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“jcr09009” — 2009/6/16 — 12:14 — page 57 — #1
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The Journal of Credit Risk (57–76)
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Volume 5/Number 2, Summer 2009
Balance sheet exposures leading toward the credit crunch in global investment banks
Omar Masood
Business School, University of East London, Docklands Campus,
University Way, London E16 2RD, UK; email: omar@uel.ac.uk
This paper examines the effect of the 2007–8 predicament in the investment banking sector from a balance sheet perspective. The main factors that led to the crisis are identified and discussed, along with how an investment banking sector searching for high yields got involved in mortgage-related securities. Data from the five major US investment banks between 2004 and the second quarter of 2008 is used to argue that the predicament is the result of the combined effect of the subprime crisis and the credit crunch. The main focus of this paper is an analysis of the effect of leverage and liquidity factors on the balance sheet during the crisis, using data from Goldman Sachs and, more importantly, Lehman Brothers from 1999 to the second quarter of 2008. The two investment banks are compared and analyzed to assess whether the balance sheet argument is holding as the crisis deepens.
1 INTRODUCTION
The 2007–8 predicament is the product of two crises: the subprime crisis and the credit crunch, which combine to create the perfect storm. Individually, neither crisis would have created a big problem but combined they have had a lasting effect on the banks, albeit in different ways. However, as Adrian and Shin (2008b) point out, the subprime securities market is relatively small compared with the overall financial market, and the total loss in overall write-downs from the entire investment banking sector, which stands at US$81.5 billion (Onaran and Pierson (2008)), is less than or equivalent to an average daily gain or loss on the stock market under normal conditions. In order to fully understand the problems affecting the investment
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“jcr09009” — 2009/6/16 — 12:14 — page 57 — #1
✐
The Journal of Credit Risk (57–76)
✐
Volume 5/Number 2, Summer 2009
Balance sheet exposures leading toward the credit crunch in global investment banks
Omar Masood
Business School, University of East London, Docklands Campus,
University Way, London E16 2RD, UK; email: omar@uel.ac.uk
This paper examines the effect of the 2007–8 predicament in the investment banking sector from a balance sheet perspective. The main factors that led to the crisis are identified and discussed, along with how an investment banking sector searching for high yields got involved in mortgage-related securities. Data from the five major US investment banks between 2004 and the second quarter of 2008 is used to argue that the predicament is the result of the combined effect of the subprime crisis and the credit crunch. The main focus of this paper is an analysis of the effect of leverage and liquidity factors on the balance sheet during the crisis, using data from Goldman Sachs and, more importantly, Lehman Brothers from 1999 to the second quarter of 2008. The two investment banks are compared and analyzed to assess whether the balance sheet argument is holding as the crisis deepens.
1 INTRODUCTION
The 2007–8 predicament is the product of two crises: the subprime crisis and the credit crunch, which combine to create the perfect storm. Individually, neither crisis would have created a big problem but combined they have had a lasting effect on the banks, albeit in different ways. However, as Adrian and Shin (2008b) point out, the subprime securities market is relatively small compared with the overall financial market, and the total loss in overall write-downs from the entire investment banking sector, which stands at US$81.5 billion (Onaran and Pierson (2008)), is less than or equivalent to an average daily gain or loss on the stock market under normal conditions. In order to fully understand the problems affecting the investment
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