The Tenth Anniversary of the Lehman Brothers Collapse

There are six standout public events in my memory - I can still picture where I was when I heard the news and who told me the news. The events are the resignation of Margaret Thatcher as PM, the death of Princess Diana, the Omagh bomb, the tragic events of 9-11, the collapse of Lehman Brothers on 15 September 2008, and the results of the Brexit referendum.

The collapse of Lehman Brothers a decade ago was the news that really brought home to ordinary people the scale of the financial crisis that was enveloping the world economy. Why was Lehman Brothers pushed into bankruptcy whereas AIG was rescued a day later? Prior to Lehman's difficulties, the Fed had rescued Bear Sterns in March 2008 and the U.S. Treasury had placed Fannie Mae and Freddie Mac into conservatorship and had injected substantial funds into both institutions.

The standard narrative is that the U.S. government and the Fed refused to bail it out because it was illegal to do so. They also did not believe that it posed a systemic risk and they needed to reduce the moral hazard problem associated with bank bailouts, whereby banks gamble for resurrection by taking on more risk in the knowledge that the taxpayer will pick up the tab if things don't pan out.

In a recent book The Fed and Lehman Brothers, Laurence Ball performs a very careful forensic study of the bankruptcy of Lehman Brothers. He rejects the standard narrative and his evidence suggests that Hank Paulson (Treasury Secretary at the time) and the Bush administration were motivated by a bipartisan backlash against yet another bailout, with Republicans accusing the administration of socialism and Democrats accusing them of helping out their buddies on Wall Street. However, the chaos after its collapse made it much easier for the Bush administration and the Fed to rescue the system by bailing out financial institutions. Ultimately, it appears that Lehman Brothers was sacrificed so that Wall Street could be saved. 
   

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