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Toyoharu Takahashi

Toyoharu Takahashi [profile]

Lessons from the “Lehman shock”

Toyoharu Takahashi
Professor, Faculty of Commerce, Chuo University
Areas of Specialization: Investments, Financial Engineering

Read in Japanese


In the Japanese media, we frequently hear the phrase “Lehman Shock,” which is an expression that is seldom heard overseas. Here, I will not argue about whether the term “shock” is appropriate. In the media overseas, the term “oil crisis”—and not “oil shock”— is more commonly used. It is certainly interesting to see that the Japanese media prefers the expression ”shock,” as seen in other examples such as oil shock, Nixon shock, and for the topic this time, Paribas shock, and Lehman shock. I am tempted to examine the underlying cultural background of such expressions, but I will leave that to experts in the field this time.

On September 15, 2008, Lehman Brothers Holdings Inc., one of the prestigious investment banks on Wall Street (Manhattan, New York), went bankrupt and filed for Chapter 11 reorganization procedures. This triggered turmoil in the financial markets, which in turn led to a global financial crisis, leaving the world economy in dire straits. This is the so-called Lehman shock. This description is very superficial because the failure of Lehman Brothers was a symbolic event but was not the trigger.

In the following section, I will discuss what the Lehman shock was by examining the flow of events that led to the global financial crisis.

Collapse of the IT Bubble and the Great Moderation

We need to go back to late 1990s in order to examine how the Lehman shock happened. The late 1990s was an era called the IT bubble, or dot-com bubble. The bubble burst after the NASDAQ composite stock price index peaked in March 2000. With the continued decline in stock prices from 2000 to 2001, most notably for IT stocks, the Board of Governors of the Federal Reserve System (FRB) decided to adopt monetary easing to counter the turmoil in the markets and economic stagnation.

With such monetary easing acting as a tailwind, the world economy entered a period of the Great Moderation, in which economies were able to grow under the stable prices and interest rates at low levels. (In hindsight, however, this Great Moderation may have been a Great Illusion.) On the other hand, the low interest rates and expansion of economies resulting from the monetary easing brought about a rise in stock prices and real estate prices.

Taking advantage of the booming housing market, financial institutions, particularly in the United States, increased their lending not only to the most credit-worthy who are eligible for a prime loan—but also to low-income groups who do not qualify for prime rate loans. This type of lending is called a subprime loan. Subprime borrowers may have a higher risk of setbacks and may face difficulty maintaining repayment schedule. The rise in real estate prices increased collateral values, and combined with low interest rates due to the monetary easing, the outstanding subprime loans increased. Moreover, complex mortgage backed securities (MBS) were created with subprime loans, resulting in financial institutions—not only in the U.S. but also in other countries—aggressively putting them in the portfolio to manage funds gained from the monetary easing. This trend further facilitated the inflow of funds, further accelerating the boom in the housing market.

Collapse of the Housing Bubble and the Global Financial Crisis

Nonetheless, such a boom in the housing market did not last forever. Early in 2006, the number of housing construction shrank and the housing prices started to decline. Along with the rise in interest rates, the number of foreclosures of housing loans began to increase, centered on subprime loans with variable interest rates. This was the beginning of the collapse of the housing bubble.

Under these circumstances, two hedge funds under Bear Sterns, a major U.S. investment bank, failed in June 2007. In a chain reaction many investment and commercial banks, as well as insurance companies, faced liquidity shortfalls that caused the risk of credit to rise in inter-bank markets. In August, disruption in relevant securities markets prompted the largest French bank BNP Paribas to freeze the assets of its subsidiary funds, which market participants call the "Paribas shock.” The collapse of the bubble in the U.S. real estate market is thought to have triggered a financial crisis on a worldwide scale. Such crises of subsidiary hedge funds spread to major financial institutions, with Bear Sterns going bankrupt in March 2008, U.S. Treasury Secretary and the FRB announcing support measures for two government-sponsored housing loan institutions in July, leading to the failure of Lehman Brothers on September 15. The next day the FRB announced support measures for the American International Group (AIG), spreading turmoil and accompanying economic uncertainty not only in the U.S. but also to Europe and other parts of the world. This was the origin of the Euro Sovereign Crisis.

Governments were pressed to infuse public funds and prepare measures to stimulate economic activities. Former Federal Reserve Chairman Alan Greenspan told a House committee that "we are in the midst of a once-in-a-century credit tsunami,” to indicate the vastness of the crisis[1] In our joint research,[2] we concluded that the slump of Japan’s economy stemming from the big damage of this “tsunami” which originated from the housing bubble, largely affected the manufacturing sector and not so much the Japanese financial institutions. We also testified the importance of cooperation in international policy to contain the damage from the “tsunami.”


From the sequence of events, we can clearly see that while it was a symbolic event, the failure of Lehman Brothers was not the trigger. In a simplified story, the collapse of the IT bubble led to monetary easing, which created the housing bubble, followed by the “credit tsunami” of subprime loans that led to the global financial crisis.

In the U.S., subprime loans are said to be increasing again these days, not in relation to housing but cars, this time. In comparison to the moderate increase in car-related debts in the past decade, outstanding car loans have rapidly increased in the past three years from $700 billion in 2010 by 25%. It is reported that this has led to fast-growing car sales, bringing large profits to major car manufacturers in the U.S.[3] Are the financial institutions becoming blind in the new bubble after they were once bitten twice shy? We need to remember the lessons learned from the Lehman shock.

  1. ^ Aaron Smith (2008)
    Greenspan: It's a 'credit tsunami' Former Fed chairman says crisis will pass, but congressmen say he dodged responsibility and didn't foresee crisis. 23 October, (accessed on line in June 2012 at window)
  2. ^ Tatsuyoshi Miyakoshi, Toyoharu Takahashi, Junji Shimada, and Yoshihiko Tsukuda(2011)
    “Impact of Sub-Prime Mortgage Problems on the Japan’s Economy [Sabupuraimu ron-Mondai no Nihon Keizai heno Eikyo],” Chapter 2 in Macroeconomics after the Financial Crisis [Kinyukiki to Makuro-keizai], University of Tokyo Press, 2011
  3. ^ Gillian Tett (2014)
    ”American subprime lending is back on the road” April 10, 2014 4:55 pm
    (accessed on line in Apr 2014 at window)
Toyoharu Takahashi
Professor, Faculty of Commerce, Chuo University
Areas of Specialization: Investments, Financial Engineering
Toyoharu Takahashi was born in Fukuyama City, Hiroshima Prefecture in 1959. He graduated from the Faculty of Commerce, Yokohama City University in 1981. After finishing the Master’s program, in 1985, he earned credits in the Doctoral program in the Graduate School of Commerce and Management, Hitotsubashi University in 1988. Takahashi was appointed Full-Time lecturer at Chiba Keizai University, Director and Head of R&D , Sigma Base Capital Corporation, Associate Professor and Professor at Takachiho University, before taking the current post in 2002. Takahashi was also a Visiting Fellow at The Australian National University in 2010-2012.
His current major research topics include pricing in secondary bond markets, contagion of financial crisis (how financial crisis in one country impacts on other countries).
His major works include: Recent Advances in Financial Engineering 2011 World Scientific Publishing, 2012, Macroeconomics after the Financial Crisis: Changes in Asset Markets, and Monetary Policy, and Financial Regulation [Kinyu-kiki to Makuro-keizai: Shisan-shijo no Hendo to Kinyu-seisaku/Kisei], (co-authored), University of Tokyo Press, 2011.