Life Investment Lesson from the Fall of Lehman Brothers

On this Blog I will review about the infamous Lehman Brothers that has the entitlement to be: The Bank that crash the world, the Bank that creates the infamous 2008 credit crisis and lastly the bank with a long-term successful CEO, however nowadays his known as a criminal.

The 2008 financial crisis is one of my favourite economic cases that devastate not only in the US, however all around the world, and one of the major players was Lehman Brothers which was the 4^th major Investment Bank in the US with a net profit of $1.3 billion and $398 billion in assets in 2007, however because of its insidious banking strategies that creates the financial crisis, Lehman Brothers went bankrupt.

Furthermore, I’m going to relate this topic with the finance theory of International Cost of Capital which are formulas and calculation to value a debt and equity securities and determining the amount of return, value, spreads and risks.

Lehman Brothers plays a big role in international investment and foreign investment, including foreign investors invest on Lehman brothers’ toxic assets and securities which created the financial crisis making evaluation to the cost of capital to have high risks, significant undercapitalized and low creditworthiness.

So…. Why is it important for investor to understand international cost capital?

Well, I’m a beginner foreign investor and I invest in foreign securities and I often use financial calculation based on Capital Asset Pricing Model, Weighted Average Cost Capital and the Black Scholes formula to value the securities and market. These are important, as I obtain substantial returns so far, and these calculations such as Capital Asset Pricing Model, Weighted Average Cost Capital and Beta Coefficient contributed to Net Present Value are useful to understand the Expected return, expected risks and expected value of the investment to make sure that I am completely aware of the current market, previous market and may predict the future market.

But, some investment went wrong, even though the calculation are positive return…. Why? what happen? Well, I did not take the account of macroeconomic condition such as economic and political changes, because a sudden drop of bond and share price will influence other investor to sell thus share price will decrease and making the new Cost of Capital to be undervalued and riskier.

So, for Lehman Brother……. what do I think?

Well there’s two things, one, it’s not the banks fault because it’s the sub-prime mortgage issuer which are poor irresponsible family who wants a house based on debt and they cannot pay the debt, which resulted to defaults. With hundreds of mortgage defaults, property value decreases which symbolizes as Depression in the economic cycle. In my opinion, if the poor people did not issue the mortgage then this event will not occur!

Lehman Brothers is doing gods will they said, well its true; helping families to obtain a proper settlement to live, but with a little twist that if the family defaults which they are force to be evicted, the bank confiscate the property and sell it at higher price, which is funny.

You might be thinking: its not the families fault, they were manipulated and exploited by the banks to accept the mortgage, because they are not knowledgeable and do not understand the circumstances! Well I agree, as the mortgage-broker was highly persuasive in the issue of mortgage to brainwash the un-wealthy families on accepting the sub- prime mortgage, however, even a student in high school should understand the basics of debt and the consequences of debt default, if they don't pay there'll be consequences, hence they shouldn't had to accept the mortgage. 

Secondly, the only illegal activity that Lehman Brothers did was financial report and credit rating fraud to the Collateralize Debt Obligation, which abuse investors and the market. The simplest explanation is that the bank provides false credit rating on the bond to be seemingly safe (however is not safe but highly volatile) including the financial report to have high cash provided to the investor which should persuade the investor to invest on the bond. This is ridiculously and ignorant idea because the investors know that the bank does not have sufficient financial reserves, profits and capital buffer, including the flawed manner of banks corporate governance and ethics.  

I was surprise that this financial crisis provides low impact to Indonesia which is my home country, and surprisingly my family business is growing, and banks in Indonesia was solvent….. why? What happen?

Look at that graph, Indonesia economy was growing!

Well, the reason is that Indonesia has a sufficient system of foreign relations and foreign investment, meaning that Indonesia provide foreign value investment with sufficient cost of capital calculation, international econometric calculations and able to predict future occurrence, and Indonesia’s regulators restrict foreign debt structuring to prevent economic stress.

This really reflect on me because at the future I would like to be a successful investor, and I learned that not to highly focused on financial calculation such as Cost of Capital, but also on the macroeconomic changes. I mean, those financial theory are important, however it does not consider actual future situations whether the market will go down or go up, because we do not know if there will be a sudden economic crisis or the business approaching bankruptcy. 

Furthermore, I think to be a successful investor, I have to continually monitor the market, often evaluate my investment, often put rational decision making and provide a sufficient portfolio management to invest mostly on blue chip stock value investments and high credit rating bonds that way the calculation of cost of capital is more flexible and ensure gains are achieved.