Lehman Lessons

Should the Government have let Lehman fail?

Photo: David Shankbone. Source: Wikipedia CC BY-SA 3.0

Seven years ago Lehman Brothers filed for protection from creditors under Chapter 11 of the bankruptcy code. A last-minute deal to save the global investment bank had fallen through.

In the immediate aftermath, Lehman bonds traded at 60—then 30—cents on the dollar; Barclays and Nomura purchased Lehman’s North American and global franchises, respectively. Thousands of employees packed up their desks and started looking for work.

The plummeting value of Lehman debt had an immense ripple-effect. A large institutional money market fund was forced to “break the buck” and began redeeming shares at 97 cents. This led other institutional investors to shift their cash holdings from “prime” funds—which invested in corporate debt—to government funds, moving over a trillion dollars away from the private sector. This was the final domino of the financial crisis that led to the Great Recession.

Source: Bloomberg

In retrospect, should the Government have let Lehman fail? Bailouts and rescues were arranged for other systemically important financial companies: Bear Stearns and Fannie Mae before Lehman; Merrill, Citibank, and other major banks afterwards. Officials argue they had no authority to arrange a direct rescue, but so much was made up on the fly at that time that something probably could have been arranged.

In hindsight, letting Lehman fail was probably a mistake—for three important reasons:

1. The global financial system is far more integrated than we knew. Lehman’s bankruptcy immediately caused a crisis at AIG, the insurance giant. Their failure would have been even more momentous, and the Government did rescue them.

2. Our domestic economy is much more financially vulnerable than we knew. The run on prime money market funds led to millions of layoffs and trillions in economic losses.

3. Finally, when the establishment fails, anti-establishment groups will rise. We’ve seen huge growth in political radicalism both domestically and abroad. But radical solutions rarely add economic value. Instead, the uncertainty they create causes consumers and investors to be even more careful.

Letting Lehman fail has led to persistent underperformance economically and the emergence of political extremism. In theory, the Dodd-Frank legislation has procedures in place so that it doesn’t happen here again. Let’s hope that they work.

Douglas R. Tengdin, CFA

Chief Investment Officer

By |2017-07-17T12:22:27+00:00September 16th, 2015|Global Market Update|0 Comments

About the Author:

Mr. Tengdin is the Chief Investment Officer at Charter Trust Company and author of “The Global Market Update”. The audio version of each post can be heard on radio stations throughout New England every weekday. Mr. Tengdin graduated from Dartmouth College, Magna Cum Laude. He received his Master of Arts from Trinity Divinity School, Magna Cum Laude and received his Chartered Financial Analyst (CFA) designation in 1992. Mr. Tengdin has been managing investment portfolios for over 30 years, working for Bank of Boston, State Street Global Advisors, Citibank – Tunisia, and Banknorth Group. Throughout his career, Mr. Tengdin has emphasized helping clients manage their financial risks in difficult environments where they can profit from investing in diverse assets in diverse settings. - Leave a comment if you have any questions—I read them all! - And Follow me on Twitter @GlobalMarketUpd

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