Five Lessons from the World's Biggest Bankruptcies
Date: 2015-10-07; view: 523.
Scan the text and
TEXT 4
Work either individually or in pairs / groups. Answer the following questions. Prepare a report, if necessary.
Watch the film “Margin Call” (2011) and describe the situation of the 2008 crisis.
What are possible development options, from your point of view, of future crises / bubbles?
Make projections of the beginning, scale, outcome and consequences.
A. say what time period / periods is / are mentioned in the text;
B. list the companies mentioned in the text.
2. Read the text and give your own titles to the “Lessons”.Then, compare them with those given by the author of the article.
The five biggest corporate bankruptcies – and nine of the top 10 – in the U.S. all occurred in the first decade of the 21st century. This should come as no surprise, given that there were two distinct recessions and bear markets that savaged the U.S. economy over this period. The technology sector was the worst hit in the 2000-2002 downturn – the Nasdaq Composite tumbled as much as 78% over this period – and was marked by an outbreak of accounting scandals that led to the bankruptcy of a number of companies including WorldCom and Enron. The 2007-2009 global recession was unprecedented in the scale of destruction it wrought worldwide. It erased $37 trillion, or 60%, of global market capitalization within a span of 17 months, raising fears of a global depression. Corporate icons that were forced into bankruptcy during this tumultuous period included Lehman Brothers and General Motors. (If you're unclear how this recession began, see The 2007-08 Financial Crisis In Review.)
There are obvious differences in size and complexity between corporate financial statements (such as the balance sheet, income statement and cash flow statement) and your own personal financial statements. But these differences apart, there are a number of important lessons to be learned from some of the biggest bankruptcies in U.S. history that are applicable to our own personal finances.
Lesson 1. _____________________________________________________________
Financial leverage refers to the practice of utilizing borrowed money to invest in an asset. Leverage is often referred to as a double-edged sword, since it can amplify gains when asset prices are rising, but can also magnify losses when asset prices are tumbling.
Excessive leverage was a major contributing factor to the 2001-2006 U.S. housing bubble and the subsequent bust from 2007. The housing bubble was fueled by a huge increase in subprime lending, as borrowers with poor credit histories were lured into the housing market by low introductory interest rates and minimal down payments. Excessive leverage was also apparent on the banking side, as the five largest U.S. investment banks significantly increased their leverage between 2003 and 2007, borrowing vast sums to invest in mortgage-backed securities.
Lehman's demise is a case study in the dangers of excessive leverage. Lehman's big push into the subprime mortgage market initially provided stellar returns, as it reported record profits every year from 2005 to 2007. But by 2007, its leverage was reaching dangerously high levels. In that year, Lehman was the leading underwriter of mortgage-backed securities on Wall Street, accumulating an $85 billion portfolio. The ratio of total assets to shareholders equity was 31 in 2007, which meant that each dollar of assets on its balance sheet was backed by only three cents in equity.
Legions of real estate speculators and "condo-flippers" in the U.S. also resorted to excessive leverage during the housing bubble, with equity withdrawals from residences used to fund speculation in additional real estate. Similar to Lehman, their initial success encouraged progressively greater risk-taking, but eventually, they had little choice but to resort to distress sales as the crumbling housing market rapidly erased their minimal equity cushion.
It is safe to surmise that none of these parties – subprime borrowers, real estate speculators or the investment banks – saw the crash coming. Their entire speculative strategy may have been predicated on being able to exit their investments while the going was good – in other words, cash out while still ahead. But market corrections can occur faster and run deeper than speculators generally expect, and excessive leverage gives borrowers very little flexibility at such times.
The lesson here is that, while a reasonable degree of leverage is not necessarily a bad thing, excessive leverage is generally too risky for most individuals. It is prudent to have an adequate amount of equity backing an asset purchase or investment, whether the asset in question is one's residence, a vacation property or a stock portfolio.