Crisis-Era Memories Haunt Wall Street This Week

Bank of America

The financial product known as mortgage-backed securities has become a term synonymous with the 2008 financial crisis; Lehman Brothers, which collapsed five years ago this week, was the symbolic domino that caused one financial institution after another to begin wobbling until the entire banking industry, and the economy as a whole, was in crisis. In the financial industry and among regulators, the generally held assessment is that Lehman failed under the weight of risky real estate investments, characterized by a rise in subprime mortgage delinquencies and the resulting decline in value of securities backed by those mortgages. The lower credit quality ultimately caused massive defaults, which in turn caused a significant disruption in the flow of credit from financial institutions to businesses and consumers. When Lehman Brothers filed for bankruptcy on September 15, 2008, it was fourth-largest investment bank in the United States.

Federal regulators have spent years investigating and litigating the financial firms whose practices contributed to the financial meltdown. In fact, the Securities and Exchange Commission spent two years investigating Lehman Brothers, and while the probe hit one dead end after another and not a single civil charge was filed, the resulting report showed bank officials used accounting maneuvers known as “balance sheet manipulation” to mislead shareholders into believing that the firm was healthy until five days before it collapsed.

In a way, Lehman Brothers was a shining example of what went wrong with the American banking system: it made bad bets on mortgage-backed securities and when its finances became dicey, management attempted to hide the problem. But because it was allowed to fail, its history was much different than many other firms that invested heavily in mortgage-backed securities. Other firms were hastily incorporated into other institutions to avoid further disaster — a solution that could not be worked out for Lehman. During the crisis, the Federal Reserve and the Treasury fought to prevent the complete collapse of the American banking system; Bear Stearns was sold to JPMorgan Chase (NYSE:JPM), and Bank of America (NYSE:BAC) bought Merrill Lynch, transactions that can be described as quasi-shotgun marriages aimed at saving those brokerages.