Bear vs. Lehman

by Russ Roberts on March 9, 2011

in Financial Markets, The Crisis

I’m reading Diane Coyle’s The Economics of Enough, preparing to interview her for EconTalk. She is of the persuasion (and she is in populous company) that the world was on the brink of a financial apocalypse in 2008 when Lehman Brothers went bankrupt, interest rates spiked, money markets shuddered and so on.

I believe that one of the central questions of the crisis will be whether this narrative is true. Was the decision not to rescue Lehman the precipitating cause of the crisis? Or was it the decision months before to rescue the creditors of Bear Stearns via the marriage to JP Morgan Chase?

I have argued that the Bear Stearns decision encouraged other firms with similar balance sheets (Lehman for example) to assume that they too would be rescued. This allowed them to continue to borrow. It also encouraged lenders (including money market funds, incredibly) to continue to finance Lehman.

Vincent Reinhart also argues for the importance of the Bear Stearns decision. (HT: Arnold Kling at EconLog). Reinhart points out that the expectation of creditor rescue encouraged speculators to short Lehman’s stock and load up on Lehman debt. I have also observed that in the bankruptcy filing of Lehman, most of its largest creditors were Japanese banks with limited political pull. I’d love to know if this is accurate and if Bear was different. There is more of these stories to be told.

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