Too Big To Fail?

The Wall Street Journal’s (2008) opinion was that Lehman Brothers was treated harshly by the Fed. The government always had the option to provide Lehman with a loan. The Federal Reserve had provided funds for mortgage providers Fannie Mae and Freddie Mac in the week previous to Lehman’s bankruptcy. They even supplied financial support to the insurers American International Group (AIG) the day following Lehman’s collapse. AIG were pressing for a loan and as the Lehman situation had distorted the market with more volatility, the government gave in reluctantly. Many commentators at the time claimed that the government and the Fed had no other option as the effects of AIG’s collapse would be all encompassing. These institutions were categorised by the government as “too big to fail”, whilst Lehman was not.

Graph taken from CNBC indicating AIG's falling share price and the amount of government it received and dates paid. Total was $137.8billion.

The US economy, like many other economies across the globe, is dependent upon the financial stability of certain institutions. These are viewed as integral parts of the economic system because of their connections to other banks, businesses and governments via contracts, loans and insurances, as defined by Joines (2010). If this select group were to fail, many others would crash along with them and in turn, the economy would struggle to ever recover. If their failure could be prevented, the government would step in and save them with the use of tax payers’ money. There were numerous financial institutions that gained this tag over the 2008-2009 period.

AIG was one such company given this tag because they guaranteed the debt of multiple corporations and many mortgages, which was customary as a result of the Subprime Mortgage Crisis. The New York Times newspaper that was published on September 16^th reflected that AIG’s failure would have caused significant write-downs in value of all the companies that had bonds insured by them. Roger Altman, a former Treasury officer, was reported in the New York Times, saying that because of the span of their reach, the world over was genuinely scared by the thought of AIG’s collapse. Andrew Clark, writing for The Guardian, highlighted these fears as UK retailers like Boots, Argos and Sainsbury’s would be devalued as AIG provided a substantial portion of their insurance.

Simultaneously in the UK, Northern Rock was undergoing a nationalisation themselves. Like Lehman, they too had got caught up in the mortgage market. One of their attractions was the 125% house value mortgages they were offering, which coincidentally accounted for the majority of their repossessions. The National Audit Office summarised that they were trying to maintain their assets of over £100billion, with short-term loans. Treasury announced they were backing Northern Rock, spread panic amongst depositors who began to “run the bank.”  Administration was considered as the search for buyers was unsuccessful but eventually the Treasury themselves took over Northern Rock because the potential “hardship” that the public could have faced was viewed as too extreme.

Why was Lehman not saved whilst AIG was? To this day there is a debate as to whether Lehman Brothers was too big to fail and whether it should, ultimately, have been bailed out. Opposition Democrats, like Christopher Dodd, criticised the government for being inconsistent. The Fed released a statement that they believed the market could handle the disruption caused by an investment bank, but held the view that AIG’s downfall would “lead to substantially higher borrowing costs and reduced household wealth”. It confirmed that the government were willing to let a bank fail, and what would stop them from doing the same again? It was a method of re-incentivising the sector again, to remain prudent, as there was no back-up plan otherwise. Vince Cable, Economics minister of the UK Liberal Democrat Party believed that “the US government had drawn a line in the sand.”

My own opinion is that the US government were trying to make an example of Lehman. It was a political decision. Votes were the main motive. Elections were scheduled a few months later and the Republican Party wanted to be re-elected. They couldn’t be shown to the public as being weak and bowing to the pressure that big business put on them (of course, this was undermined the following day). The taxpayers had already seen their own money that they worked hard for being used to rescue Fannie Mae and Freddie Mac and the government didn’t want to risk any more. Multi-million corporations had already gained a reputation for dismissing and belittling the every-man in the street. If the government were going to help a company, who as it would turn out were blatantly lying about their funds, it would create a very bad image for all involved.