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Alternative to QE? The Lehman Bros. Plan.

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Henry Lehman got started in business in 1844 with a dry-goods store in Montgomery, Alabama. After his two brothers joined him a few years later, they named the business Lehman Brothers. They accepted raw cotton in exchange for their goods. This increased the volume of their business because people had more cotton than money, and it increased their profit margin because they made money selling the goods, and then they made more money selling the cotton. They later opened an office in New York and helped start the New York Cotton Exchange in 1870. Later, they joined the New York Stock Exchange and helped take companies such as Sears, Macy's, B.F. Goodrich, Woolworth's, and Studebaker public by selling their initial public stock offering. It was a great American success story from Dixie.

Unfortunately, in the beginning of the 21st century, Lehman Brothers was heavily involved in the subprime-mortgage market, and even though they quickly exited the market for new junk, they still held vast quantities of the lower-quality, higher-risk securities on their books. They got left holding the bag. They went into bankruptcy, where their assets were sold off to other firms to meet the company's obligations to creditors. Creditors received a share of their money back, but they did sustain losses. Retail clients were largely unhurt, except by those losses sustained generally in the market. The big losers were the stockholders, with the biggest pain borne by those who were running Lehman Brothers — the same people who made tons of money during the boom. The world did not come to an end.

At this point a mainstream economist will complain that if you allowed liquidation, it would result in contagion and runaway deflation, and the economy would enter a black hole. Let's take a look at the role of deflation during a crisis.

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