FORTUNE -- September 15, 2008 was a watershed moment for the financial crisis that consigned much of the world to an economic malaise from which we are still recovering. That day, government officials hastily arranged a sale of investment bank Merrill Lynch to Bank of America (BAC), while another bank -- Lehman Brothers -- was allowed to file for bankruptcy.
The failure of Lehman Brothers sent shockwaves through the global financial system, accelerating the crisis until leaders of the seven largest economies met on Oct. 10 and pledged to not let any more systemically important financial institutions go under. This promise led to the eventual passage of TARP and the much-maligned bank bailouts that, while politically unpopular, helped the world avoid a Great Depression-style meltdown.
Here's a slide from Ben Bernanke's 2012 lecture on the Federal Reserve's response to the crisis. It shows just how much this concerted action helped calm financial markets and dampen the severity of the crisis:
The chart shows the interest rates banks required to lend to each other overnight, an excellent measure of overall stress in the financial system. While they were at elevated rates going back to the middle of 2007, it was really Lehman's failure that sent financial markets into panic mode and the promise of government backstops that calmed the markets and set the stage for a recovery.
Given this picture, the decision to not even attempt to use whatever government powers were available to save Lehman Brothers is questionable. Ben Bernanke and other officials have claimed that they did not have the necessary tools to save Lehman. In the case of the Treasury Department, this may be accurate. TARP had not yet been passed and Secretary Hank Paulson didn't have a huge pot of money to pump into Lehman, as it later would with other major banks.
The Fed's claim that it didn't have the power to save Lehman is much more dubious, and is further weakened by transcripts released Friday morning of the central bank's 2008 meetings. The standard excuse for its inaction on Lehman is that central banks should be the lender of last resort to banks that are in a liquidity crunch, but are still solvent. That is, the Fed should lend money to any bank that has collateral to offer. When defending his decision to not intervene with Lehman, Bernanke has claimed that he could not offer anything because the bank was insolvent:
Lehman Brothers was in itself probably too big to fail, in the sense that its failure had enormous negative impacts on the global financial system ... But there we were helpless, because it was essentially an insolvent firm.
But the difference between a firm being insolvent and illiquid isn't cut-and-dried, and it hinges on how you value a bunch of inscrutable assets. Based on the opinions of Federal Reserve Open Market Committee members revealed in the recently released minutes, the decision to let Lehman fail seems to have much more to do with an ideological aversion to government intervention than anything else. Here's St. Louis Fed President James Bullard on Sept. 16, the day after the Lehman bankruptcy:
My policy preference is to maintain the federal funds rate target at the current level and to wait for some time to assess the impact of the Lehman bankruptcy filing, if any, on the national economy ... By denying funding to Lehman suitors, the Fed has begun to reestablish the idea that markets should not expect help at each difficult juncture. Changing rates today would confuse that important signal and take out much of the positive part out of the previous decision.
Hindsight is 20/20, of course, but it is stunning that Fed members thought that the Lehman bankruptcy could conceivably have no effect on the economy. Notice as well that Bullard paints the decision to not save Lehman as not one of necessity but of choice.
Boston Fed President Eric Rosengren was perhaps the most insightful member of the Fed Board in 2008, as he was one of the few in favor of lowering interest rates as early as September, and questions the wisdom of the decision to let Lehman fail:
I think it's too soon to know whether what we did with Lehman is right. Given that the Treasury didn't want to put money in, what happened was that we had no choice. But we took a calculated bet. If we have a run on the money market funds or if the nongovernment tri-party repo market shuts down, that bet may not look nearly so good.
Rosengren's statement is a bit murky here. He calls letting Lehman fail a "calculated bet" but then says that the Fed had "no choice." This waffling has the whiff of justification, however. In e-mails unearthed by the Financial Crisis Inquiry Commission, we can see that the Fed was clearly considering a $200 billion loan to help keep Lehman afloat. These emails called that approach "a gamble" that might be worth taking.
But the Fed never took it, and it appears they did so at least partly for ideological reasons. This is all the more confusing because the federal government had spent the last 30 years intervening in crises to prevent destructive financial system meltdowns. In light of this, economist Alan Meltzer has called the decision "one of the worst blunders in Federal Reserve history." Five years later, the recently released transcripts give us no reason to disagree with Meltzer's assessment.
The plight of the Americans that were hurt most has been largely forgotten in the power politics that have overcome financial reform.
By Sheila Bair
FORTUNE -- I told myself I wasn't going to do a "Lehman" column given the media frenzy over this month's five-year anniversary of that institution's bankruptcy. But in researching a new book I am writing for young adults about the 2008 financial crisis, I have been MORESep 13, 2013 5:00 AM ET
The bankruptcy of Lehman Brothers almost killed Neuberger Berman. Can the company succeed now by embracing Lehman's global ambitions?
FORTUNE -- The asset management business isn't the bastion of stability it used to be. Long known for oh-so-reliable fees and enviable profit margins, traditional equity managers have seen clients stampede to alternatives as the stock market stalled for a decade. They've lost customers to everything from low-cost ETFs to emerging-markets funds, MOREScott Cendrowski, writer - Sep 26, 2012 5:00 AM ET
Caught up in the Libor scandal, the star investment banker and American CEO of the British bank was forced to resign. His departure represents the end of an era for big banks.
FORTUNE -- By the time the call came, Bob Diamond knew his tenure as CEO of Barclays was at an end. It was 9:30 p.m. on Monday, July 2, and Diamond had just gotten home from the office when MOREShawn Tully, senior editor-at-large - Jul 30, 2012 5:00 AM ET
Five years after the U.S. economy teetered on collapse, here are five reasons why we need to stop pointing fingers and fix the problems that nearly sank us.
FORTUNE -- It's hard to believe, but it's been five years and a day since the U.S. financial system's problems surfaced, and we're still not even remotely close to being able to feel good about the economy. My admittedly arbitrary start date is MOREAllan Sloan, senior editor-at-large - Jun 13, 2012 5:00 AM ET
The U.S. government's often maligned $14 trillion intervention not only staved off global collapse - but is making money.
With Doris Burke
FORTUNE -- The bailout of the financial system is roughly as popular as Wall Street bonuses, the federal budget deficit, or LeBron James in a Cleveland sports bar. You hear over and over that the bailout was a disaster, it cost taxpayers a fortune, we didn't really need it, it MOREAllan Sloan, senior editor-at-large - Jul 8, 2011 5:00 AM ET
The Greece-will-default trade may have run its course, as Europe's politicians and officials face the stark consequences if Athens fails to pay on its debt.
FORTUNE -- A Greek default is being treated like an inevitability in the market, with the cost of insuring against such an event soaring to record levels. This is due, as we well know, to the fact that European finance ministers denied Greece a final installment of MOREKatie Benner - Jun 21, 2011 2:15 PM ET
People on Wall Street don't make their fortune by churning out widgets, but by providing capital and wielding power. A forum designed to help women in finance obtain and maintain that clout has taken off.
FORTUNE -- As the credit crisis swept away venerated Wall Street firms and some of the banking industry's brightest stars, Jane Newton -- a wealth manager and finance industry veteran -- found herself counseling clients through the MOREKatie Benner - May 11, 2011 12:38 PM ET
Charles Ferguson elaborates on his famous Oscar speech.
by Adam Lashinsky, senior editor-at-large
Inside Job, which recently won the Academy Aware for best documentary film of 2010, continues to be a conversation starter. Paul Krugman titled his latest column in The New York Times, "Another Inside Job." Time Magazine's Joe Klein evokes director Charles Ferguson's now-famous acceptance speech at the Oscars in which the filmmaker lamented that so far no one MOREMar 15, 2011 4:15 PM ET
Don't look for indictments in Andrew Cuomo's case against the accounting firm. That could kill the business, and no one wants that.
If you're going to screw up, make sure you're working at a company that regulators aren't going to allow to fail. That's the lesson not only for big financial companies, but for the Final Four big national accounting firms as well.
Take Ernst & Young, which is a target of MOREAllan Sloan, senior editor-at-large - Dec 21, 2010 11:23 AM ET
|Regulators pave way for Internet "fast lane" with net neutrality rules|
|Apple shares soar on increased buyback|
|What stumps Warren Buffett? Minimum wage|
|Facebook profit triples on mobile growth|
|Thanks to Obamacare, more workers may quit their jobs|