At most, the moral hazard encountered as a result of these considerations likely carries only minimal influence over decision makers when compared to the myriad of other factors they face. Advanced Search. Privacy Copyright. Skip to main content. This would provide two lines of defense, bankruptcy as the first resort and Title II as the backup. In addition to the legislative changes since , the regulators themselves have adjusted to the post-crisis world.
In , the Fed and Treasury seem to have had very few bankruptcy experts in their midst. This may have been one reason bankruptcy was not more seriously considered with Bear Stearns. A decade later, there seems to be much more bankruptcy expertise within the ranks of the regulators. Given all these changes, the misperception of Lehman may seem to be solely of historical interest, and of little relevance for current financial markets.
In reality, however, the misperception still matters a great deal. First, the conventional wisdom could chill enthusiasm for enacting the bankruptcy-for-banks legislation currently pending in Congress. Lawmakers and others who are skeptical about bankruptcy are likely to view bankruptcy amendments through the lens of that skepticism.
This would be unfortunate. As I have argued on this site previously, 19 the proposed legislation would significantly improve the effectiveness of bankruptcy by facilitating SPOE-style transactions. Under SPOE, shareholders would not be the only constituency that would bear losses.
Bondholders and other holders of longterm debt would too, and they can be expected to argue vehemently that SPOE will unleash chaos if it is implemented, just as according to them bankruptcy would.
The shadow of Lehman could reinforce this reasoning. It could discourage regulators from invoking Title II, or could encourage them to delay intervention too long. If regulators and others do not believe bankruptcy can work, they may slack off in their preparations for its use.
They may not oversee the living will process and stress tests as vigorously, and incorporate bankruptcy as fully, if they do not believe bankruptcy will actually be an option if a large financial institution falls into distress. I do not want to exaggerate the significance of these consequences. Most do not seem to have materialized thus far, at least among those most involved in the design of the post-crisis financial architecture.
Ten years after Lehman, memories of are still vivid. Regulators have been energetically and creatively working to make the SPOE process and the bankruptcy alternative as effective as possible. But as memories of the crisis grow dimmer, the conventional wisdom about Lehman could prove corrosive.
The best antidote would be to pass the proposed bankruptcy for banks legislation, and to rethink the meaning of Lehman, so that a new narrative is in place when the next crisis hits. The author did not receive financial support from any firm or person for this article or from any firm or person with a financial or political interest in this article.
He is currently not an officer, director, or board member of any organization with an interest in this article. David Skeel S. Play Video. Brookings Now Bernanke on the causes of the financial crisis, questioning how we measure potential economic output, and more new research in economics Fred Dews.
Footnotes See, e. Too Big to Fail , pp. Too Big to Fail , p. These were lenders who provided loans to those with impaired credit ratings. In , Lehman made the deliberate decision to embark on an aggressive growth strategy, to take on significantly greater risk. In , as the subprime residential mortgage business progressed from problem to crisis, Lehman was slow to recognise the developing storm and its spillover effect on commercial real estate.
Rather than pull back, Lehman made the conscious decision to double its bet, and significantly and repeatedly exceeded its own internal risk limits. The markets were shaken by the Bear Stearns crisis. Lehman, an independent investment bank, was widely considered to be the next bank that might fail. To buy more time, Lehman painted a misleading picture of its financial condition. Over the weekend of September 12th to 14th, , an intensive series of meetings was conducted, including then US treasury secretary Henry, or Hank, Paulson, senior regulators and the chief executives of 14 leading financial institutions.
Insufficient assets Paulson began the meetings by stating the government would do all it could — but that it could not fund a solution. Many commentators believe the Bush administration had run out of political capital to rescue Lehman. On September 14th, it appeared that a last-minute deal had been reached with Barclays Bank in the UK to save Lehman from collapse.
The deal fell apart. Lehman no longer had sufficient liquidity to fund its daily operations and filed for bankruptcy on the following day. As a result of the collapse, the Dow Jones index plunged points on September 15th. Bank of America was enticed to come to the rescue of Merrill Lynch. Up to that point, the markets implicitly believed that no big bank would be allowed to fail by governments. Many believe that if he had his time over, Paulson would not have allowed Lehman to collapse.
Please update your payment details to keep enjoying your Irish Times subscription. Why Lehman Brothers was allowed to fail In a departure from its strategy on other banks, the US Federal Reserve refused to assume any of the risk faced by potential buyers.
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