Next week marks the two-year anniversary of the failure of Lehman Brothers, one of the major triggers of the financial crisis. Andrew Ross Sorkin questions whether the government really could have saved the firm and just chose not to. The answer isn't likely black-and-white. There were a number of factors that contributed to the firm's failure.
There Was No Buyer
The first, and probably most major, problem was the lack of a buyer. Think about the situations of other troubled institutions like Bear Sterns, Merrill Lynch, Washington Mutual, and Wachovia. None of those declared bankruptcy, because they all found buyers. Lehman didn't. Bank of America was interested until it realized it could get Merrill Lynch instead. Barclays wanted Lehman, but British regulators balked.
This is an important point, because all along U.S. regulators believed a deal could get done. They never really wanted to simply save a firm -- acquisition was the acceptable alternative to failure. Finalizing one with Barclays looked particularly promising. But then, as former Treasury Secretary Hank Paulson recounts in his book, "The British screwed us." Had British regulators allowed the acquisition to proceed, then there would be nothing to debate today.
Its Balance Sheet Was a Disaster
Since there wasn't a buyer, the next option was for the Federal Reserve to come through with an emergency loan. It decided not to, because it did not believe that Lehman had strong enough collateral to back up the loan. And here's where the subjectivity comes in. Although the Fed could have technically provided such a loan, its calculations required that it not do so, because they showed that the central bank would sustain a significant loss by trying to revive an institution that would likely fail ultimately anyway.
There Was No Political Palatability for Bailouts
And that wasn't a politically desirable option. The public was already becoming impatient with the financial industry. The idea that the Fed or Treasury might step in to bail out a firm like Lehman, and stick taxpayers with billions of dollars in losses, just didn't fly politically. With other acquisitions, the losses were calculated to be less significant, and a willing acquirer was on board. That way, it didn't seem like the institution was simply saved, but that it still sort of failed, and was purchased by another bank.
Its Failure Wouldn't Directly Affect Average Americans
Of course, when it came to AIG, none of those reasons mattered. It was bailed out the day after Lehman failed to the tune of $85 billion. It also had no acquirer; its balance sheet was also a mess; and its losses could also be quite significant. What changed? In part, the politics were completely different. A failure of Lehman would indirectly affect all Americans. But its direct losses would mostly fall on the shoulders of institutional investors and current and former Lehman investment bankers who held the firm's stock. A failure of AIG, however, would directly affect a huge number of average Americans. This wasn't just a problem for Wall Street: its insurance products were intertwined throughout Main Street.
Once the world realized how bad of an idea it was to allow Lehman to fail, everything changed. That's why the widespread bank bailouts occurred. While the U.S. might be able to get away with one major investment bank defaulting, it couldn't possibly allow two or three more big institutions to fail. So the calculus above became irrelevant. But at the time, during the weekend of September 13-14, 2008, the logic above explains why Lehman wasn't revived
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