Too Big to Fail

4 ideas

1. Lehman's Weekend: No Buyer, No Bailout

   Over the weekend of September 12–14, 2008, Treasury Secretary Hank Paulson, New York Fed president Tim Geithner and Wall Street CEOs gathered at the New York Fed to find a buyer for Lehman Brothers. Bank of America walked away to buy Merrill Lynch instead. Barclays' deal collapsed when Britain's Financial Services Authority would not waive a shareholder-vote requirement for Barclays to guarantee Lehman's trading. The government refused to put up its own money, and Lehman filed for bankruptcy on September 15.

2. AIG Rescued Two Days After Lehman

   On September 16, 2008, the day after letting Lehman fail, the Federal Reserve lent AIG $85 billion in exchange for roughly 80% of its equity. AIG had written credit default swaps across the whole financial system, so its default would have spread losses to counterparties everywhere. That interconnectedness, not AIG's size alone, is what made regulators treat it differently from Lehman within 48 hours.

3. Moral Hazard Line Abandoned Under Contagion

   Regulators refused to rescue Lehman partly to show that firms would bear the cost of their own risk-taking after the Bear Stearns rescue. Once Lehman's failure froze money markets and caused the Reserve Primary Fund to 'break the buck,' officials reversed course within days.

4. Confidence as the Real Balance Sheet

   The book shows investment banks funding themselves overnight through repo markets, so their survival depended on counterparties being willing to roll that funding the next morning, not on their measured solvency. Short sellers, rumors and credit-default-swap spreads could drain a firm's liquidity within days whatever its reported capital. Looking at banks this way puts the danger in how quickly lenders can pull out, not in how large the losses are.

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