Risk Management

RISK MANAGEMENT 4

RiskManagement

Riskmanagement is a significant aspect because it helps a business tocontinue with its operations. In case risk management is notconsidered by an organization, there is a possibility of theorganization becoming adversely affected by risks, which may even endup with the organization closing its operations. The aim of thisassignment is to discuss how Lehman Brothers failed to use riskmanagement appropriately and explain how the organization could haveavoided the problem.

Lehmanbrothers had been indicated as one of the best performing entities inJanuary 2008 this could be judged from the trading of the company’sstock. During the time, the company was estimated to have a marketcapitalization of more than $30 billion. However, on September 2008,the stock of the company declined by approximately 95% from theJanuary’s value. This made the organization move to the filing ofbankruptcy proceeding (McDonald&amp Robinson, 2009).

Theproblem of Lehman Brothers having assets that were chiefly Long term,while its liabilities were chiefly short-term. This brought theproblem of asset-liability mismatch. Besides, Lehman Brothers used tofund itself through short-term repo markets (Ferrellet al, 2010). The organization kept on vast sums of money in the repomarkets in order to sustain daily business operations. Confidence ofcounterparties was exceedingly significant in ensuring that LehmanBrothers obtained daily funding. Loss of the counterparties’confidence in the company denied the company daily funding and thismade it cease operations since it was not capable of funding itself.Besides, the growth strategy that the organization adopted was risky(Ferrellet al, 2010). The growth strategy made Lehman Brothers to exceed itsinternal risk levels and controls by large margins. When Lehman waspredicted to fail, it used different strategies in order to maintainits confidence and avoid failure. For instance, Lehman Brothersreported a deceiving picture of its financial situation.

Inmaintaining the counterparty and investor confidence, Lehman ensuredthat it obtained favorable ratings from the chief rating agencies.The organization understood that liquidity and net leverage weresignificance in the rating process therefore, it ensured that it hadthe necessary net leverage position so as to maintain favorableratings and ensure investor confidence (Gup,2010). In addition, when the organization made a loss, it claimedthat it had a strong liquidity pool and that it had immenselymitigated its leverage ratio in fact, the organization failed todisclose that its balance sheet had been designed with the use ofRepo 105 so as to control the balance sheet.

Theproblem of this organization could have been avoided through theorganization following different risk management practices. One ofthe practices that the organization could have used in order to avoidthe problem entails following proper valuation procedures. In casethe organization followed appropriate valuation process, it could nothave suffered financial problems because it engaged in riskyprocesses in order to increase its investor confidence. Besides, theorganization could have avoided the problem by refraining from theuse of Repo 105. The use of Repo 105 made the organization to givemisleading information, which risked its operations in the market. Inaddition, in order to avoid the problem, Lehman could have followed aprudent path of corporate governance. This could have made theorganization to adhere to best industrial practices, thus saving itsoperations.

References

Ferrell,O. C., Fraedrich, J., &amp Ferrell, L. (2010).&nbspBusinessethics: Ethical decision making and cases : 2009 update.Mason, OH: South-Western Cengage Learning.

Gup,B. E. (2010).&nbspTheFinancial and Economic Crises: An International Perspective.Cheltenham: Edward Elgar Pub.

McDonald,L. G., &amp Robinson, P. (2009).&nbspAcolossal failure of common sense: The inside story of the collapse ofLehman Brothers.New York: Crown Business.

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