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 FINANCIAL CRISIS INQUIRY COMMISSION REPORT

(through credit default swaps on Lehman’s debt) put the cost of insuring  million
of Lehman’s five-year senior debt at , annually; for Merrill Lynch, the cost
was ,; and for Goldman Sachs, ,.
The chief concerns were Lehman’s real estate–related investments and its reliance
on short-term funding sources, including . billion of commercial paper and 
billion of repos at the end of the first quarter of . There were also concerns about
the firm’s more than , derivative contracts with a myriad of counterparties. 
As they did for all investments banks, the Fed and SEC asked: Did Lehman have
enough capital—real capital, after possible asset write-downs? And did it have suffi-
cient liquidity—cash—to withstand the kind of run that had taken down Bear
Stearns? Solvency and liquidity were essential and related. If money market funds,
hedge funds, and investment banks believed Lehman’s assets were worth less than
Lehman’s valuations, they would withdraw funds, demand more collateral, and cur-
tail lending. That could force Lehman to sell its assets at fire-sale prices, wiping out
capital and liquidity virtually overnight. Bear proved it could happen.
“The SEC traditionally took the view that liquidity was paramount in large securi-
ties firms, but the Fed, as a consequence of its banking mandate, had more of an em-
phasis on capital raising,” Erik Sirri, head of the SEC’s Division of Trading and
Markets, told the FCIC. “Because the Fed had become the de facto primary regulator
because of its balance sheet, its view prevailed. The SEC wanted to be collaborative,
and so came to accept the Fed’s focus on capital. However, as time progressed, both
saw the importance of liquidity with respect to the problems at the large investment
banks.” 
In fact, both problems had to be resolved. Bear’s demise had precipitated
Lehman’s “first real financing difficulties” since the liquidity crisis began in ,

Lehman Treasurer Paolo Tonucci told the FCIC. Over the two weeks following
Bear’s collapse, Lehman borrowed from the Fed’s new lending facility, the Primary
Dealer Credit Facility (PDCF), but had to be careful to avoid seeming overreliant

on the PDCF for cash, which would signal funding problems.
Lehman built up its liquidity to  billion at the end of May, but it and Merrill
performed the worst among the four investment banks in the regulators’ liquidity
stress tests in the spring and summer of .
Meanwhile, the company was also working to improve its capital position. First, it
reduced real estate exposures (again, excluding real estate held for sale) from  bil-
lion to  billion at the end of May and to  billion at the end of the summer. Sec-
ond, it raised new capital and longer-term debt—a total of . billion of preferred
stock and senior and subordinated debt from April through June .
Treasury Undersecretary Robert Steel praised Lehman’s efforts, publicly stating

that it was “addressing the issues.” But other difficulties loomed. Fuld would later
describe Lehman’s main problem as one of market confidence, and he suggested that
the company’s image was damaged by investors taking “naked short” positions (short
selling Lehman’s securities without first borrowing them), hoping Lehman would fail,
and potentially even helping it fail by eroding confidence. “Bear went down on ru-
mors and a liquidity crisis of confidence,” Fuld told the FCIC. “Immediately there-