Can a Subsidiary Lead to the Downfall of Its Parent Company? The Case of Lehman Brothers and Archstone

 Once at the forefront of the global investment banking industry, Lehman Brothers has an interesting past that captures both its ascent and disastrous decline. In Montgomery, Alabama, the corporation was first established in 1844 as a modest cotton trading enterprise. Over the years, it developed into a major force on Wall Street. The Lehman brothers, Henry, Emanuel, and Mayer, used their knowledge of commodities to create a company that provided financing for important areas of the American economy, such as manufacturing and railroads, during the Industrial Revolution.

The financial landscape changed, and Lehman Brothers expanded its operations. In order to raise money for businesses through bond issuing and underwriting, it had expanded into banking and consultancy services by the late 19th century. The company was able to flourish and grow internationally because of its flexibility.

Turning Into a World Powerhouse
Several significant turning points in Lehman Brothers' development into a financial behemoth were established:

• 1970s Growth: Lehman expanded its fixed-income trading and investment banking operations under the direction of Pete Peterson and Lewis Glucksman.
• Lehman's position in global markets was further cemented in the 1980s with a combination with Shearson/American Express.
• Golden Age of the 1990s: Lehman went public after splitting out from American Express in 1994 and had incredible expansion. Under CEO Richard Fuld, the company rapidly grew into investment management, derivatives, and equity and fixed-income trading.
• International Growth: Lehman built a solid presence in both Europe and Asia by capitalising on emerging markets and riding the globalisation wave.
  Dominance of the Mortgage Market: Lehman made money as the mortgage-backed securities market flourished in the early 2000s.

What Went Wrong? Archstone and the 2008 Financial Crisis

The aggressive growth plan of Lehman started to show signs of weakness by the mid-2000s. Its investment in residential real estate subsidiary Archstone was a major contributing element to its demise. Lehman's expansion strategy included the acquisition of Archstone, which appeared to be a viable asset during the real estate boom.

But Lehman's position was shown to be vulnerable by the collapse of the housing market in 2007. Archstone became a financial problem as a result of its high level of borrowing and exposure to falling real estate prices. Its troubles were representative of a larger issue: Lehman's excessive dependence on risky, debt-driven investments.

The more Archstone lost, the more financially strained Lehman was. Lehman's exposure to mortgage-backed securities and the subsidiary's demise damaged investor trust and caused a liquidity crisis.

The Influence of Ripples
Lehman's problems with Archstone were a sign of more serious problems.

1. Excessive Leverage: When the markets turned, Lehman's losses were exacerbated by its aggressive use of debt.
2. Risk management: Ineffective portfolio diversification and underestimation of real estate market risks were the firm's two main areas of risk management.
3. Market Overexposure: It was susceptible to systemic shocks because of its significant involvement in the failing mortgage market.

When September 2008 arrived, everything had gotten out of hand. When Lehman Brothers declared bankruptcy, it was the worst failure in American history and a major contributing factor to the global financial crisis.

Lehman Brothers and Archstone: Some Takeaways

• Subsidiary risks: If a subsidiary performs poorly, it could have disastrous consequences for its main firm.
• Diversification with Caution: A thorough risk analysis must be integrated with the expansion into new industries or regions.
• Proactive Risk Management: Early risk identification and mitigation can save minor problems from turning into major ones. This is known as proactive risk management.

Final Thoughts

Lehman Brothers' ascent to fame was evidence of its capacity for growth, innovation, and adaptation. The consequences of unbridled ambition and poor risk management, however, were starkly brought home by its demise. Archstone's demise was a major factor in Lehman's financial collapse, underscoring the relationship between market forces and company policies.

Modern firms can learn from Lehman Brothers' example, which highlights the significance of striking a balance between sustainability and growth.

References

• The History of Lehman Brothers-The Wall Street Journal
• Lehman Brothers: The Rise and Fall of the American Bank-The Guardian.
• How Lehman Brothers’ Investment in Real Estate Led to its Collapse -MarketWatch.