter that Lehman has collapsed and others are in trouble?
A. Lehman does not have any High Street branches, ordinary savers or mortgage customers. However, its collapse will have profound implications for people around the world – and not just for its 25,000 staff, 5,000 of them in the UK who are almost certainly out of a job.
Crucially, the US's central bank, the Federal Reserve has refused to step in to rescue the firm, even though it bailed out Bear Stearns, Fannie Mae and Freddie Mac earlier this year. This has rattled Wall Street and the City as investors realise that others could be allowed to go to the wall.
As a result, share prices have fallen heavily on stock markets around the world.
Q. But how does this affect ordinary householders?
A. Millions in the UK are hit when stock markets fall – not just investors that directly buy and sell shares. Anyone with a pension will have some of their retirement fund tied up in the stock market.
Added to this, is the £70 billion invested in stocks and shares by savers with Individual Savings Accounts. There are also 1.9 million Child Trust Funds – the Government-backed savings and investment accounts for children – that are invested in the stock market.
All of these investments have fallen over the last year as the credit crisis has taken hold. The fall out from the Lehman crisis means they are likely to continue falling. By the close of play on Monday, the FTSE 100 had fallen by nearly 5 per cent in one day.
Q. How about my mortgage?
A. The main symptom of the global credit crisis has been the unwillingness of banks to lend money to each other and to consumers.
This has caused, particularly in Britain, the complete drying up of the mortgage market, with 70 per cent fewer home loans sold compared with a year ago, according to the Bank of England. This has made it almost impossible for first-time buyers to get on the housing ladder, and very expensive for people re-mortgaging.
However, rates had been slowly improving in recent weeks, with optimists predicting the worst might be over for the mortgage market. The average interest rate on a two-year fixed-rate mortgage – the most popular deal taken out by home owners – has dropped from a peak of 7.08 per cent at the beginning of July to 6.39 per cent.
That optimism has been snuffed out by the chaos on Wall Street, with most experts predicting that rates are unlikely to fall any lower, as banks around the world once again sit on their hands.
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