How miscommunication caused Lehman’s collapse

By Felix Salmon
September 3, 2009
Larry Elliott and Jill Treanor have a big story today, although I'd love to see it re-reported elsewhere. Remember the tick-tock on why Lehman Brothers was allowed to fail: although there was a bid on the table from Barclays, it required government funds, and neither the US nor the UK government were willing to provide them.

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Larry Elliott and Jill Treanor have a big story today, although I’d love to see it re-reported elsewhere. Remember the tick-tock on why Lehman Brothers was allowed to fail: although there was a bid on the table from Barclays, it required government funds, and neither the US nor the UK government were willing to provide them.

One hurdle remained: To ink a Lehman deal, Barclays needed a shareholder vote. There was no way to get one on a Sunday. Barclays would need the U.S. or British government to back Lehman’s trading balances until a vote could be held.

Government approval never came, though there are diverging views on why. Some blame the U.S. government for refusing to commit resources. Others say the British government refused to entertain a deal they worried would expose England to unnecessary risk.

From the other side of the pond, it seems that the Brits were convinced all along that the US money was there for the asking:

In London, the Treasury, the Bank of England and the Financial Services Authority all believed that the US government would step in with a financial guarantee for the troubled Wall Street bank…

The UK tripartite authorities – the FSA, the Bank of England and the Treasury – had expected the US government to stand behind Lehman in the way that it had backed two crucial mortgage lenders the previous week and helped to orchestrate the bailout for Bear Stearns in March.

No explanation has ever been given for the lack of government funds offered in the final weeks of the Bush administration, which had to step in to prop up the insurance company AIG days after Lehman’s demise.

That final paragraph is not strictly true. An explanation has been given, repeatedly: that Treasury had no legal authority to provide such funds. It’s just that nobody really believes it. In any event, it’s pretty clear that no one in Treasury was making its inability to provide funds clear to anybody in the UK. Treasury should have been saying “look, gents, we’ve saved the world three times now, but we’ve come a bit unstuck on this Lehman thing, we’re not going to be able to do it ourselves, do you think you could step up this time, give those Barclays chaps a bit of a helping hand, we’ll owe you one, it’s rather urgent”.

Instead, there seems to have been a complete breakdown in communication, with the UK team convinced that the US could and would bail out Lehman. After all, the Yanks had given them every indication that they were perfectly capable of dealing with such things on their own, and didn’t need any help from abroad:

The UK tripartite authorities were concerned about the financial system in the spring of 2007 and asked their American counterparts to participate in a “war game” to prepare for the collapse of a major US bank and develop a response to a financial crisis. However, the war game, which was to have included the UK, Switzerland, the Netherlands and the US, never took place because of a lack of willingness to participate by the US regulatory bodies.

The enormous global costs associated with the chaotic Lehman bankruptcy were entirely avoidable, and to my knowledge no one in power has ever apologized for letting it happen. Maybe Hank Paulson could be the first, in his upcoming memoir.

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