By Roy (Jung-hun) Baeck, VI Form

The 2008 Financial Crisis: Examining the Causes of Lehman Brothers Bankruptcy

Editor’s Note: This paper was completed as a part of the History Research Fellowship, a one-semester course available to sixth form students.

Student-Submitted Note: As part of the History Research Fellowship, I conducted research on the history of financial and housing regulations up to the 2008 Financial Crisis and the impact it made to one of the Wall Street firms, Lehman Brothers, and more.

The following are headlines from The New York Times between September 10 and September 15, 2008.

A Battered Lehman Fights for Survival
Pressure grows on Lehman as shares slide again
Shares Continue Decline as Lehman Looks for Buyer
U.S. demands that Wall Street save Lehman
Lehman’s Fate Is in Doubt as Barclays Pulls Out of Talks
Lehman in Bankruptcy; Merrill to Be Sold; A.I.G. Struggles

On September 15, 2008, the Wall Street firm Lehman Brothers filed for the largest bankruptcy in the history of the United States. At a market value of nearly $46 billion at its peak, the firm’s glory ended with $613 billion of debt and over 25,000 unemployed people. To this day, historians consider the collapse of Lehman Brothers as the turning point of the 2008 financial crisis, causing turmoil in the already struggling United States and eventually worldwide.

The bankruptcy of Lehman Brothers, considered the centerpiece of the crumpled US financial market, illustrates the United States government’s poor effort to maintain a sustainable economy and a successful financial sector. A history of excessive emphasis on homeownership and unreasonably extensive housing policies resulted in the US housing market bubble. The bubble, integrated with the lack of regulations on financial derivatives and Wall Street’s substantial firms making reckless investments in the securities market, created the most impactful market crash of the 21st century.

This paper first explores how the United States has historically pursued increasing homeownership. It examines the effects of various housing policies and their cumulative contribution to the housing market crash by the 2000s. After the early 20th century, when the push for homeownership first started, policies on increasing home ownership transformed into a mere custom, without much constructive plan, to the latter presidents. Then, the focus shifts to the history of Lehman Brothers. It narrates the progression of how the dried goods store in 1847 became one of the most influential investment banks on Wall Street but ultimately disintegrated, with its bankruptcy playing a vital role in the financial crisis. Lastly, it follows the course of events directly leading to the 2008 crash, from SEC’s regulation changes to Lehman Brothers declaring bankruptcy.

Foundation of the Crisis in the 20th Century

Owning a home has always been a vital measure of success in America. As a result, the United States has consistently made home ownership one of its policy priorities. Presidents have introduced bills that allow more citizens to own homes, and many of these laws have had lasting impacts. However, during the late twentieth century, the national push for home ownership led to the largest financial debacle in contemporary history: the 2008 financial crisis.

Expansive home ownership policies often accompanied the American people’s numerous predicaments during the twentieth century. Global crises such as the Great Depression, World War I, World War II, and the Cold War required the government to provide social welfare and relief, some of which towards expanding home ownership.

The first federal program to explicitly support home ownership was a public relations campaign called “Own Your Own Home.” Initially launched by the National Association of Real Estate Boards, the U.S. Department of Labor took over the campaign in 1917. However, the program did not contain any firm structures or financial support and primarily focused on promoting the idea. The following notable policy came as a remedy for the Great Depression, when the United States saw the homeownership rate, the percentage of US houses occupied by its owner, drop from 47.8% in 1930 to 43.6% in 1940. As part of the New Deal, President Franklin D. Roosevelt created the Home Owners’ Loan Corporation (HOLC) to help Americans threatened with foreclosure on their homes. By purchasing the mortgages of homeowners who may eventually default, the agency would then refinance the mortgage in a more advantageous way for the homeowners. Using government backing, HOLC rapidly relieved Americans from the recession’s devastating effects, refinancing over one million mortgages in the next two years.

While the HOLC accounted for short-term relief, Roosevelt also created government agencies to help regulate the housing market in the long run. Under the National Housing Act of 1934, Roosevelt established the Federal Housing Administration (FHA). The government sought to stimulate the housing market through the FHA by insuring mortgages for banks and private lenders. FHA’s insurance made lenders less conservative with their loans since the government would mitigate the risk of their clients’ potential default. At the time, this policy allowed people with less wealth to access mortgages and encouraged more prospective borrowers to purchase housing. The FHA made another crucial contribution by altering the structure of mortgages. Until the 1930s, a conventional mortgage would last up to ten years, and the mortgage would only cover up to 50% of the home’s cost.10 Requiring prospective homeowners to pay half the house price in cash at purchase created a high barrier for people to purchase houses. To resolve this issue, the FHA created specific criteria that a mortgagee must meet, such as a minimum down payment or income level, so the lender could receive government-backed insurance. As a result, borrowers could obtain friendlier loans. Eventually, the mortgages that lasted 20 to 30 years and covered 80% of the house price became the new norm.

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Roy Baeck is a VI form boarding student from Newton, MA. Roy enjoys studying economics, statistics, and policymaking. Roy also loves watching major sports leagues, especially baseball.