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The Failure of Lehman Brothers

Discuss about the Bank Failures During the Financial Crisis.

The current study intends to study the global financial crisis through the lens of different concepts that include the market failures and the behavioral bias theory.  The present study also aims to examine the impact of the market failures as well as the behavioral bias theory on the failures of the bank.  In this case, a case of the Lehman Brothers is taken into consideration for analyzing the reasons behind the bankruptcy of Lehman Brothers. The present case also elucidates different the primary reasons that can lead to the worldwide financial crisis and the consequently the failure of the bank.

The Lehman Brothers was regarded as the fourth largest investment firm in the world before it declared bankruptcy aftermath the global financial crisis (Ait-Sahalia et al.  2012). The company was a worldwide financial services organization that offered financial services, investment banking as well as investment management services worldwide. The company officially declared bankruptcy during the year 2008 owing to the huge exodus of a large chunk of clientele, severe losses of different stocks as well as devaluation of different assets rated by expert rating agencies (Cukierman 2013).

Present Context under consideration sheds light on the reason behind the collapse of the Lehman brothers and analyses the impact of different concepts of market failure on the bankruptcy of the Lehman Brothers. Lehman Brothers declared largest bankruptcy since the assets surpassed different bankrupt organizations that include the WorldCom as well as (Enron Gambacorta and Mistrulli 2014). The organization Lehman Brothers also became the highest victim of the financial crisis influenced by the US subprime mortgage that in turn affected the overall worldwide financial markets during the pear 2008.Again, the US housing boom is also regarded as a primary reason behind the demise of the Lehman Brothers. The Lehman Brothers acquired around five different mortgage lenders that includes the subprime lenders such as the BNC Mortgage along with Aurora loan Services (Gillespie and Hurley 2013). Again, the crisis of credit also surfaced during the year 2007 that in turn led to the failure of the hedge funds and consequently led to the fall in prices of the Lehman brothers. The paper also intends to study different regulatory as well as market failures that resulted in the worldwide financial crisis during the year 2008. An important market failure challenge was that the rating agencies were very much influenced by the securitizers in order to undervalue the risk of different mortgage pools. The causes behind the worldwide financial crisis were sub-prime lending as well as securitization. The government as well as the tax payers upholds the financial obligations of different firms and the firms need to be regulated for the purpose of assuming excessive risk and for which the taxpayers are essentially responsible (Goodhart 2014). The government also compelled the bank to assume different risky mortgages in order to increase the home ownership among households belonging to different classes. This also led to the housing bubble that led to the financial crisis and the collapse of the bank (Haas and Lelyveld 2014).

Market Failures and Financial Market Crises

Economic market failure theory refers to the important concepts of the market failure refer to different situations that lead to absence of government intervention, diverse inefficiencies that include the losses of wealth or else the Hicks-Kaldor inefficiencies (Han 2016). There are essentially six different types of the market failures that include Natural Monopoly, Public Goods, moral hazard, Asymmetric and transaction costs among many others (Harris 2013).

Again, the imperfect competition also generates inefficiencies compared to the perfect competition and the dead weight loss due to the inefficiencies generally result from the higher prices that is set above the level of marginal cost. The imperfect competition in the market is primarily treated with different anti-trust rules and regulations. The regulations allow the implementation of government to prohibitions and permits punishment for cartelization as well as price setting (Jin et al.  2016). The regulations also help in dividing the monopolies. Again, the externality can also be considered as a cost or else an advantage for a particular party that is not openly related to a specific transaction. Again, the Coase Theorem also indicates the fact that the evaluation of the externality also fails to take into account the opportunity cost that is more than just an overt cost (Kapan and Minoiu 2015). The Coase Theorem also reflects the fact that the distribution of diverse legal rights can be considered to be irrelevant for efficiency and can be related to the appropriate distribution and allocation of the wealth. The public good can also be regarded as a very positive externality circumstances that is essentially characterized by positive externality circumstances (Kaufman 2014). Moral hazard essentially refers to a risk that occurs at the time when one individual assumes more risk owing to the fact that the individuals are essentially protected against different risky events.

Regulation Theory refers to the markets has the capability to apportion different resources economically but that do not imply that it is done at all time and for all types of resources. The market also refers to a procedure of decentralized system of exchange of different commodities that can be regulated by the use of prices. The market failure that be represented by imperfect competition, imperfect information, externalities can lead to the failure of the bank (Lindquist et al. 2015). Again, the risky mortgage levels can lead to different consequences of the change in the regulation. Furthermore, the banks were also compelled by diverse regulations that cab offer risky mortgages to different undeserved regions (Lindquist et al. 2015)

Regulatory Failures and Bankruptcy

The behavioral biases include different aspects such as the cognitive as well as the emotional biases in the investment (Liu 2015). The investment biases can be categorized into cognitive as well as emotional factors.


The cognitive biases can be considered as a rule of thumb that might be or might not be factual. The cognitive biases include the confirmation biases where the investors put more weight age to the viewpoints of other investors who share the same view (Liu and Ngo 2014). Again, gamblers’ fallacy can also be regarded as a cognitive bias that considers that the past events do not influence the future events. Here the investors predict that the Furthermore, the cognitive biases also refer to the status quo bias that refers to the habit of different creatures to resist the alterations in the investment portfolios by persistently trading with the same shares instead of studying other shares. Again, the negativity bias refers to the attitude that influences the potential investors in the market to rely comparatively more on the bad news than on the good news (Mishkin and White 2014). The cognitive bias also refers to the bandwagon effect that explains the fact that the investors like to invest along with other people.

The emotional bias refers to the attitude and outlook of the investors that include the loss aversion bias, overconfidence bias and endowment bias.

The behavioral bias therefore can also be held responsible for the collapse of the Lehman Brothers where the share prices of the company fell drastically and reached a record low of $86.18 that resulted in a market capitalization value that was around $60 billion. Many experts are of the view that the shares of the Lehman fell by approximately 48% in anticipation of the fact that Lehman Brother will be the next organization to face the failure in the stock market. Therefore, it can be said that the behavioral bias also played a big role in the failure and bankruptcy of the organization.


The bankruptcy of the Lehman Brothers also reveals different factors that are associated to the systematic financial market failure for a particular player in diverse counterparty dealings that is repulsively exaggerated. Lehman Brothers can be considered as the third largest firm that made use of the different credit default swaps on different mortgage supported stock and the fifth largest user of different credit default swaps on different government backed stocks  (Gillespie and Hurley 2013). The senior Supervisors Group examined the influence of different financial markets on the bankruptcy of the Lehman Brothers along with the impact of the financial failures of the Fannie Mae, Freddie Mac as well as Lands banki Islands. Therefore, it became evident that the events of the credit were handled in a very orderly fashion that faced no operational disruptions or else the liquidity challenges. Again, there are private financial market institutional instruments that can ensure the even declaration of credit default swaps that actually happened in case of the Lehman Brothers.

Behavioral Biases and Financial Market Crises


The above mentioned study hereby presents the different effects of the market failure and the behavioral bias theory on the bank failures during the financial crisis. The study elucidates in detail the background of the organization along with the context of the bank failure during the global financial crisis with special reference to the case of Lehman Brothers. Next, the above study explains in detail the concepts and theories associated to the economic market failure, regulation theory along with different aspects of the behavioral biases and the emotional biases. Different theories that can be associated to the failure of the banks are lucidly illustrated in the study in order to gain an understanding regarding the bankruptcy of Lehman Brothers.

References

Ait-Sahalia, Y., Andritzky, J., Jobst, A., Nowak, S. and Tamirisa, N., 2012. Market response to policy initiatives during the global financial crisis. Journal of International Economics, 87(1), pp.162-177.

Cukierman, A., 2013. Monetary policy and institutions before, during, and after the global financial crisis. Journal of Financial Stability, 9(3), pp.373-384.

Gambacorta, L. and Mistrulli, P.E., 2014. Bank heterogeneity and interest rate setting: what lessons have we learned since Lehman Brothers?. Journal of Money, Credit and Banking, 46(4), pp.753-778.

Gillespie, N. and Hurley, R., 2013. 8. Trust and the global financial crisis. Handbook of advances in trust research, p.177.

Goodhart, C.A.E., 2014. Central Bank evolution: Lessons learnt from the Sub-prime Crisis. In Unpublished article presented at Norges Bank’s conference “Of the Uses of Central Banks: Lessons from history.

Haas, R. and Lelyveld, I., 2014. Multinational banks and the global financial crisis: Weathering the perfect storm?. Journal of Money, Credit and Banking, 46(s1), pp.333-364.

Han, M., 2016. The Global Financial Crisis: The Challenge for Central Banks. In Central Bank Regulation and the Financial Crisis (pp. 40-50). Palgrave Macmillan UK.

Harris, R., 2013. Warning Signs Prior to the Financial Crisis of 2008: A Comparative Analysis. Journal of Management & Engineering Integration, 6(1), p.88.

Jin, J., Kanagaretnam, K. and Lobo, G.J., 2016. Discretion in bank loan loss allowance, risk taking and earnings management. Accounting & Finance.

Kapan, T. and Minoiu, C., 2015. Balance sheet strength and bank lending during the global financial crisis. Available at SSRN 2247185.

Kaufman, G.G., 2014. Size, Risk, and Governance in European Banking. Journal of Economic Literature, 52(3), pp.861-862.

Lindquist, E.A., de Vries, J. and Wanna, J., 2015. 1. Meeting the challenge of the global financial crisis in OECD nations: fiscal responses and future challenges. The Global Financial Crisis and its Budget Impacts in OECD Nations: Fiscal Responses and Future Challenges, p.1.

Lindquist, E.A., de Vries, J. and Wanna, J., 2015. 1. Meeting the challenge of the global financial crisis in OECD nations: fiscal responses and future challenges. The Global Financial Crisis and its Budget Impacts in OECD Nations: Fiscal Responses and Future Challenges, p.1.

Liu, H., 2015. Constructing the GFC: Australian banking leaders during the financial ‘crisis’. Leadership, p.1742715015584537.

Liu, W.M. and Ngo, P.T., 2014. Elections, political competition and bank failure. Journal of Financial Economics, 112(2), pp.251-268.

Mishkin, F.S. and White, E.N., 2014. Unprecedented actions: the Federal Reserve’s response to the global financial crisis in historical perspective (No. w20737). National Bureau of Economic Research.

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