FAQ: Lehman bankruptcy

The Lehman Brothers bankruptcy explained

Why has Lehman Brothers gone bust?

In short, other banks refused to trade with it. Without the ability to trade, and without investors prepared to bet on its long-term viability, Lehman in effect had no business.

Why would the other banks not trade?

It is similar to the Northern Rock debacle. Lehman, while it was a large and complex business trading a web of assets, also supported 100% mortgage loans offered by specialist lenders to people with few visible means of support.

When interest rates jumped, borrowers could no longer afford their monthly payments.

Like Northern Rock, it mattered less that 80% of its assets were rock solid, if 20% were considered toxic. The bank's trading partners did not know the full extent of its exposure to these toxic loans or how much they were worth which is why they refused, in growing numbers, to do business with it. Banks had lost confidence in Lehman which is vital to a financial firm's existence.

Could the US government have stepped in?

The US treasury has reached the limit of taxpayer funds it is willing to gamble on propping up investment banks. Henry Paulson, the treasury secretary, committed £3tn last week to saving mortgage companies Fannie Mae and Freddie Mac.

If they had failed, the mortgage market in the US would have collapsed and hundreds of banks around the world that had invested in US property would suffer huge losses.

The US treasury bailed out Bear Stearns in March, but appears to believe a trading house such as Lehman Brothers, which has little direct connection with retail markets and ordinary homeowners, could be allowed to go bust without causing the kind of systemic risk posed by Fannie and Freddie.

Why was Barclays interested?

Barclays joined the talks at the weekend to buy Lehman because it was interested in picking up the bank on the cheap.

But Barclays asked Paulson for some kind of government guarantee to support the deal. He refused.

The main City regulator, the Financial Services Authority, was also believed to have expressed concerns to Barclays boss, John Varley, that it was unwise to buy a US investment bank at this time.

Will the whole bank be liquidated?

Not yet. Chapter 11 administration in the US allows administrators PricewaterhouseCoopers to take its time while it tries to find buyers for the least-affected businesses. The year-long protection offered by Chapter 11 shields a company from creditors while it is reshaped or sold as a whole or in parts.

PWC said a number of group companies remain solvent and would continue to trade.

"These companies include Lehman Brothers Asset Management (Europe) and a series of special-purpose vehicles designed to manage portfolios of residential and commercial real estate assets and non-performing loans," the administrators said.

Will everyone at Lehman get the sack?

If PricewaterhouseCoopers manages to salvage some parts of the business as going concerns, those employees could be saved. But most of Lehman's 25,000 employees will be out of work.

What are the risks for other banks?

Share prices have tumbled and are likely to fall further as investors take flight from a sector that appears to be in meltdown.

A flight of investors will make their situation worse because they are to a great extent dependent on their shareholders for capital.

The capital provided by shareholders is the bedrock for their lending and without it they cannot continue trading. The Financial Services Authority is now asking other British banks for constant updates on their exposure to Lehman.

Phillip Inman

The GuardianTramp

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