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The Big News: Disgraced investment banking giant Lehman Brothers, which was first in line among the Wall Street’s bellwethers to collapse, announced its emergence from bankruptcy earlier this month.
The Immediate Question: Is this an indication of strong economic recovery?
The Answer (According to us): The collapse of Lehman was the starting point of the recession. On that count, a hopeful mind might believe that its revival should accelerate the pace of economic recovery. However, the equation is not so simple. We believe the lingering fundamental challenges will not allow the economic growth to return to its pre-recession level anytime soon.
Fall of Lehman & the Weary Banks
Turning back the pages, Lehman once boasted being the fourth-largest investment bank in the U.S. with operations in more than 40 countries and total assets of $639 billion. However, it became a victim of the sub-prime crisis and unfortunately earned the infamous record of being the biggest corporate bankruptcy case in history.
On September 15, 2008, Lehman had to take the cover of Chapter 11 bankruptcy to reorganize its business and protect itself from endless lawsuits. Lehman announcing its bankruptcy had spread shock waves to every corner of the globe.
Thereafter, many other Wall Street giants followed suit. Timely government bailout packages brought back American International Group Inc. (AIG - Analyst Report) and Citigroup Inc. (C - Analyst Report) from the brink of collapsing in September and November 2008, respectively.
Washington Mutual Inc. also filed for Chapter 11 bankruptcy in September 2008. In the same month, Morgan Stanley (MS - Analyst Report) and The Goldman Sachs Group Inc. (GS - Analyst Report) converted from investment banks to bank holding companies, while Fannie Mae and Freddie Mac were placed under the control of the Federal Housing Finance Agency.
Further, financial services company Wachovia was acquired by Wells Fargo and Company (WFC - Analyst Report) in December 2008 and Merrill Lynch was taken over by Bank of America Corporation (BAC - Analyst Report) in January 2009.
Soon after going bankrupt, Lehman started selling its assets to generate some cash for debt repayment. The company offloaded its investment management business to Bain Capital Partners and Hellman & Friedman, sold the U.S. brokerage business to Barclays Plc (BCS - Snapshot Report) and divested its European, Middle Eastern and Asian businesses to Nomura Holdings Inc. .
Chapter 11: A Closed Chapter
Finally, after about three and a half years, Lehman recently announced that it is coming out of the protection of Chapter 11 bankruptcy to liquidate its assets and pay off as much debt as possible, before fading into oblivion.
Lehman is over $450 billion in debt. On the other hand, it has about $30 billion in cash, which it raised from asset divestitures. Another $35 billion are expected to be raised from the sale of its remaining assets, such as the Ritz-Carlton Kapalua hotel in Hawaii, luxury ski resort Moonlight Basin in Montana and a boutique hotel in Manhattan.
Lehman will make the first payment of about $10 billion to creditors on April 17, 2012, followed by bi-annual payments till the completion of the liquidation process. The second lot of payments is expected in September.
While Lehman’s decision to exit bankruptcy brings a sliver of hope to its creditors, they can expect to receive only a tiny fraction of their dues, that too over a five-year period. Ironically, the holders of the company’s ‘100% Principal Protection’ Notes will collect less than 30% of their principal amount.
True, that Lehman’s collapse commenced the U.S. recession and it symbolized the economic downturn. However, as attributed by many, the weak American financial system was the reason behind the economic turmoil, and Lehman just paid a big price for it. Thus, it will not be prudent to read too much into Lehman’s exit from bankruptcy.
The partial recovery of Lehman’s creditors’ money might spark some cheer and provide a boost to the U.S. economy. But the global economy is still reeling under a financial uncertainty. Yes, the Dow has returned to its pre-recession levels and is hovering over and near the 13,000 mark. The other benchmarks, too, are back to levels last seen before the recession.
Separately, Federal Reserve has also been fairly upbeat about the economy, claiming it to be “expanding moderately”. But several key indicators have yet to return to pre-recessionary levels. For instance, unemployment rate is still higher than it used to be before the crisis. Additionally, cross-Atlantic concerns have dented enough damage to the financial arena. Moreover, last August, Standard & Poor’s downgraded the much-cherished ‘AAA’ credit rating of US by a notch. Thus, full recovery is a long way ahead.
As the banking sector is undergoing a radical structural change, the economy will witness headwinds in the near- to mid-term. We believe that the U.S. economy will regain its growth momentum once the nagging issues are resolved. Thus, Lehman’s exit from bankruptcy remains only a small development in the wider scheme of things.