The article of Lanchester looks through the reasons and consequences of the biggest bankruptcy in history the downfall

of LB. It s generally divided into several sections. I will also be referring to The love of money a documentary of BBC that the author of the article recommends. The collapse of LB Consequences: 1) Loss of jobs, livelihood etc. 2) Financial panic regarding stock markets, business 3) Further recession Conclusion: the interconnections between bigger western banks are so tight that they are too big to fail given the guarantee that they will eventually be bailed out by government (taxpayers)

Big enough to blackmail the government the bankruptcy of LB created an economic sphere where it became clear that no huge bank should be left to fail examples : Goldman Sachs rescued by 10 a taxpayer injection of $10 billion; AIG few days after LB bankruptcy Reasons: lack of competition and taxpayer guarantee banks merge when facing insolvency Merrill Lynch and Bank of America (BBC)

Richard Fuld CEO of LB for 40 years dominated the bank s culture and decision-making was a god-like figure to the employees and not in a good way (BBC not greeting him in the elevator, not talking to him, not arguing with him unless having a huge argumentation basis) the person to run a Wall Street bank in the longest period of time testimonials to Congress in the aftermath of his bank s destruction angry, not apologizing- even when a congressman asked him if he had actually taken 480 million $s in compensation for 8 years (2000 - 2008) two main mistakes that led to the destruction of LB: 1) levels of leverage for the bank went up to 44 to 1 means that for every $ the bank had, it owned somebody 44; 2) LB invested too much in real estate market sub-prime mortgages and Alt-A loans; (BBC) The reason which caused those mistakes is that LB borrowed huge amount of assets and invested all of it in properties. This practice is not new but has never so far been done so massively. It actually guarantees doubling the assets when market goes up, but also tripling of the losses when market goes down. What brought LB down is that they couldn t manage to get out of this risky plane before the market crashed so basically what has brought them faster to the top, got them twice as fast to the bottom. LB employees sharp division between bankers and traders negligent homicide employees did not know what was going on at senior levels

Joseph Tibman Fuld s paranoid world view that spread into the LB s mentality is what prevented employees of realizing how critical the situation in the bank was Larry McDonald trader at the bank who owned convertible bonds  bonds mostly popular with companies in trouble when they desperately try to raise money from their investors  companies usually don t tell investors the entire truth in order to get them to invest in the troubled company; McDonald s explanation of how financial products were sold when he arrived in LB (2004): bonds and stocks that are well known by LB to be worthless are sold; employees tasks were to find wealthiest investors and to assure them that those bonds will eventually pay back; bottom line official market rules do not apply to reality;  employees inside LB tried to do what saved Goldman Sach s hedging bets the other way which could cash in and save the bank; what followed is that concerned parties were forced to leave the bank shortly

Specifics of the disaster The bank announced a record loss of $2.8 billion for the second quarter of 2008, and then another record of $3.9 billion for the third. J.P. Morgan, asked for an increase in its Lehman collateral of $5 billion LB went to the treasury for help, because they were unable to find the money; Hank Paulson, who was in charge of us economy policy at that time, summoned up all of the chief executives in a crisis meeting called Masters of the universe and told them to figure out a plan for LB because bailing out from the government is not an option. Not new practice to set up a meeting of senior bankers to decide who s going to rescue the one in trouble last one was March 2008, JP Morgan bought what was left of Bear Stearns; The idea was to form a bad bank from the lower assets of LB and to sell the rest as a working concern. What turned out was that the bank had grossly overstated the value of many of its assets. Barclays chief executive for example said in the BBC movie that they ve expected something like that but definitely not to the extent they saw what was recorded in LB s balance sheets to worth $ 100 mil, had an actual value of $50 or sometimes $ 25 mil. Favorite to rescue was Bank of America until Merrill Lynch s CEO called them and offered the sale of his own bank, which he admitted to have done the minute he found out what was really happening in the Fed building in NYC, because he didn t want to be in Fuld s shoes a week later. The only offer left was Barclays , no other bank was interested. Regarding what happened next Lanchester offers the explanation of Tibman, but I consider the one given in the BBC documentary more accurate since it s given from the main actors at the time.

 John Thain, Merrill Lynch Allowing LB to go bankrupt was a tremendous mistake. The amount of money it would have taken, 20 billion, 30 billion, compared to the destruction in value that followed the Lehman bankruptcy and the complete shutdown of the credit markets, the billions and billions and billions of losses that were experienced in the market subsequently.

 Neel Kashkari, US Treasury - When the Federal Reserve lends money - they can loan money to financial institutions - the law requires the Fed to be secured, so that they're not taking much risk. And so in the case of Bear Stearns, they lent $30 billion against a pool of mortgages. In the case of Lehman Brothers, the question is, "What assets could they lend against?"  Timothy Geither, US Treasury Secretary US came into crisis without an adequate set of tools to withstand and protect the economy from the acute stress you saw in the financial system. The constraints we faced at Lehman were one example of those kind of constraints.  Hector Sants, Chief Executive of FSA (Financial Services Authority), UK - To be absolutely, categorically clear, the FSA did not stop the Barclays deal. Barclays never brought us a deal. Barclays never negotiated a deal that they thought was satisfactory from their own point of view and therefore never proposed any deal to us.  John Varley, Chief Executive, Barclays - We were quite prescriptive about what was going to work and what wasn't going to work. What we wanted was not available, so we walked, end of story. The biggest bankruptcy in history Barclays bought the assets they wanted at a knockdown price - the bulk of Lehman's North American assets for $1.75 billion The Dow Jones (the leading stock exchange index) plummeted 500 points which was the biggest fall in a day since 9/11. By the end of Monday s trading (15 sept) 700 billion had been wiped off the global stock markets. The collapse of LB did something with future consequences it destroyed the confidence between banks, so they stopped lending money to each other. Hank Paulson s stepping out 2 versions: 1) he loathes Fuld and as a former CEO of Goldman Sachs s he was fine with seeing his rival going insolvent; 2) Paulson s policy of non-intervention -> committed believer in capitalism and the free market -> moral hazard after the government guarantees in Bear Stearn s deal with JP Morgan -> the banks definitively got the point about what market discipline looks like in practice The decision to let Lehman go under was undoubtedly the biggest economic misjudgment in modern American history. After this huge crash suddenly explanations for what had happened started changing. Specialists tried to put LB in a different category from AIG, Bear Stearns, Fannie Mae and Freddie Mac to explain the lack of bail out. Actually the the idea of endless bailouts is highly inappropriate, but what LB did in fact was to expand the term too big to fail to a whole new level. According to Lanchester there was a brief moment of horror when there was a chance to change the system but with the stock market s recovery that moment is passing by. And since we re only the paying public with no choice in this new bankocracy system, we should settle back for the next set of bills and forget about the two basic elements of capitalism creative destruction and the freedom to fail.