How the Fed Reached Out to Lehman

Lehman's failure remains a gaggle of unanswered questions, unresolved issues and doubts.

In the early hours of Sept. 15, after the government refused to rescue the foundering Lehman Brothers, something odd happened. The Federal Reserve lent tens of billions of dollars to a subsidiary of the newly bankrupt bank. In other words, government officials who had refused to risk taxpayers’ money on Lehman before it collapsed did just that after it collapsed.

Why was Lehman not rescued? Why was Bear rescued?

Many people, at least on Wall Street, have come to view the decision to let Lehman die as one of the biggest blunders in this whole financial crisis. Christine Lagarde, France’s finance minister, called the decision “a genuine error.” Judge James Peck, who approved the sale of Lehman’s carcass to Barclays, the British bank, said it was a shame that Lehman had failed.

Excellent point.

The authorities are investigating whether Lehman executives misled investors about the firm’s financial condition before the firm failed. But the authorities might be asking similar questions about executives at other banks if, like Lehman, those institutions had been allowed to go under.

Why was the money lent? Twice?

The recently disclosed documents detailing the Fed’s loan to Lehman’s subsidiary cast some light on a failed effort to prevent Lehman’s implosion from cascading through the financial system. The loan, according to these documents, was a “carefully thought-out decision” to stabilize the market by propping up Lehman’s broker-dealer business, called LBI New York, so it could stay afloat long enough to “facilitate an orderly wind-down” of tens of thousands of trades with the other Wall Street firms. The unit was kept out of the Lehman bankruptcy.

Good reasoning, but the implosion did cascade; many people got scared, petrified, and things got ugly.

People involved in the process said that the Fed only lent the money as part of “an orderly wind-down,” which would have been different from lending money to an ongoing, or in this case, insolvent concern.

Key point.