Though the world awaited the outcome of the negotiations with baited breath, none believed the US government would allow Lehman Brothers, the one hundred and fifty eight year old Wall Street bank, to fail. The belief was the government would step in at the last minute with a plan to save the bank, just as it had done for AIG and after arranging shotgun marriages for Bear Stearns and Merrill Lynch.
Monday morning, 15 September 2008, the world awoke to a shock of historic scale; Lehman Brothers had filed for Chapter 11 bankruptcy protection. It debts exceed six hundred billion dollars of debts and its twenty five thousand employees found themselves on the street. Seconds after the news fell traders stampeded for safety and creditors panicked at the thought of losing hundreds of billions of dollars in what was the biggest financial collapse since banks were invented.
As the shock wave reverberated across the world banking shares went into free fall and governments rushed to save what they could by propping up their own stricken financial systems. Banks froze lending threatening to shutdown entire economies. At the end of that racking week the US Treasury Secretary proposed a plan to rescue the country’s financial system with seven hundred billion dollars of taxpayers’ money. Goldman Sachs and Morgan Stanley, the last remaining independent investment banks, became holding companies, to take advantage of the central bank’s emergency funds.
On the other side of the Atlantic, within the week that followed, Bradford & Bingley was nationalised and a series of Icelandic banks collapsed. A month later the British government was forced to bail out Lloyds, HBOS and the Royal Bank of Scotland.
As the dominos fell, AIG insurance, the eighteenth largest company in the world, which had insured the enormous bets wagered on the sub-prime market and other equally doubtful derivatives, was hit by a flood of claims. Hundreds of billions of dollars had been thrown away in a vast binge, gambling on every kind of derivative transaction conceivable.
Whilst the US administration fiddled, its attention turned to the Bush family’s sponsored wars, AIG had been at liberty to do whatever it liked following a coup carried out by the it’s top management. Control had been effectively wrested from its shareholders hands, leaving them stranded as helpless onlookers. Profits piled-up as AIG covered the risks of investment banks that in turn made fortunes from selling triple A rated CDOs, fobbed-off as being as safe as houses. The banks’ mathematical wizards calculated the risk of CDO default as once in a thousand years, when in reality they were as worthless as common junk bonds.
Following the Great Depression banks were prevented from becoming involved in the insurance business by law, but this changed in 1999 when new laws were introduced that allowed banks, securities houses, investment banks and insurers to enter each other businesses. This led to the creation of Wall Street giants such as the Citigroup. These laws allowed banks to compete with investment firms.
This transformation allowed top management to expand its powers filling their pockets with ladles full of cash from the immense profits produced by the Street’s giants, offering themselves private jets, yachts, vast Fifth Avenue penthouses, luxurious villas in the sun, art collections, jewellery, in short the life of Renaissance princes.
In 2007, the president of AIG’s financial products division said: It is hard for us, without being flippant, to even see a scenario within any kind of realm of reason that would see us losing a single dollar. Less than a year after his cheerful prognostic the company was on the verge of collapse and asked to be bailout.