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SEPTEMBER : THE BANKRUPTCY OF LEHMAN 

COMMISSION CONCLUSIONS ON CHAPTER 18

The Commission concludes the financial crisis reached cataclysmic proportions
with the collapse of Lehman Brothers.
Lehman’s collapse demonstrated weaknesses that also contributed to the failures
or near failures of the other four large investment banks: inadequate regulatory
oversight, risky trading activities (including securitization and over-the-counter
(OTC) derivatives dealing), enormous leverage, and reliance on short-term fund-
ing. While investment banks tended to be initially more vulnerable, commercial
banks suffered from many of the same weaknesses, including their involvement in
the shadow banking system, and ultimately many suffered major losses, requiring
government rescue.
Lehman, like other large OTC derivatives dealers, experienced runs on its de-
rivatives operations that played a role in its failure. Its massive derivatives posi-
tions greatly complicated its bankruptcy, and the impact of its bankruptcy
through interconnections with derivatives counterparties and other financial in-
stitutions contributed significantly to the severity and depth of the financial crisis.
Lehman’s failure resulted in part from significant problems in its corporate
governance, including risk management, exacerbated by compensation to its ex-
ecutives and traders that was based predominantly on short-term profits.
Federal government officials decided not to rescue Lehman for a variety of
reasons, including the lack of a private firm willing and able to acquire it, uncer-
tainty about Lehman’s potential losses, concerns about moral hazard and political
reaction, and erroneous assumptions that Lehman’s failure would have a manage-
able impact on the financial system because market participants had anticipated
it. After the fact, they justified their decision by stating that the Federal Reserve
did not have legal authority to rescue Lehman.
The inconsistency of federal government decisions in not rescuing Lehman af-
ter having rescued Bear Stearns and the GSEs, and immediately before rescuing
AIG, added to uncertainty and panic in the financial markets.