Looking Back At Lehman, Ten Years Later

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.