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The 2008 Financial Crisis
The Lehman weekend
Nine steps, about fourteen minutes, a question at each and one decision you take yourself. You need no economics and no preparation, only a willingness to guess before you are told.
Step 1 of 9
British banks were brought down by borrowing they had to find again every few months, not by the American bonds they owned, and the first to fail waited five months while three bodies worked out who decided.
The question
In March 2008 Bear Stearns could not fund itself and was sold, with the Federal Reserve paying for the deal. In September the two mortgage companies the American government had always been assumed to stand behind were taken over. Eight days after that, Lehman Brothers ran out of money too.
You will be asked to make the American authorities' decision yourself, over the weekend of 13 and 14 September 2008, knowing only what was known then. You find out what was actually done, and hear the argument that has run ever since about whether anything else was lawful, only after you have chosen.
Nine steps take it in order: the firm whose sale the Federal Reserve paid for, the two that were taken over, the weekend, the argument about the law, the insurance company lent to the next day, who a central bank may lend to, the dollars sent to other central banks, what the Bank of England took in at home, and the one measure that lent nothing at all.
What this module covers
Written for every level. Tap any underlined word for what it means, and open the boxes below for the economics behind each decision. If you already know the theory, skip both and the history reads straight through.
Bear Stearns was one of the five largest American investment banks, which trade and lend for companies and governments and hold no savings for the public. It could not fund itself in March 2008 and did not go bankrupt.
A bank that holds people's savings is covered by rules that name the public body responsible when it fails. Bear Stearns held no savings, so no rule made anybody responsible for it, and nothing said it would be helped at all.
A bank can be sound and still run out of cash on a particular morning: what it owns is lent out for years, and what it owes can be demanded today. Selling in a hurry raises less than the assets are worth. A central bank can create the currency it issues, so it can lend against those assets until the panic passes and take its money back afterwards.
Put it another way. Think of it like being asked to settle a bill today when everything you own is a house you cannot sell until next year: you own more than the bill and you still cannot pay it.
The Federal Reserve Board, which runs America's , met on Sunday 16 March 2008 and announced a new lending scheme. It was for the firms that trade government debt directly with the central bank, and it opened the following morning.
Take a guess. You are not expected to know the answers, and being wrong is what makes a number stick.
Bear Stearns ran out of money in March 2008 and did not fail. What did the Federal Reserve do?
For scaleThe Federal Reserve had not lent widely to firms outside banking since the 1930s, seventy years earlier.
On 7 September 2008 the American government took control of Fannie Mae and Freddie Mac, the two mortgage companies it had always been assumed to stand behind.
Neither company lent to households itself: each bought mortgages from the banks that did, and promised to pay the investors who bought them if the households stopped paying. The American mortgage market ran on that promise.
Taking control of a failing company without buying it is called . The government appointed the managers and took the powers the owners had.
Owners' money is what the people who own a company have put in and left there, and losses come out of it before the lenders lose anything. The commission Congress set up later worked out how much lending the two companies carried for each dollar of it.
The people who had lent to the two companies went on being paid. The people who owned them kept shares that paid nothing.
By the end of 2007, for every dollar of their owners' money, how many dollars of loans did Fannie Mae and Freddie Mac own or guarantee between them?
For scaleThe same commission put the five largest American investment banks at up to $40 of loans and other assets for each dollar of their owners' money.
Lehman Brothers, another of the five largest American investment banks, could not fund itself in September 2008. It needed either a buyer or a loan by Monday morning.
The Federal Reserve had been lending to firms like it since March, under an emergency lending law: the one law that lets it lend to something that is not a bank. It may lend only if the borrower pledges something valuable, called collateral, and only if the collateral is good enough.
Lehman was the fourth largest American investment bank, holding $639 billion of assets. One slice of that was property, and bonds built out of the payments on property: $111 billion at the end of 2007. That slice on its own was more than four times the whole of its owners' money.
Investors lend to all these firms and cannot tell which one is next, so a failure here may stop that lending everywhere at once.
You are among the American authorities over the weekend of 13 and 14 September 2008. Lehman Brothers cannot fund itself on Monday, no buyer has agreed to take it, and the table above is what you have. What do you do?
No rescue was arranged. On 15 September 2008 Lehman Brothers asked an American court for bankruptcy protection, which freezes what a firm owes while the courts work out who gets what.
What followedCongress later set up a commission to examine the crisis. It judged that this run of decisions, two rescues, one refusal and a loan to an insurance company the next day, increased uncertainty and panic in the market.
Bear Stearns had been sold in March with the Federal Reserve paying for the deal. Lehman came six months later, a week after two far larger firms had been taken over, and no public money went into it at all.
Size did not separate the two. One was rescued and the other was not.
Module 4 of 7 in The 2008 Financial Crisis
[1] What was done for Bear Stearns, and the new lending facility of the same day: Board of Governors of the Federal Reserve System, press release, 16 March 2008.
[2] The two mortgage companies taken over: Federal Housing Finance Agency, statement of Director James B. Lockhart, 7 September 2008, and the agency's conservatorship history.
[3] How much the two companies owed against what they owned, and what Lehman was holding: Financial Crisis Inquiry Commission, The Financial Crisis Inquiry Report, Official Government Edition, January 2011.
[4] The dates, from a timeline written to record them rather than to win an argument: Bank for International Settlements, 79th Annual Report, June 2009, chapter II.
[5] What the law let the Federal Reserve do, and the argument about Lehman that has not ended: Congressional Research Service, Federal Reserve: Emergency Lending, R44185, 27 March 2020.
[6] How large Lehman Brothers was, and the day it filed: Congressional Research Service, Lehman Brothers and IndyMac: Comparing Resolution Regimes, R40928, 12 October 2009.
[7] The loan to an insurance company, the day after Lehman: Board of Governors of the Federal Reserve System, press release, 16 September 2008.
[8] What the whole of it came to in the end: Congressional Research Service, Government Assistance for AIG: Summary and Cost, R42953, 13 October 2017.
[9] The dollars lent to other central banks: Linda S. Goldberg, Craig Kennedy and Jason Miu, Central Bank Dollar Swap Lines and Overseas Dollar Funding Costs, Federal Reserve Bank of New York Economic Policy Review, May 2011.
[10] What the Bank of England lent against, and on what terms: Bank of England, news release: Special Liquidity Scheme, 21 April 2008.
[11] How long the emergency lasted after it stopped being news: Bank of England, The Bank of England's Special Liquidity Scheme, Quarterly Bulletin 2012 Q1.
[12] The promise, and what it was expected to do: Federal Deposit Insurance Corporation, Temporary Liquidity Guarantee Program, final rule, Federal Register, 26 November 2008.
Country data from the World Bank (CC BY 4.0) and the UNDP Human Development Report (CC BY 3.0 IGO)
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