The cost of Bernanke’s failure-aversion

By Felix Salmon
September 3, 2010
John Cassidy has very little patience for Ben Bernanke's latest attempt, in front of the FCIC, to explain how Lehman Brothers was allowed to fail so catastrophically. Bernanke is now saying that Lehman was in such bad shape that it would have failed whether or not the Fed had stepped in to guarantee its debts; like Cassidy, I'm very suspicious of that argument, since a Fed guarantee would have stopped any bank run cold in its tracks.


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John Cassidy has very little patience for Ben Bernanke’s latest attempt, in front of the FCIC, to explain how Lehman Brothers was allowed to fail so catastrophically. Bernanke is now saying that Lehman was in such bad shape that it would have failed whether or not the Fed had stepped in to guarantee its debts; like Cassidy, I’m very suspicious of that argument, since a Fed guarantee would have stopped any bank run cold in its tracks.

So what does Bernanke mean when he says that “the view was that failure was essentially certain in either case”? My feeling is that Bernanke, along with Hank Paulson, had an unnecessarily binary idea of what exactly “failure” meant. They were faced with a choice between the chaotic collapse that we saw, on the one hand, and a much more orderly failure, on the other; and they utterly failed to grok how much worse the first option was than the second.

Bernanke has long said that the Treasury “did not have the authority to absorb billions of dollars of expected losses to facilitate Lehman’s acquisition by another firm” — but now it seems that he’s also saying something which demonstrates much weaker leadership. If we lose billions of dollars and Lehman still fails, goes the argument as I understand it, then we will have failed too. So we might as well just let Lehman fail on its own. Even if the consequences of that decision are orders of magnitude worse.

A leader will take a hit for the greater good. A profit-driven trader like Hank Paulson, not so much. As Cassidy puts it:

Many people from Lehman and Barclays suspect that the real barrier to the Barclays rescue wasn’t the legal niceties in London but a reluctance on the part of Bernanke and others—Treasury Secretary Hank Paulson in particular—to fill the gaping gap in Lehman’s balance sheet by providing a Bear-style loan from the Fed, which could have topped fifty billion dollars.

With hindsight, $50 billion would have been a very small price to pay for an orderly wind-down of Lehman Brothers. But Bernanke and Paulson, it seems, were too caught up in wanting to avoid “failure” to work that out.

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