The Collapse of Lehman Bros.: A Reassessment – OpEd

Robert Samuelson takes on the collapse of Lehman a decade ago and assesses the argument of Larry Ball that the Fed could have bailed out Lehman. He ends up siding with Bernanke–Paulson and says the Fed would have taken big losses if it bailed out Lehman. He also says we would have seen the financial crisis anyhow.

There are three points worth making here. First, the claim that the Fed lacked the legal authority to bail out Lehman is absurd on its face. The Fed was doing lots of things at that point on questionable legal authority. It was operating in uncharted grounds.

But, whether or not a bailout out of Lehman would have been fully lawful, the more practical question is: Who would have stopped them? Who would have filed a suit to prevent the Fed from bailing out Lehman? Is it plausible that a court would grant standing and then tell the Fed that it had to let Lehman go bankrupt? That one is absurd on its face. Letting Lehman go bankrupt was a choice.

The second point is that the Fed need not have taken losses on a bailout. Regardless of the value of Lehman’s assets at the time, there is a simple logic that the bailouts should have taught everyone. If you make massive loans to banks at below-market rates for a long enough period of time, and also give them a Timothy Geithner “no more Lehmans” guarantee, so that others will also make loans, any bank will eventually return to solvency.

This was the story of Citigroup, AIG, and Bank of America, all of whom were effectively bankrupt in the fall of 2008. In each case, the Fed set up special lending facilities to bring them back to life. Do the arithmetic. If banks get $500 billion in loans at 4–5 percentage points below the market rate (that’s being generous, since the market rate for an effectively bankrupt bank in the middle of a financial crisis is going to be very high), then they can make $20 to $25 billion a year in profit lending at the market rate. Given two or three years, you can patch up a pretty big hole.

Certainly, the Fed could have done this with Lehman, say a Maiden Lane 4. Then Lehman would repay the loan, including the below market rate interest, and Timothy Geithner would have another success story where he could boast about how we actually made money on the bailout. And, the vast majority of the media would agree with him.

The third point is that we would have had the economic crisis anyhow, even if Lehman had been bailed out. Nationwide house prices were falling at a rate of close to 2.0 percent a month, even before Lehman. The bubble was deflating and there was nothing to stop it. This meant that the bubble-driven construction boom was going to end, costing more than 2.0 percentage points ($400 billion a year in today’s economy) in lost demand.

We also were losing the consumption boom driven by the housing wealth effect. This would cost us another 2 percentage points of GDP or so in lost demand. A loss of 4 percentage points of GDP in annual demand ($800 billion) is going to lead to a bad recession even if the financial system is operating perfectly.

This column originally appeared on Dean Baker’s Beat the Press blog.