DEFINITION of Lehman Formula
The Lehman formula is a compensation formula developed by Lehman Brothers to determine the commission on investment banking services or other commercial brokerage services.
Lehman Brothers developed the Lehman formula, also known as the Lehman Scale formula, in the 1960s while raising capital for businesses.
FAILURE Lehman Formula
The original structure of the Lehman formula is a 5-4-3-2-1 scale, as follows:
- 5% of the first million dollars involved in the transaction
- 4% of the second million
- 3% of the third million
- 2% of the fourth million
- 1% of everything thereafter (above $ 4 million)
Today, due to inflation, investment bankers often look for a multiple of the original Lehman formula, like the double Lehman formula:
- 10% of the first million dollars involved in the transaction
- 8% of the second million
- 6% of the third million
- 4% of the fourth million
- 2% of everything thereafter (above $ 4 million)
A Brief History of Lehman Brothers
Lehman Brothers was previously regarded as one of the main players in the global banking and financial services sectors; however, on September 15, 2008, the company declared bankruptcy, mainly due to its exposure to subprime mortgages. Lehman Brothers also had a reputation for short selling in the market.
A subprime mortgage is a type of mortgage that is normally issued by a lending institution to borrowers with relatively poor credit ratings. These borrowers will generally not receive conventional mortgages, given their above-average risk of default. Because of this risk, lenders often charge higher interest on subprime mortgages.
Lenders have started providing NINJA loans, a step beyond subprime mortgages, to people with no income, no job and no assets. Many issuers have also not required any down payments for these mortgages. When the housing market started to decline, many found their housing values lower than the mortgage they owed because the interest rates associated with these loans (called “teaser rates”) were variable, which means that ‘They started low and increased over time, making it very difficult to pay off the mortgage, these credit structures translating into a domino effect of defaults.
The Lehman Brothers bankruptcy was one of the largest bankruptcies in US history. Although the stock market was down slightly before these events, the Lehman bankruptcy, coupled with the previous collapse of Bear Stearns, significantly depressed the main US indices in late September and early October 2008. After the fall of Lehman Brothers, the the public has become more knowledgeable about the coming credit crisis and the recession of the late 2000s.