Why did the Lehman Brothers Fell? Answers for you in Layman Language….

To understand the present Financial crisis in US that led to the fall of Lehman brothers one has to understand what’s sub-prime lending. When banks give loan to person from elite strata of society, this loan borrowers are known as known as primes. Lending to these primes is an risk less venture due to a sound assurance of loan money retrieval. Whereas people who have a slightly low financial credibility to return loans are known as ‘sub-primes’. Mortgages given to sub prime are risky as there’s always a chance that sub-prime people will default from repaying.

So the question is why US would have lent money to sub-primes? The answer is, during the period 2002 to 2007, the housing and property business was booming in US and property rates during these five years went double. Thus every major investment bank gave housing loans to sub-primes because they believed that the booming property rates will enable them to pay-back easily. Almost every major investment bank came up with a product for housing loans (even capped into mutual funds) to sub-primes. Investment in house mortgage was gigantic.

But after 2007, due to saturation of property market and increase in competition, property rates fell flat down. Entire scenario was heading towards a cold death. Inflation was rising, dollar was weakening and economy slowed down drastically. The sub-primes (largely consisting of poor people and young students) were unable to repay loans (which came with heavy interest rates due to the risk involved). Thus investment banks went straight to gallows. The combination of sub-prime lending, declining economy and inflation led to the downfall of Lehman brothers who were actually worst affected by this ongoing crisis.

Implications for India:

As they say, “when US sneezes, India and China catch cold”. Lehman Brothers demise will mostly affect the BFIS sector of India (the Banking, Finance, Insurance & Service sector). IT Companies like Infosys and TCS had Lehman Brothers and other Investment giants as their top clients. Surely lots of employees in BFIS sector and IT sector will be given Pink Slips. Students of IIM’s have something to worry about as Lehman Brothers used to come at Day zero of campus placements. Markets in India were already on a downfall & Lehman brothers case has made the matters worst. Things have changed even for Barclays and AIG as even their share prices have gone down. Budding MBA graduates should be ready for a slightly less pay-package ( if at all ) than previous year. Especially the heart goes out to the Indian IT sector which was the backend for all this US investment giants.

Tarun A. Raipure
Post Graduate Student, IsquareIT Pune