The Fall of Lehman Brothers

Image taken from www.boston.com

Many economists have been lamenting about the fate of Lehman Brothers since the first sign of the economic downturn in the first half of the year. After a long drawn back and forth saga, its spokesperson today announced that Lehman Brothers is set to file for bankruptcy in order to protect the value of its remaining assets. Other victims of the crisis include investment banks Merrill Lynch and Bear Stearns, each of these being bought out by Bank of America and J.P. Morgan respectively.

We only now begin to appreciate the full extent and impact of the subprime crisis on the economy, with three former banking powerhouses disappearing from the street in the span of a year. Nothing like this has ever been witnessed in history and that goes to say alot about the damage effected by the subprime mortgage fiasco.

It all came about when banks and other mortgage brokers decided to securitize mortgage loans with poor credit ratings (high risk of default) and sell these structured investment products to individual and institutional clients. The structural problems inherent within the US banking system were then exposed as these re-packaged products were given ratings of AAA (high investment grade) by rating agencies such as Moody's or Fitch. Therefore, how they could substantiate such ratings will always remain a mystery for most of us, up till now, when we realise that the fees paid to these rating agencies were from the people responsible for coming up with these investment products themselves.

We also notice that the widespread dissemination of these products to investors all over the world has led to another huge problem of tracking the extent of losses. This has led to continuous speculation that there are further losses and write-downs to be witnessed, and this consequently caused a lack of investor sentiment throughout the globe.

I believe we have yet to see the final act of this spectacular fall-out from the subprime crisis and there will be further casualties in the pipeline (AIG?, Wachovia?, Washington Mutual?). The Federal Reserve will stop bailing out institutions who are poor capital positions for political as well as, economic reasons and hence we will indeed see more blood being shed on the streets.

In such a state of economic emergency, i think we should continue to save more money and invest it in relatively safe asset classes such as 1-yr governement bonds etc to protect our capital and earn slightly above interest rates. This will ensure we still manage to grow our wealth, as little as it may seem, slowly but steadily.

So what are your views on the latest world economy?

Sources: Channel News Asia, 15th September 2008
BBC News UK, 15th September 2008
Bloomberg.com, 15th September 2008