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KEITH HENNESSEY, DOUGLAS HOLTZ-EAKIN, AND BILL THOMAS 

These losses wiped out capital throughout the financial sector. Policymakers were
not just dealing with a single insolvent firm that might transmit its failure to others.
They were dealing with a scenario in which many large, midsize, and small financial
institutions took large losses at roughly the same time.

Conclusion:

Some financial institutions failed because of a common shock: they made similar
failed bets on housing. Unconnected financial firms were failing for the same reason
and at roughly the same time because they had the same problem of large housing
losses. This common shock meant the problem was broader than a single failed
bank–key large financial institutions were undercapitalized because of this common
shock.
We examine two frequently debated topics about the events of September .

“The government should not have bailed out _____”

Some argue that no firm is too big to fail, and that policymakers erred when they
“bailed out” Bear Stearns, Fannie and Freddie, AIG, and later Citigroup. In our view,
this misses the basic arithmetic of policymaking. Policymakers were presented, for
example, with the news that “AIG is about to fail” and counseled that its sudden and
disorderly failure might trigger a chain reaction. Given the preceding failures of Fan-
nie Mae and Freddie Mac, the Merrill Lynch merger, Lehman’s bankruptcy, and the
Reserve Primary Fund breaking the buck, market confidence was on a knife’s edge. A
chain reaction could cause a run on the global financial system. They feared not just a
run on a bank, but a generalized panic that might crash the entire system–that is, the
risk of an event comparable to the Great Depression.
For a policymaker, the calculus is simple: if you bail out AIG and you’re wrong,
you will have wasted taxpayer money and provoked public outrage. If you don’t bail
out AIG and you’re wrong, the global financial system collapses. It should be easy to
see why policymakers favored action–there was a chance of being wrong either way,
and the costs of being wrong without action were far greater than the costs of being
wrong with action.

“Bernanke, Geithner, and Paulson
should not have chosen to let Lehman fail”

This is probably the most frequently discussed element of the financial crisis. To
make this case one must argue:

• Bernanke, Geithner, and Paulson had a legal and viable option available to
them other than Lehman filing bankruptcy.
• They knew they had this option, considered it, and rejected it.