1

Introduction

On Monday, September 15, 2008, at 1:45 AM, Lehman Brothers Holdings Inc. filed a bankruptcy petition in the United States Bankruptcy Court for the Southern District of New York. This action was the most dramatic event of the financial crisis of 2007–2009, and many economists believe it greatly worsened the crisis and the Great Recession that followed.

Why did Lehman Brothers fail? At one level, the answer is clear. Lehman suffered large losses on real estate investments in 2007–2008, which threatened its solvency. Other financial institutions lost confidence in Lehman, precipitating a liquidity crisis: the firm could not roll over the short-term debt that funded its illiquid assets. Lehman declared bankruptcy in the early hours of September 15 because it did not have enough cash to open for business that morning and pay debts that were due immediately.

At another level the Lehman story is less clear. Lehman was the only large financial institution that had to file for bankruptcy during the financial crisis. Others, such as Bear Stearns and AIG, also experienced liquidity crises and surely would have gone bankrupt if not for emergency loans from the Federal Reserve. Why didn’t the Fed make a loan to rescue Lehman?

This question is controversial among students of the financial crisis. Some say that Fed officials bowed to political opposition to a Lehman “bailout.” Others say that policymakers were concerned about moral hazard: they feared that rescuing Lehman would encourage excessive risk-taking by other firms. Yet another factor, according to many, is that policymakers underestimated the damage that Lehman’s bankruptcy would do to the financial system and economy.

Fed officials insist, however, that none of these views is correct. The people in charge in 2008, from Federal Reserve Chairman Ben Bernanke on down, have said repeatedly that they wanted to save Lehman, but could not do so because they lacked the legal authority. When the Fed lends to a financial institution, Section 13(3) of the Federal Reserve Act requires that the Fed receive “satisfactory” collateral to protect it if the borrower defaults. In a speech at the Fed’s Jackson Hole conference in 2009, Bernanke said of Lehman:¹

[T]he company’s available collateral fell well short of the amount needed to secure a Federal Reserve loan of sufficient size to meet its funding needs. As the Federal Reserve cannot make an unsecured loan … the firm’s failure was, unfortunately, unavoidable.

Bernanke reiterated this point in 2010 in his testimony before the Congressionally appointed Financial Crisis Inquiry Commission (FCIC):²

[T]he only way we could have saved Lehman would have been by breaking the law, and I’m not sure I’m willing to accept those consequences for the Federal Reserve and for our systems of laws. I just don’t think that would be appropriate.

In his 2015 memoir, The Courage to Act, Bernanke states again that Lehman did not have “sufficient collateral to back a loan of the size needed to prevent its collapse.”³

This book sets the record straight on why the Fed did not rescue Lehman Brothers by presenting evidence that clearly supports two related conclusions. First, Fed officials’ beliefs about their legal authority were not the real reason that they chose not to rescue Lehman. Second, the Fed did, in fact, have the authority to rescue the firm.

The following findings support these conclusions:

· A substantial record of policymakers’ deliberations before the Lehman bankruptcy contains no evidence that legal barriers deterred them from assisting Lehman or that they examined the adequacy of the firm’s collateral.

· Arguments about legal authority made by policymakers since the bankruptcy are unpersuasive. These arguments involve flawed interpretations of economic and legal concepts, and factual claims that are not accurate.

· From a detailed examination of Lehman’s finances, it is clear that the firm had more than enough collateral to secure a loan to meet its liquidity needs. Such a loan could have prevented a disorderly and destructive bankruptcy, with negligible risk to the Fed.

· More specifically, Lehman probably could have survived by borrowing from the Fed’s Primary Dealer Credit Facility on the terms offered to other investment banks. Fed officials prevented this outcome by restricting Lehman’s access to the PDCF.

We will never know what Lehman Brothers’ long-term fate would have been if the Fed had rescued it from its liquidity crisis. There are several possibilities: Lehman might have survived indefinitely as an independent firm; it might have been acquired by another institution; or it might have eventually been forced to wind down its business. Whichever of these outcomes occurred, however, would have been less disruptive to the financial system than the bankruptcy that actually happened.

If legal constraints do not explain why the Fed did not rescue Lehman, then what does? The available evidence supports the theories that political considerations were important, and that policymakers did not fully anticipate the damage from the bankruptcy. The record also shows that the decision to let Lehman fail was made primarily by Treasury Secretary Henry Paulson; Fed officials deferred to Paulson even though they had the sole authority to make such a decision under the Federal Reserve Act.

A Preview of the Argument

The Lehman crisis and the Federal Reserve’s response to it were complex, and this book examines the episode in considerable detail to determine, as precisely as possible, exactly what happened and why. Here is an overview of how the book proceeds.⁴

The Financial Crisis and Lehman’s Failure

Chapter 2 presents a history of the Lehman crisis and places it within the broader financial crisis that unfolded in 2008. Other landmark events include the Fed’s rescues of Bear Stearns in March and AIG in September when liquidity crises threatened those firms. As many have pointed out, a satisfactory account of Fed policy must explain why Lehman was treated differently from Bear, AIG, and other companies.

During the week that began on Monday, September 8, Lehman’s liquidity was wiped out by a run. Over the weekend of September 13–14, Fed and Treasury officials tried to broker the sale of Lehman to a stronger firm, and they almost succeeded, but a deal with the British bank, Barclays, fell apart on September 14. The central issue examined in this book is what the Fed could have done after the Barclays deal failed to avert Lehman’s bankruptcy on September 15.

An important detail of the story – and one that is not widely appreciated – is that not all of the Lehman enterprise failed on September 15. The entity that Barclays almost purchased on the 14th, and which famously filed for bankruptcy on the 15th, was Lehman Brothers Holdings Inc. (LBHI), a corporation with many subsidiary companies. Most of these subsidiaries immediately entered bankruptcy along with LBHI, but one did not: Lehman Brothers Inc. (LBI), Lehman’s broker-dealer in New York. The Fed kept LBI in business from September 15 to September 18 by lending it tens of billions of dollars. After that, Barclays purchased part of LBI and the rest was wound down by a court-appointed trustee. These events raise another important question: Why did the Fed choose to assist LBI but not its parent, LBHI?

Section 13(3) of the Federal Reserve Act

Chapter 3 explores the law that governs lending by the Federal Reserve. Normally, the Fed lends only to depository institutions (traditional discount lending). Under Section 13(3) of the Federal Reserve Act, however, the Fed can lend to non-depository institutions such as investment banks under “unusual and exigent circumstances.” Almost everyone agrees that conditions in 2008 were unusual and exigent.

The legal controversy about Fed lending concerns the requirement under Section 13(3) that a loan be “secured to the satisfaction of the Reserve Bank” that makes the loan. Usually, security takes the form of collateral – borrower assets that the Fed can seize if the borrower defaults. Nobody has given a precise definition of “satisfactory security,” but Fed officials have interpreted the concept to mean that the Fed cannot make a loan if there is a significant risk that it will lose money on the deal. In the words of the General Counsel of the Board of Governors, “You have to be pretty confident you will be repaid.”

Was Lehman Solvent?

Chapter 4 analyzes LBHI’s financial condition before its bankruptcy as summarized by the firm’s balance sheet, and examines the controversial issue of whether Lehman was solvent. Section 13(3), as it stood in 2008, did not require that recipients of Fed loans be solvent by any definition. However, examining Lehman’s solvency helps us to understand what assistance the firm needed to survive its liquidity crisis, and to assess its longer-term prospects.

In a financial statement for August 31, 2008, LBHI reported assets of approximately $600 billion and liabilities of $572 billion. These figures imply that the firm was solvent, with stockholder equity of $28 billion.

It is generally agreed that Lehman valued some of its assets at more than their true market values. Yet the extent of overvaluation was not as great as some commentators have suggested. About $60 billion of reported assets (primarily investments in real estate and private equity) were questionable. Other financial institutions estimated that these assets were overvalued by $15 billion to $32 billion. If we subtract that amount from Lehman’s total assets, the firm’s equity falls from the reported level of $28 billion to something between −$4 billion and +$13 billion. Thus, with realistic asset values, Lehman was near the border between solvency and insolvency.

These calculations are based on mark-to-market valuation of Lehman’s assets, that is, on estimates of the prices at which Lehman could have sold the assets at the time of its crisis. In the distressed markets of September 2008, the prices of many assets had fallen below their fundamental values (as determined, for example, by likely repayment rates on loans). If Lehman was near the edge of solvency with mark-to-market valuation, then it was probably solvent based on its assets’ fundamental values.

Fed officials have said repeatedly that Lehman was insolvent, but they have never supported this claim with an analysis of the firm’s balance sheet. When pressed to back up the claim, officials have offered explanations with a number of flaws, including confusion between the concepts of insolvency and illiquidity and misinterpretations of statements by Lehman executives.

Lehman’s Liquidity Crisis

After Bear Stearns nearly failed in March 2008, many commentators suggested that Lehman Brothers might also be in danger. Fears about Lehman grew throughout the summer of 2008 as the firm suffered losses on its real estate investments. Eventually Lehman experienced a run: a self-reinforcing cycle of decreases in its share price, downgrades of its bonds by rating agencies, and a flight of its customers and counterparties in various financial transactions.

The fatal part of this cycle was a liquidity crisis, which Chapter 5 examines in detail. This liquidity crisis involved a number of factors, the most important of which involved Lehman’s repurchase agreements, or repos.

These repos were effectively short-term loans that Lehman took out using the firm’s securities as collateral. In early 2008, Lehman’s liabilities included more than $200 billion in repos, which it rolled over continuously. Lehman and other investment banks believed that repos were a stable source of funds. They were safe for lenders because the loans were secured by collateral that was worth more than the loans. In determining how much cash to provide, lenders would take off some percentage of the collateral’s value, called a “haircut,” to cover any costs of selling the collateral if the borrower defaulted. Investment banks believed that because lenders were protected by this over-collateralization, they would not cut off a firm’s repo funding during a crisis.

A surprising aspect of the 2008 crisis was that repo funding proved not to be reliable. Cash lenders abruptly cut off repos with Bear Stearns in March and with Lehman in September. The reasons for these actions are not entirely clear, but whatever the reasons, the loss of repo financing was disastrous for Bear’s and Lehman’s liquidity.

Lehman’s loss of liquidity began during July and August of 2008, and accelerated sharply during the week of September 8. On Friday, September 12, Lehman had almost no cash, and it was clear the firm would immediately default on its obligations if it opened for business on Monday, September 15.

The Fed Could Have Provided Lehman with Liquidity Support

Chapter 6 turns to the central question of this book: Could the Fed have kept Lehman in operation with a loan that was well-secured, and hence legal? This question turns on how much cash the firm needed to borrow, and how much collateral it had available. I examine this issue in three complementary ways.

A Simple Calculation On the eve of its bankruptcy, Lehman’s balance sheet had two key features. First, the firm was on the borderline of solvency, which means its total assets (with reasonable valuations) and its total liabilities were approximately the same: each was about $570 billion. Second, the liabilities included $115 billion of unsecured long-term debt, meaning debt that was not due for 12 months or more. Together, these facts imply that Lehman had enough collateral for any liquidity support it might have needed.

To see this point, consider the most severe liquidity crisis imaginable: Lehman must immediately repay all of its short-term liabilities, defined as its liabilities less its long-term debt. Assume also that Lehman cannot liquidate any of its assets. Short-term liabilities total $455 billion ($570 billion minus $115 billion), so Lehman must borrow that much cash. It has $570 billion of assets, which are unencumbered because its only remaining liability, long-term debt, is unsecured. Therefore, Lehman’s available collateral ($570 billion) exceeds the largest loan it could possibly need ($455 billion) by $115 billion, or about 25 percent.

A Likely Scenario How much would Lehman have actually needed to borrow from the Fed to stay in operation? While the answer to this question is speculative, detailed information on the liquidity drains the firm experienced allows me to make a reasonable estimate: Lehman would have needed about $84 billion of assistance to stay in operation for a period of weeks or months.

Lehman could have borrowed this $84 billion from an existing Fed facility, the Primary Dealer Credit Facility (PDCF), because the firm had at least $114 billion of available assets that were acceptable as PDCF collateral. Thus, the Fed probably could have rescued Lehman without a new Section 13(3) authorization. Instead, Fed policymakers chose to restrict Lehman’s access to the PDCF.

Comparison to Liquidity Support for LBI After the bankruptcy of its parent company (LBHI), Lehman’s New York broker-dealer, LBI, was permitted to borrow daily from the Fed’s PDCF in amounts ranging from $20 billion to $28 billion. These loans allowed LBI to operate from September 15 to September 18, on which date Barclays acquired most of LBI. The amounts of these loans are consistent with my estimate that $84 billion could have sustained the entire Lehman enterprise for weeks or months.

Fed Pre- and Post-Bankruptcy Discussions about Liquidity Support

As Chapter 7 describes, Fed officials discussed the possibility of liquidity support for Lehman before the bankruptcy; after the bankruptcy, Fed officials made many statements about why they withheld that support.

Discussions before September 15 From the Bear Stearns crisis in March 2008 to September 13, the staffs of the New York Fed and the Board of Governors extensively analyzed Lehman’s liquidity risk and how the Fed might assist the firm if it experienced a crisis. The staffs reported to senior officials on several policy options, including loans from the PDCF to replace the cash that Lehman would lose if its counterparties refused to roll over repos.

These discussions do not explain why, in the end, the Fed chose not to lend to Lehman when its crisis actually occurred. In the available records, there is little discussion of Lehman’s collateral, and no discussion at all of any legal issues related to Section 13(3).

Bernanke on September 23 Ben Bernanke first discussed the Lehman bankruptcy in Congressional testimony just eight days after it happened. On that occasion he said that “the Federal Reserve and the Treasury declined to commit public funds” to Lehman because “the troubles at Lehman had been well known for some time” and “we judged that investors and counterparties had had time to take precautionary measures.” Bernanke did not mention concerns about collateral or legal barriers to assisting Lehman.

Bernanke later disavowed his initial testimony about Lehman. In 2010 he told the Financial Crisis Inquiry Commission, “I regret not being more straightforward there, because clearly it has supported the mistaken impression that in fact we could have done something [to save Lehman].” Bernanke makes a similar statement in his 2015 memoir.

Dubious Claims about Lehman’s Collateral In a speech on October 7, 2008, Bernanke first claimed that Lehman had insufficient collateral for the loan it needed, thus making the loan illegal under Section 13(3). Since then he has repeated that position many times, as have other officials including Timothy Geithner (the New York Fed President in 2008) and the General Counsels of the Board of Governors and the New York Fed. However, nobody has ever presented any details about Lehman’s finances to support this position.

In 2010, Bernanke testified at a public hearing of the FCIC, and several FCIC Commissioners pushed him to back up his claims about Lehman’s collateral. Bernanke said that the New York Fed analyzed Lehman’s finances and reported to him that “the liquidity demands on the holding company [LBHI] were much greater than the collateral that they had available to meet those demands.” The FCIC sent Bernanke a follow-up letter that asked pointedly for details of the New York Fed’s analysis and for “the dollar value of the shortfall of Lehman’s collateral” relative to its liquidity needs. Bernanke never answered these questions.

Another witness at the 2010 FCIC hearing was Thomas Baxter, General Counsel of the New York Fed. Baxter also testified that Lehman’s collateral was inadequate, but when pressed for details he deflected the question. He said that a loan to LBHI “was never seriously considered by the Federal Reserve,” and that policymakers had decided before LBHI’s final weekend that it must declare bankruptcy unless it was acquired by a stronger firm.

How the Fed Ensured Lehman’s Bankruptcy

Fed officials did not stand by passively as Lehman failed. They took actions to force LBHI to file a bankruptcy petition, as Chapter 8 describes. On the afternoon of Sunday, September 14, after it became clear that Barclays was not going to buy LBHI, officials of the New York Fed called Lehman executives to a meeting. According to multiple accounts, General Counsel Baxter announced, “We’ve come to the conclusion that Lehman has to go into bankruptcy,” or words to that effect. Baxter said that LBHI should file a bankruptcy petition by midnight that night.

The Fed does not have the legal authority to order a corporation to file for bankruptcy. However, officials took actions to ensure that Lehman had no good alternative. Specifically, they prevented Lehman Brothers International Europe (LBIE), the firm’s London broker-dealer, from obtaining the cash it needed to meet its obligations on September 15. Because many of these obligations were guaranteed by LBHI, LBHI was also forced into default. The LBHI Board of Directors decided that bankruptcy was preferable to defaulting and then trying to operate the firm.

Fed officials denied cash to LBIE through two actions. First, they refused a request from Lehman that LBIE, as well as the New York broker-dealer LBI, be allowed to borrow from the PDCF. This refusal contrasts starkly with the Fed’s treatment of other investment banks when they experienced liquidity problems. Starting on September 21, for example, the Fed granted PDCF access to the London broker-dealer subsidiaries of Goldman Sachs, Morgan Stanley, and Merrill Lynch.

Second, the Fed thwarted an effort by LBI to borrow enough to fund both itself and LBIE. This plan would have required LBI to gather collateral from other parts of Lehman to pledge to the PDCF. The plan was prevented by the Fed’s “Friday criterion,” a rule which stated that LBI could only pledge assets that were on its own balance sheet on Friday, September 12. Policymakers have never given a clear rationale for this restriction.

The Long-Term Resolution of Lehman’s Crisis

An adequate loan from the Fed would have kept Lehman in business while the firm looked for long-term solutions to its problems. We will never know what the outcome would have been, but Chapter 9 outlines some possibilities.

One possibility is that the Barclays acquisition of LBHI – the plan on September 13 – would have eventually been completed. This deal failed because British regulators would not approve it without a vote by Barclays shareholders, which would have taken a month or two to organize. Liquidity support from the Fed could have kept Lehman in operation until the vote was held.

Another possibility is that Lehman would have survived as an independent firm. This outcome would have been more likely if Lehman could have removed some of its illiquid assets from its balance sheet. Before it failed, Lehman was planning to spin off its illiquid real estate assets into a real estate investment trust in early 2009. Alternatively, the Fed might have created a special purpose vehicle to buy Lehman’s illiquid assets, like the Maiden Lane facilities that bought assets from Bear Stearns in March and AIG in November.

In the worst case, Lehman would eventually have had to declare bankruptcy. In this case, liquidity support from the Fed would have given Lehman the time to wind down or sell various of its businesses before declaring bankruptcy. This process could have greatly mitigated the disruption of the financial system that occurred because of the firm’s sudden failure. On September 14, Lehman executives began planning a six-month wind down, but they abandoned the plan when they realized the Fed would not provide the liquidity support necessary to execute it.

The Fed’s Treatment of Other Firms

Many have asked why the Fed let Lehman fail but rescued other financial institutions in 2008. The Fed’s answer is that, unlike Lehman, the firms it assisted had sufficient collateral, which made it safe to lend to them. As Chapter 10 discusses, this claim is yet another Fed position that does not survive scrutiny.

The Fed’s assistance to some institutions was similar to the assistance that Lehman needed and did not receive. In particular, Goldman Sachs and Morgan Stanley received large amounts of PDCF financing when their liquidity positions deteriorated after Lehman’s failure. The PDCF lent to both the New York and London broker-dealers of Goldman and Morgan, and it accepted types of collateral – including speculative-grade securities and equities – that Lehman had possessed in ample quantities.

In lending to Bear Stearns in March 2008 and AIG starting in September, the Fed took on more risk than it would have in rescuing Lehman. Lehman probably could have survived with overnight, overcollateralized loans from the PDCF. In rescuing Bear Stearns, the Fed provided long-term financing for illiquid assets, and might have taken substantial losses had financial markets not recovered as strongly as they did in 2009. In the case of AIG, the collateral accepted by the Fed included equity in privately-held insurance companies. The value of this collateral was highly uncertain, and might well have been less than the amount the Fed lent AIG.

Who Decided to Let Lehman Fail?

There is plentiful evidence showing that lack of legal authority because Lehman had inadequate collateral was not the reason that the Fed refused to rescue Lehman. What then were the real reasons?

To answer this question, we must first understand who decided that Lehman should fail. Chapter 11 shows that the primary decision maker was Treasury Secretary Henry Paulson, even though he had no legal authority over the Fed’s lending decisions. Paulson traveled to New York on September 12 and took charge of the negotiations about Lehman that were taking place at the New York Fed. Other officials on the scene, including New York Fed President Geithner, deferred to Paulson. Chairman Bernanke remained in Washington and received periodic reports on developments in New York.

Explaining the Decision to Let Lehman Fail

Chapter 12 asks why Secretary Paulson insisted on Lehman’s bankruptcy and why Fed officials acquiesced. The available evidence supports the common theory that Paulson was influenced by the strong political opposition to financial rescues. He had been stung by criticism of the Bear Stearns rescue in March and the government takeovers of Fannie Mae and Freddie Mac just a week before the Lehman decision. He ruled out any assistance to Lehman because, in his widely-quoted words, “I can’t be Mr. Bailout.”

Another factor is that although Paulson and Fed officials worried about the effects of a Lehman failure, they did not fully anticipate the severe damage to the financial system that it would cause. Since the bankruptcy, Ben Bernanke has said that he knew before the event that it would be a “catastrophe” and a “calamity” for the economy, but this claim is not consistent with what he and other officials said shortly before and shortly after the bankruptcy.

Sources of Evidence

What distinguishes this book from others on the 2008 financial crisis is the level of detail in which it examines one specific topic, the Fed’s decision not to rescue Lehman Brothers. A detailed analysis is made possible by the wealth of information on the topic that is available from a variety of public sources. Previous authors have made conflicting, unproven claims about the Fed and Lehman, but having extensively studied the available record, I can make a number of firm conclusions about what happened and why. The following are the major sources for my research. The endnotes to the book give citations for each specific piece of evidence that I present.

The Valukas Report (March 2010)

LBHI’s bankruptcy petition, filed on September 15, 2008, was the first step in an extraordinarily complex bankruptcy case, which is ongoing in 2018 (In re Lehman Brothers Holdings Inc., Case No. 08–13555, U.S. Bankruptcy Court, Southern District of New York). At the outset of the case, the court appointed an Examiner, Anton Valukas, and charged him with writing a report on what happened to Lehman, including its interactions with the Federal Reserve. The report does not directly address whether the Fed could have rescued Lehman, but it contains much information that bears on that question.

During his investigation, Valukas was the Chairman of Jenner and Block, an international law firm based in Chicago (where he remains in 2018). He was assisted by lawyers from his firm and elsewhere, and by the accounting firm of Duff and Phelps. Valukas’s team had subpoena power, and they gained access to Lehman Brothers’ records and computer systems, received documents from other financial institutions and the Fed, and interviewed more than 250 people. In March 2010, Valukas published a report of more than 2,000 pages, 8,000 footnotes, and 24 appendices.

The Valukas Report is available at jenner.com/lehman. In the online report, the footnotes include hyperlinks to most of the documents that are cited, including numerous emails, memos, and PowerPoint presentations from Lehman executives and Fed officials.

The Investigation of the Financial Crisis Inquiry Commission (FCIC) (2009–2011)

In May 2009, Congress established the FCIC to investigate the causes of the financial crisis and policymakers’ responses to it. Like Valukas, the FCIC had subpoena power, and its staff gathered numerous emails and other documents related to the Lehman failure and interviewed scores of people. The Commission also held public hearings at which key actors in the Lehman crisis testified under oath. The FCIC issued its final report in January 2011.

Stanford Law School maintains a website, fcic.law.stanford.edu, with the FCIC report and the documents it cites. The FCIC website also includes transcripts of the Commission’s hearings and records of staff interviews, mostly in the form of audio recordings. Additional FCIC records are held at the National Archives.

For this book, the most important FCIC documents include testimony at a 2010 hearing by two people: Ben Bernanke and Thomas Baxter, the General Counsel of the New York Fed. Commissioners questioned Bernanke and Baxter aggressively, challenged their statements about the Lehman episode, and sent follow-up questions that Bernanke and Baxter answered in writing. These exchanges produced the most detailed defenses of Fed actions that are available.

The FCIC’s final report expresses some skepticism about the claim that rescuing Lehman would have been illegal. The report notes that Bernanke initially gave a different reason for inaction (“the market was prepared for the [bankruptcy]”), and it then says:⁵

In addition, though the Federal Reserve subsequently asserted that it did not have the legal ability to save Lehman because the firm did not have sufficient collateral to secure a loan from the Fed under Section 13(3), the authority to lend under that provision is very broad.

Reports on LBI and LBIE

When LBHI entered bankruptcy, LBIE, Lehman’s broker-dealer subsidiary in London, entered a separate process of “administration,” a British version of bankruptcy. LBI, the New York broker-dealer, stayed in business for several days with Fed assistance, and part of it was sold to Barclays. On September 19, however, the rest of LBI entered a Securities Investor Protection Act (SIPA) liquidation, yet another version of bankruptcy for US broker-dealers. Like the LBHI bankruptcy case, the LBIE administration and LBI liquidation are ongoing in 2018.

Both of these processes have produced reports roughly analogous to the Valukas Report on LBHI. The Joint Administrators of LBIE issued a Progress Report in 2009, and the LBI Trustee (James Giddens) has issued two reports: a Preliminary Investigation Report in 2010 and a Preliminary Realization Report in 2015. Each of these three reports contains significant details about the Lehman episode that are not available elsewhere.

Reports on AIG

Two authorities issued reports on the AIG crisis: the Special Inspector General for the Troubled Asset Relief Program (TARP), and the Congressional Oversight Panel for TARP. Each of these reports describes Federal Reserve actions to assist AIG, as well government aid through TARP. This material is helpful when comparing the Fed’s policies toward AIG and Lehman.

Lehman’s Financial Statements

LBHI’s annual and quarterly filings with the Securities and Exchange Commission (SEC), forms 10-K and 10-Q, include extensive information about the firm’s finances. The last of these reports is the 10-Q for the second quarter of 2008, which ended on May 31 under Lehman’s accounting calendar. Just before its bankruptcy, the firm issued a press release with preliminary results for the third quarter, ending August 31.

It appears that Lehman reported inflated values for some of its assets. Nonetheless, we can construct a credible balance sheet for the firm by combining its statements with outside estimates of overvaluation.

Federal Reserve Records

The websites of the Board of Governors and the New York Fed contain many relevant items. A section of the Board’s site called “Credit and Liquidity Programs and the Balance Sheet” describes the Fed’s responses to the financial crisis in detail. Other relevant material includes speeches and Congressional testimony by Fed officials; transcripts of Federal Open Market Committee (FOMC) meetings during 2008; and the balance sheets of the Maiden Lane LLCs which bought illiquid assets from Bear Stearns and AIG.

The website of Bloomberg News contains daily data on Fed lending during the crisis, broken down by borrower. Bloomberg requested these data from the Board under the Freedom of Information Act (FOIA); the Board declined the request, but Bloomberg litigated the matter successfully and obtained the data in 2011. Reporters from Bloomberg and the Financial Times have analyzed these data, and I draw on their work.

Popular Books

Of the many books on the financial crisis, the most informative for my purposes is Too Big to Fail, by New York Times reporter Andrew Ross Sorkin (2009). This book includes a rich narrative of the Lehman crisis, focusing on the interactions among policymakers, Lehman executives, and others involved in the episode. Sorkin’s account provides information about policymakers’ deliberations and decisions that is not available elsewhere.

An important qualification is that Too Big to Fail is based primarily on interviews with anonymous sources. It is therefore less authoritative than the carefully documented reports of the Lehman Examiner (Valukas) and the FCIC. On the other hand, many of Sorkin’s accounts are corroborated by other sources, and I do not know of any allegations of major inaccuracies.

My research also draws on David Wessel’s account of the crisis, In Fed We Trust (2009), and on the memoirs of Henry Paulson (On the Brink, 2010), Timothy Geithner (Stress Test, 2014), and Ben Bernanke (The Courage to Act, 2015).

Interviews

I sought interviews with people involved in the Lehman episode, with moderate success. I talked off the record to half a dozen people with direct knowledge of events surrounding the bankruptcy or the investigations that followed. These interviews have helped me understand the Lehman episode, but the arguments in this book do not rely on specific information from the interviews. All facts and opinions that I relate come from publicly available sources.

Even with the voluminous records that are available, some aspects of the Lehman episode remain hazy. At times, I had to interpret fragmentary evidence and try to reconcile conflicting statements by different people. Nonetheless, the overall record shows clearly that a Federal Reserve rescue of Lehman would have been legal and feasible.