The aftermath/aftershock

After the collapse of Lehman what has become known as the great panic of 2008 ensued (Clark, 2009). Kindleberger (1989) describes this panic as the final stage of a financial crisis. On the day Lehman filed for bankruptcy a record number of 8bn share were exchanged (Clark, 2009). Lehman had been considered by many as too big to fail so its collapse triggered a crisis of confidence in the economy. The fall of Lehman has been described as an “earthquake” and as a “heart attack” in the financial markets, some also postulated that after Lehman the economy was just one financial institution away from a global financial meltdown (FT, 2009). Not long after the announcement of Lehman’s bankruptcy, Bernake (Chairman of the Federal Reserve) made his famous statement “we may not have an economy on Monday” (Thomas & Hirsh, 2009).

(Google Images, 2013 : Lehman employs lining up to hear the news of their future)

After Lehman’s demise the world's economy spiraled, global trade froze and panic came with the announcement that some money market funds were heavily invested in Lehman bonds. This led to investors rushing to withdraw their money from money market funds (CNN, 2008). In order to prevent the panic causing further damage Bernake assured investors that all their money would be guaranteed. In the following days the Treasury and Federal Reserve pumped trillions of dollars in to try to support the ailing financial system (NY Times, 2012).

Many had assumed that the government would intervene and stabilize Lehman to avoid it collapsing. Executives at Lehman claim they warned key government figures such as the Treasury Secretary Henry Paulson and the chairman of the Federal Reserve Ben Bernake of the contagion effect Lehman could have on world markets. They claimed that letting Lehman fail would be to “unleash the forces of evil on the global markets” (Clark, 2009).

Leaders in government maintained that they could do nothing to prevent the failure of Lehman but it has been argued that the U.S. government could have intervened in the interbank money markets, putting guarantees in place to allow short term funding for Lehman. In addition, the U.S. government could have provided guarantees against future losses to Barclays, who expressed interest in buying Lehman. Financial institutions who had run into difficulty before Lehman and many that ran into difficultly after Lehman were bailed out for example Bear Sterns in March 2008. This inconsistency in bailout policy further introduced uncertainty into the economy.

 So why didn't the U.S. government bailout Lehman?

There are several possible explanations of why the government let Lehman fail, some of which point to conspiracy theories among government and senior figures in the financial services sector but here I will discuss what I believe are the most plausible theories. Number one is that the government wanted to stress to the financial sector that there existed consequences for risky actions. Cassidy (2010) states that “Many people suspect Paulson and Bernanke let Lehman go bankrupt to re-establish the principle that irresponsible behaviour would be punished”. Another possible reason behind the Federal Reserve’s refusal to bailout Lehman is public opinion. The U.S. government was under increasing pressure concerning the use of public funds to bail out large financial institutions. The public was angered that for many years the banks had privatised the gains but now the losses were being socialised. Henry Paulson, Secretary of the Treasury, said “I am being called Mr Bailout. I can’t do it again” (Nocera, 2009).

(Bailout Money: Google Images, 2013)

In the next post I will discuss the role of regulation in Lehman’s demise as well as looking at regulatory reforms post Lehman.

Bibliography

1.     CASSIDY, J. (2010). How markets fail: the logic of economic calamities. New York, Picador.

2.      Clark, A. (2009) How the collapse of Lehman Brothers pushed capitalism to the brink. Guardian, 4 Sept. Available at: http://www.guardian.co.uk/business/2009/sep/04/lehman-brothers-aftershocks-28-days

3.      Financial Times Video (2009) Sep 14: Part 2 - The Lehman aftershock - markets - FT.com. [online] Available at: http://video.ft.com/v/63078044001/Sep-14-Part-2-The-Lehman-aftershock [Accessed: 23 Feb 2013].

4.      Kindleberger, C.P. Manias, Panics and Crashes: A History of Financial Crises, rev. ed. Basic Books, New York, 1989.

5.      Money.cnn.com (2008) Monday Meltdown: How Lehman's fall created a global panic - Dec. 15, 2008. [online] Available at: http://money.cnn.com/2008/12/15/news/economy/monday.meltdown.fortune/index.htm [Accessed: 23 Feb 2013].

6.      Nocera, J (2009) The New York Times Lehman Had to Die So Global Finance Could Live. [online] Available at: http://www.nytimes.com/2009/09/12/business/12nocera.html?pagewanted=all [Accessed: 23 Feb 2013].

7.      Thomas, E., & Hirsh, M. (2009). Paulson's complaint. Newsweek, May 25. Available at http:// www.highbeam.com/doc/IGl-200187807.html. Retrieved on February 19,2013

8.      Topics.nytimes.com (2008) Lehman Brothers Holdings Inc. News - The New York Times. [online] Available at: http://topics.nytimes.com/top/news/business/companies/lehman_brothers_holdings_inc/index.html [Accessed: 23 Feb 2013].