Lehman Brother's Crash

The collapse of the Lehman Brothers happened over seven years ago, I’m surprised this could happen to one of the world’s largest banks! I watched the ‘The Last Days of the Lehman Brothers’ documentary which definitely gave me more of an understanding in what actually happened. The Lehman Brothers was a huge bank, they had 25,000 employees.

The investment bank overstated the value of their assets, deliberately, such as the collateralised debt obligations (CBO’s). This, along with the issues of subprime mortgages in the US gave Lehman Brothers a $25 billion debt which they definitely did not see coming!

This is a huge amount of money to have not noticed. So when they finally noticed this sizeable gap, they had to write down their commercial real estate assets by $7 billion, from $40 billion to $33 billion. Bit of a difference. The bank’s rating was also downgraded, not a good time for Lehman Brothers. But did they learn from that? Not really. They actually just continued doing what they were already doing, without making any real changes, until it became a huge problem. (Even more huge than $25 billion of debt).

There were other companies that got themselves into difficulties, along with Lehman Brothers. AIG, the global insurance giant was one of these companies. They were trading in credit default swaps, but again mortgages became an issue. The mortgages that were tied to the credit default swaps began to regularly default. AIG began to run out of cash, they couldn’t cover their losses and had to resort to an emergency loan from the bank, believed to be around $40 billion (again, a small sum…). AIG were bailed out by the government, unlike Lehman Brothers, this was because they were perceived to be such a big company that this would have a major effect on consumers and other companies around the world.

The government had to stop bailing out companies. The US Treasury ended up refusing to give Barclays a guarantee on Lehman’s trading obligations, meaning that the deal would eventually fall through - the US Treasury said that they would be unwilling to use public funds to save banks who had caused this issue themselves (good on them?).

It’s a difficult decision, because the Government cannot always be the ones to bail out companies who are getting themselves into financial distress. Especially for Lehman Brothers, it would have been difficult to justify bailing them out due to them understanding the financial position and further worsening it.

Football Value - An Increasingly Expensive Market

The cost of transfers in football is continuously on the rise, to the point where players are being valued at £100 million, the current record being £86 million that Real Madrid paid for Gareth Bale from Tottenham Hotspur. In the British transfer market, prices are inflated for players who are experienced in the Premier League, they generally have a faster impact on a team than those who come from leagues abroad and will need time to adapt to the English playing style.

The revenues created from football come from many sources. Ticket sales make little impact on the money made by football clubs. Large proportions of their revenues come from corporate hospitality, sponsorships and TV deals. This summer, a new Premier League TV deal will kick in that is worth £5 billion. This money will be spread through the teams in the league, meaning that the cost of relegation this season will be even more costly than before!

In the EPL (English Premier League), the TV money is split between the teams depending on various factors. These include how many times the team had a televised match, and where they finish in the league. This is widely regarded as the fairest way to share out the TV money. In Spain, however, the TV companies work directly with the clubs in the league, meaning that giants such as Barcelona, Real Madrid and Athletico Madrid take in significantly higher TV revenues than the other clubs. This increased revenue then leads to them have higher transfer funds and being able to attract a higher calibre of player.

In England, there are several ‘top’ teams, including Arsenal, Manchester City, Chelsea, Liverpool, Manchester United and Tottenham Hotspur. These are the teams that we generally expect to fill the top positions in the league come the end of the season. However, financial fair play rules have now kicked in meaning that the likes of Manchester City cannot continue to spend huge amounts of money and allow the owners to be paying for all of this. Now there are restraints on the amount of money a club can spend to ensure that the rules are fairer and there is more chance for other clubs to make an impact in the league. This season, we have seen considerably smaller clubs, such as Leicester City be a great success and they are currently sitting top of the league after more than half of the season played, they have managed this without spending the huge amounts that some other clubs have. We have also seen one of the biggest spenders in the league sitting dangerously close to the relegation zone, yet they spend millions and millions each transfer window and so many of their players are taking in wages of over £100,000 a week.

Players have huge costs attached to them, we particularly see this in strikers. How can it be calculated that a player is worth £30 million? Take Andy Carroll for example, he was playing at Newcastle United and had recently come into the first team and was getting goals, he was becoming a regular starter. By no means was he a highly-experienced player. However, on the last day of the January transfer window, Liverpool came in with a bid of £35 million for him. This deal could not realistically be rejected. Here, we are talking about a player, who is, yes, very good, but by no means irreplaceable, especially with funds of £35 million. With that money, a club could invest in 7 young players who are predicted to make good future players. That could change an entire team. But what made Liverpool decide that Carroll was worth £35 million?!

When a player is signed on a large transfer fee, a club is going to want to secure their services for many years. This means that they can somewhat regard the fee as spread across, say 5 years. However, if a player is getting older, they will want to ensure that they can potentially get some money back from this deal so they may sell them on for a reduced fee before their contract is up.

The money involved in football has increased massively. Going back only as far as the 1980s, we saw football players being signed for £1 million, which was massive amounts of money. Now we see Lionel Messi being valued at over £120 million, with wages of over £250,000 per week. This is a drastic change from when even superstar players had full time jobs and football was their hobby on the side.

With the new TV deal being brought into the Premier League though, when will the obscene transfer fees stop increasing? Will we see a £1 billion player?

Debt or Equity?

There are various types of capital that a company can raise, I was interested to read that debt is actually a cheaper form than equity!

Initially, I was under the impression that selling shares is a great form of capital as you’re getting investment into the company, whilst giving out a potentially tiny portion of ownership and not even a guarantee of a dividend payout! Companies don’t need to give out dividends consistently every year (as discussed in my dividends blog a few weeks back), sometimes it can be a better option to reinvest these funds into new projects with a positive NPV and create more shareholder value. Well, it actually turns out that this isn’t the best method of raising funds within a company.

Getting debt on the other hand, affects balance sheets more significantly I’d say. It also means that there are regular mandatory payouts to the lender, including interest charges. To me, I think I’d rather have investors! But the actual story is, companies prefer debt over equity as it is cheaper..

Although I said it could be a tiny proportion of ownership that is being given out to these new investors, it is still ownership, and with that comes rights. These owners then begin to have a say in the running of the company, to a certain extent, depending on the size of their ownership. When a company has to pay back a loan or other borrowings, it is a certain amount. With equity, the payouts are continuous during the length of the ownership. This could result in a lot higher payback than a debt version.

So, the positives of equity outweigh the positives of debt. Realistically, this becomes a cheaper option of finance for a company looking to increase capital.