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[Time] 37:42
Lehman Brothers: why were they left to twist in the wind and not bailed out? No effective means to deal with Lehman Bros. Private sector acquirers backed away; senior management at Lehman may have misjudged the situation and was asking too much. Not on the scene. May also have been a view that in the wake of Bear Stearns that Lehman Brothers's creditors had had ample opportunity to adjust their exposures if they were concerned; and if they didn't, that's too bad and they should bear some losses. People have used Lehman Brothers as a marker for the real onset of the deepening financial crisis, but Lehman Brothers gets too much blame and AIG not enough. AIG was a triple-A rated institution with exposures around the world and no effective comprehensive supervision and really did come out of the blue. Didn't know about AIG but knew they were big and would be lots of trouble if they were permitted to fail. When Bear Stearns died in March of 2008, married off to J.P. Morgan Chase; creditors, lenders, and others taken care of, but stockholders' investment went down drastically. Between March and September two things happened that have not gotten enough attention: Lehman becomes a lot more leveraged. Lehman has similar assets to Bear Stearns, and yet can continue borrowing money, which suggests strongly that people thought they would be taken care of. More dramatic: money market fund Reserve Primary--first money market fund--lends Lehman hundreds of millions of dollars during this period, and when Lehman goes bankrupt, has to "break the buck"--lower their asset value from $1 to $.97, which sent tremendous shock waves through the financial world. Even money market funds may be taking on too much risk. But why would they do that? Answer, per Arnold Kling and James Stewart in the New Yorker: they figured there was a decent chance they'd get bailed out when Lehman went bankrupt. Friend running a money market fund before Continental was bailed out--knew it was shaky--buying Continental certificates of deposit (CDs). A lot is a probability game; friend said he was willing to buy 1-mo. or 2-mo. CDs because they may fail but not in the next month or two. Worked out because Continental creditors were bailed out. Even if you think the institution may not last, there is a timing dimension. Even in the case of Bear Stearns the plug gets pulled on them when people in the repo market say they won't lend any more. Why didn't they just say the government would bail them out? Why stop lending? Did a risk/reward calculation and said maybe the government would bail them out, but didn't want to be there to find out.
Gary Stern on Too Big to Fail | EconTalk | Library of Economics and Liberty
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