International Impact of Lehman Brother’s Bankruptcy on World Economy

This paper examines the effects of the Lehman Brother’s bankruptcy on the world economy. The bankruptcy was closely related to the global economic downturn that commenced in 2008 (Asian Development Bank, 2009). It pushed not only the US economy but also other economies world over in recession (Aragon & Strahan, 2009). It destroyed what was largely taken as money-making machine that was sleek, affecting the global economy rather adversely and dramatically. It led to the dwindling of depositor confidence in banking institutions and the export market.

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Export Contraction

Before filing for bankruptcy, Lehman Brother’s had given out a lot of cash in debt, especially short-term debt. That included commercial paper, which is not very attractive in the market even though it is a critical element of the international economy (Aragon & Strahan, 2009). Ideally, every company requires marked short-term credit to fund its commercial processes such as production and transportation of goods. The bankruptcy filing reduced the worthiness of the commercial paper it had issued earlier significantly. That made those who owned the commercial paper, both funds and investors; panic (Aragon & Strahan, 2009; Kose & Prasad, 2008).

Elementarily, the market for commercial paper seized up as Lehman was seen as incapable of making good on own short-term debt (Asian Development Bank, 2009). Individual investors were worried that it was becoming imprudent to lend out money even to traditionally reputable institutions (Aragon & Strahan, 2009; Kose & Prasad, 2008). Financial and banking institutions were worried that it was becoming imprudent to lend out money even to others as well. That made the rates for lending on short-term rise steeply and quickly, slowing down global trade in effect.

The bankruptcy filing pushed the other economies into a recession just like the US economy. Notably, the US economy had been in recession since early 2008. The other economies had held up rather well until the filing happened. From the last quarter of 2008, the global trade volume started reducing significantly and sharply (Asian Development Bank, 2009). Global trade and production reduced markedly especially across the developed world. Over time, more and more developing economies registered significant drops in their production levels and trade volumes (Aragon & Strahan, 2009). It is widely estimated that global trade contracted at a yearly rate of about 0.4 from the last quarter of 2008. In Japan, export volume contracted by close to 0.6 in the period from August 2008 to the end of January 2009. In German, export volume contracted by close to 0.25 in 12 months starting July 2008. China also registered a comparable export volume contraction around the same period (Asian Development Bank, 2009).

The acute export volume contraction in the different countries shocked their economic systems significantly. For instance, the housing industry in the US registered considerable and increasing losses (Asian Development Bank, 2009). Before the bankruptcy filing, the US economy was highly reliant on easy credit, leverage as well as housing. That means that the economy was almost incapable of weathering shocks in any of the three sectors. Other leading economies were highly reliant on credit. Trade in them was largely driven by credit (Aragon & Strahan, 2009). The shock stemming from the bankruptcy filing demonstrated that the economies’ continued dependence on the sectors for economic growth and employment was ill-advised and unreliable.

Risk Management Reforms

There was considerable political, as well as public, outcry following the Lehman collapse owing to the fact that it led to diminishing confidence in banking along with financial institutions globally, deep recession, and a financial crisis (Cochrane & Zingales, 2009; Committee on the Global Financial System, 2009). Following the collapse, the paying of significant shares is now increasingly paid in terms of shares (Asian Development Bank, 2009). In many cases, there are provisions allowing for the clawing back of such awards if the corresponding businesses are unsuccessful.

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Even then, there are no provisions controlling the total amounts that individuals may be paid (Baba, McCauley, Ramaswamy & Srichander, 2009). There have been calls for the changing of regulation structures in the UK to have the Financial Services Authority cede its banking supervision mandate to the Bank of England (Aragon & Strahan, 2009). The structure is essential. Even more essential is attitudinal changes among bankers and regulators to ensure that the management of risks is viewed more and more seriously going forward (Asian Development Bank, 2009).

In the wake of the collapse, several global agreements, which are largely christened the Basel III agreements, portend that banking institutions have to have in large capital reserves to enable them to absorb possible losses. Over time, many changes relating to the agreements have been actualized (Cochrane & Zingales, 2009; Committee on the Global Financial System, 2009). The collapse has over the years affected financial disclosure, accounting, and reporting practices (Asian Development Bank, 2009). Financial analysts and other professionals learnt from the collapse that adding accounting practices that are in themselves risky to models of business that are risky and management habits that are risky as well are a recipe for the collapse of financial along with banking institutions. That has persuaded changes in some traditional accounting rules (Aragon & Strahan, 2009).

Dwindling Confidence in Financial Systems

From the early 2000s, the US economy was largely driven by low-cost finances. Individuals and investors could access money easily to satisfy various needs such as purchasing houses and expanding businesses (Cochrane & Zingales, 2009; Committee on the Global Financial System, 2009; Kose & Prasad, 2008). Prior to the crash of the housing industry, there were many individuals who took their homes’ growing value as a savings’ substitute (Aragon & Strahan, 2009; Kose & Prasad, 2008). Even then, the marked destruction of household wealth following the Lehman collapse, which made the prices of homes plunge, and a marked stock swoon reduced confidence in building homes in lieu of making savings. The building of homes was increasingly viewed as incapable of guaranteeing one financial security (Asian Development Bank, 2009).

Following the collapse, more and more individual grew less confident of the traditional financial systems, which they saw as unstable. That is largely because the US government was averse to bailing Lehman out. The government’s failure to do so shook the confidence of investors and businesses in markets significantly (Cochrane & Zingales, 2009; Committee on the Global Financial System, 2009). The investors and businesses were worried that the markets and financial systems were bound to fail altogether if everything was held at a constant. Notably, financial systems function properly if their stakeholders have confidence in them (Aragon & Strahan, 2009).

The dwindling confidence in the systems was best exemplified by the situation relating to banking institutions. That is because more and more banks became unenthusiastic about extending credit among them (Asian Development Bank, 2009; Kose & Prasad, 2008). More and more banks were afraid that those they extended credit to would not settle their debts. That general thinking led to the dramatic freezing of credit markets (Eichengreen, Mody, Nedeljkovic & Sarno, 2009; Zingales, 2008). Consequently, rates of borrowing for businesses, as well as banks, rose steeply.

Conservative Investment Took Root

The Lehman collapse persuaded more and more investors to adopt conservative practices to make themselves less prone to the related risks (Baba, McCauley, Ramaswamy & Srichander, 2009). Investors grew keener and keener on ensuring that their monies were safe. For instance, the retail investors became unenthusiastic about trading in stock markets. Stock prices, which had peaked in 2007, dropped (Cochrane & Zingales, 2009; Committee on the Global Financial System, 2009). The value of homes dropped significantly as well (Asian Development Bank, 2009).

That left many investors disillusioned. Consequently, many of the investors were keen on committing their monies to investments that they considered safe, including deposit certificates as well as money market funds (Aragon & Strahan, 2009; Kose & Prasad, 2008). That was regardless of the fact using the certificates and funds as investment vehicles is associated with limited or no returns by and large (Cochrane & Zingales, 2009; Committee on the Global Financial System, 2009). The number of cash accounts and related accounts went down significantly regardless of the high returns associated with them (Baba, McCauley, Ramaswamy & Srichander, 2009).

Owing to the collapse, consumers directed more and more money to investments associated with low returns (Eichengreen, Mody, Nedeljkovic & Sarno, 2009; Zingales, 2008).That means that they had to make more savings than they had done earlier to realize the return levels that they were used to before the collapse (Asian Development Bank, 2009). Many individuals became averse to making savings as their investment vehicle and engaged in speculation instead. That was especially so because bank credit became costly. Introductory credit offerings came to an end (Baba, McCauley, Ramaswamy & Srichander, 2009). Banks were no longer enthusiastic about dangling mortgage facilities, which are often characterized as being no-money-down, to possible home buyers regardless of their means (Aragon & Strahan, 2009).

Lenders grew more and more selective and cautious regarding who they extended credit to and the pricing of the credit (Asian Development Bank, 2009). The number of credit cards issued right after the Lehman collapse reduced sharply and numerous banks scaled their limits of credit back, closed credit lines that were not in active use, and reviewed borrowing rates upwards (Baba, McCauley, Ramaswamy & Srichander, 2009). Notably, even the customers who had remained rather dependable and loyal to the banks for long had to contend with the revised borrowing rates (Aragon & Strahan, 2009). The tightening of credit decimated consumption increasingly, slowing down the global economy.

Unemployment

The Lehman collapse reduced employment rates internationally by and large (Cochrane & Zingales, 2009; Committee on the Global Financial System, 2009). As noted earlier, the tightening of credit decimated consumption increasingly, slowing down the global economy (Asian Development Bank, 2009). The collapse forced several structural changes on the US economy as the businesses that traditionally generated many jobs found it hard to access credit and faced reduced production (Baba, McCauley, Ramaswamy & Srichander, 2009). Businesses such as those dealing with traditional media, financial services, elementary manufacturing, and the automobiles began laying off big numbers of their staff members as their profits dwindled (Aragon & Strahan, 2009).

In the wake of the collapse, the consolidation that defined retail sectors worldwide meant fewer employment openings and stores (Aragon & Strahan, 2009). The end of the recession has seen many of the businesses that lay off staff members in the wake of the collapse retrain many of the employees that remained with them (Asian Development Bank, 2009; Baba, McCauley, Ramaswamy & Srichander, 2009). By and large, employment rates that fell owing to the collapse are yet to return to their traditional levels to date (Cochrane & Zingales, 2009; Committee on the Global Financial System, 2009).

Conclusion

Before the bankruptcy filing, the US economy was highly reliant on easy credit, leverage as well as housing. That means that the economy was almost incapable of weathering shocks in any of the three sectors. Other leading economies were highly reliant on credit. Global trade and production reduced markedly especially across the developed world. Over time, more and more developing economies registered significant drops in their production levels and trade volumes. The Lehman collapse destroyed what was largely taken as money-making machine that was sleek, affecting the global economy rather adversely and dramatically. It reduced the worthiness of the commercial paper it had issued earlier significantly. That made those who owned the commercial paper, both funds and investors, panic. The ensuing acute export volume contraction in the different countries shocked their economic systems significantly. The collapse roiled the international financial market for long owing to Lehman’s size and position as a principal stakeholder in the global market. There was considerable political, as well as public, outcry following the Lehman collapse owing to the fact that it led to diminishing confidence in banking along with financial institutions globally, deep recession, and a financial crisis. Several Basel III agreements required banking institutions to have large capital reserves to enable them to absorb possible losses. Following the collapse, more and more individuals grew less confident of the traditional financial systems, which they saw as unstable.

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