One of the key financial risks that Lehman Brothers faced was the concentration of risk in their real estate holdings and related securities. The firm had invested heavily in subprime mortgages and related instruments, which were later revealed to be highly risky and illiquid (Hurley & Hurley, 2013). Additionally, Lehman Brothers had used large amounts of leverage to finance their investments, meaning that even a small decline in asset values could wipe out their equity.

To manage these risks, Lehman Brothers employed a variety of strategies, including hedging, diversification, and risk monitoring. For example, the firm used credit default swaps (CDS) to hedge against the risk of default in their mortgage-backed securities (MBS) portfolio (Hurley & Hurley, 2013). They also diversified their holdings by investing in other asset classes, such as commercial real estate and corporate debt. Finally, they monitored their risk exposures closely using sophisticated risk models and stress tests.

However, these risk management strategies ultimately proved inadequate in the face of the 2008 financial crisis. As the housing market collapsed and the value of Lehman Brothers' real estate holdings declined sharply, the firm's CDS positions were exposed, and their counterparties demanded additional collateral (Madura, 2020). Additionally, the market for MBS and related securities dried up, leaving Lehman Brothers with illiquid assets and no way to finance their operations. Ultimately, the firm was unable to meet its obligations and declared bankruptcy.

In hindsight, there were several steps that Lehman Brothers could have taken to improve their operations and mitigate the financial risks they faced. For example, they could have reduced their exposure to subprime mortgages and related securities, either by selling these assets or by hedging them more effectively (Hurley & Hurley, 2013). They could have also reduced their leverage and maintained a larger cushion of equity to absorb potential losses.

Additionally, Lehman Brothers could have improved their risk management practices by conducting more frequent stress tests and scenario analyses to identify potential risks and develop contingency plans (Madura, 2020). They could have also improved their internal controls and governance structures to ensure that risk management was given sufficient priority and oversight.

Describe the financial risks that hindered the firm's ability to increase its value in the marketplace. Explain Lehman Brothers' approach or strategy for managing these risks. What recommendation(s) would you have offered the firm to help improve their operations? Support your conclusion with material from the course text and/or from outside sources.

 

The Fed was in charge of ensuring that Lehman Brothers complied with numerous risk management rules, therefore it had the biggest influence on the company's operations. The Fed urged Lehman Brothers to raise additional capital in 2008 after expressing worries about the company's liquidity and capital levels (Hurley & Hurley, 2013). The fact that the corporation was unable to secure sufficient funding to meet the Fed's demands, however, led to its demise.

In retrospect, a number of issues, such as Lehman Brothers' excessive reliance on short-term financing, exposure to the US housing market, and a lack of adequate capital and liquidity, were responsible for the company's collapse (Madura, 2020). If authorities had acted more quickly to address these problems, it's likely that the company's demise could have been avoided. It is difficult to say for sure, though, if Lehman Brothers could have been saved by a different regulatory strategy.

In terms of whether the government should have bailed out Lehman Brothers, opinions are divided. I believe that bailing out Lehman Brothers would have created a moral hazard, by signaling to other financial institutions that they could take on excessive risk without facing the consequences.

Describe the influence of regulators on Lehman Brothers' operations. Could Lehman Brothers' bankruptcy have been prevented? Should the company have been bailed out by the government? Why or why not.