Page 464 - untitled

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

Lehman for an indefinite time period while Lehman searched for a buyer. That asset
revaluation would later have come under intense legal scrutiny, especially given the
likely large and potentially uncapped cost to the taxpayer. In the meantime, other
creditors to Lehman could have cashed out at  cents on the dollar, leaving taxpay-
ers holding the bag for losses.
Fed Chairman Bernanke, his general counsel Scott Alvarez, and New York Fed
general counsel Thomas C. Baxter Jr. all argued in sworn testimony that this option
would not have been legal. Bernanke suggested that it also would have been unwise
because, in effect, the Fed would have been providing an open-ended commitment to
allow Lehman to shop for a buyer. Bernanke testified that such a loan would merely
waste taxpayer money for an outcome that was quite unlikely to change.
Based on their actions to deal with other failing financial institutions in , we
think these policymakers would have taken any available option they thought was
legal and viable. This was an active team that was in all cases erring on the side of in-
tervention to reduce the risk of catastrophic outcomes. Fed Chairman Bernanke
said that he “was very, very confident that Lehman’s demise was going to be a catas-

trophe.” We find it implausible to conclude that they would have broken pattern on
this one case at such an obviously risky moment if they had thought they had an-
other option.
Some find it inconceivable that policymakers could be confronted with a situation
in which there was no legal and viable course of action to avoid financial catastrophe.
In this case, that is what happened.

THE SHOCK AND THE PANIC

Conventional wisdom is that the failure of Lehman Brothers triggered the financial
panic. This is because Lehman’s failure was unexpected and because the debate about
whether government officials could have saved Lehman is so intense.
The focus on Lehman’s failure is too narrow. The events of September  were a
chain of one firm failure after another:

• Sunday, September , FHFA put Fannie Mae and Freddie Mac into
conservatorship.
• This was followed by “Lehman weekend at the New York Fed,” which was in
fact broader than just Lehman. At the end of that weekend, Bank of America
had agreed to buy Merrill Lynch, Lehman was filing for bankruptcy, and AIG
was on the verge of failure.
• Monday, September , Lehman filed for Chapter  bankruptcy protection.
• Tuesday, September , the Reserve Primary Fund, a money market mutual fund,
“broke the buck” after facing an investor run. Its net asset value declined below
, meaning that an investment in the fund had actually lost money. This is a crit-
ical psychological threshold for a money market fund. On the same day, the Fed
approved an  billion emergency loan to AIG to prevent it from sudden failure.