≡ Menu


I hope I find the time to comment more fully on this recent column in the WaPo by Robert Samuelson defending the Fed. But for now, let me pull out one paragraph:

After Lehman Brothers’ failure in September 2008, American credit markets began shutting down. Banks wouldn’t lend to banks. Investors balked at buying commercial paper — a type of short-term loan — and many “securitized” bonds. Fearing they’d lose credit, businesses dramatically cut spending. Layoffs exploded: 6.3 million jobs vanished between that September and June 2009. Firms canceled investment projects in plants and equipment. In the first quarter of 2009, business investment spending fell at a 31 percent annual rate.

This is a common view–that Lehman’s collapse and the failure of the policymakers to rescue Lehman precipitated the crisis. It could be true but the evidence is quite cloudy. The claim also ignores the possibility that it once the Fed had rescued the creditors of Bear Stearns in March of 2008, lenders to Lehman (such as Reserve Primary–a money market fund!) figured they were safe. It was the unexpectedness of the government actually letting creditors lose money that caused the dislocations, not the failure of Lehman, per se.

There’s a problem with Samuelson’s version of the standard narrative. He writes:

Investors balked at buying commercial paper — a type of short-term loan — and many “securitized” bonds. Fearing they’d lose credit, businesses dramatically cut spending. Layoffs exploded: 6.3 million jobs vanished between that September and June 2009.

Well, yes. There was a lot of uncertainty about the solvency of banks and the value of their assets. There was a lot of fear of securitized loans. I would argue that both of those were generally a good thing. Banks and investors had been out of control. It was a good idea to pull back from some of the riskier activities. And yes, there were problems with commercial paper and money market funds. But is that why layoffs exploded? The implicit claim is that when the credit market “froze up” companies got scared they’d have trouble getting access to short-term credit and so they began laying off workers in droves.

The problem with this story is that it undermines the claim in the rest of the article and elsewhere that the Fed saved the day. In the weeks following the Lehman bankruptcy, the government was hyperactive. In the next three weeks, AIG was rescued. TARP was passed. Money market funds were guaranteed. And on October 7th, just three weeks after Lehman’s collapse, the Fed said it would buy commercial paper in whatever volume it took to keep that market going. The Washington Post reported:

Using its emergency authority for the third time this year, the Fed will create a special entity that will purchase “commercial paper,” the debt that companies use to fund their inventories, payrolls and other short-term cash needs. The Treasury Department will help fund the program.

Problems in the commercial paper market have been one of the most direct ways in which the financial crisis has threatened to affect the nuts and bolts economy. Banks and financial firms have become hesitant to lend, and companies have worried about raising the money needed to pay their bills.

Today’s radical move by the Fed puts the central bank in the position of funding individual financial institutions and ordinary companies, even with “unsecured” debt, or that which is backed only by the company borrowing money, rather than with specific collateral.

There is no cap on the size of the program, senior Fed staffers said, other than the size of the total universe of eligible commercial paper: $1.3 trillion. Fed officials do not anticipate taking on anywhere near that much debt, but rather are hoping that private buyers of debt will feel newly confident knowing that the central bank is available as a backstop.

So why did 6.3 million jobs disappear between September of 2008 and June of 2009? It can’t be because of Lehman and credit markets freezing up. Firms weren’t laying off workers because of inadequate action in response to the Lehman collapse. The Fed (and the Treasury) were pouring liquidity into the system with a fire hose. The layoffs occurred despite the Fed’s efforts. Maybe most of those 6.3 million lost jobs occurred because of something else, a fear that the world was coming to end, that government was out of control, that we had learned way too much about how lousy were the balance sheets of banks or who knows what. But it wasn’t Lehman.

I’ve been thinking about this after coming across this rather calm article from late in the afternoon of September 15, the day Lehman declared bankruptcy. It’s an attempt to explain why the government didn’t rescue Lehman (and its creditors) and why the government had rescued the creditors of Bear Stearns. I mention how calm the article is because you’d think from the accounts of today, the world went haywire when Lehman went down. The Dow Jones Industrial Average did fall 500 points. But that wasn’t viewed with much alarm by the contemporaneous observers that day:

Barry Ritholtz, CEO of Fusion IQ, said that Bear Stearns’ holdings also posed a greater risk to the nation’s financial institution than did Lehman’s. He said Bear Stearns had $9 trillion worth of financial instruments known as derivatives, much of it shared with other financial institutions such as its eventual buyer, JPMorgan Chase. He said Lehman had about a tenth that much exposure.

“Lehman was only incompetent enough to blow up and destroy themselves, where as Bear’s degree of incompetence was enough to threaten the entire financial system,” Ritholtz said.

There is also a sense that investors, financial regulators and Wall Street firms have a better handle on the problems in the financial markets than they did six months ago. The fact that Bear Stearns took place when there was so much more uncertainty is also a reason the Fed kept it out of bankruptcy then, but didn’t step in to help Lehman now.

“We didn’t know what we didn’t know in March,” said Art Hogan, chief market analyst at Jefferies & Co. “We know much more now.”

No panic. No wild worries. Yes, over the next two weeks, things did go a little crazy. But a lot of things happened in those two weeks other than that it was after the Lehman bankruptcy. Check out this nice Washington Post timeline. Scroll down to September 15 and work your way up. Watch markets see-saw up down up down as new information arrives. Very hard to attribute the downs of that see-saw to Lehman or the failure of government intervention when you read what else was going on.

Of course the ups and downs of the stock market are not the only measure of the health or mood of the economy. Check out John Taylor’s analysis of how interest rates (a measure of the alleged freezing up of credit markets) reacted to the Lehman bankruptcy and the various interventions of the time.

Correlation is not causation. A lot of bad things happened after Lehman failed. But there is little evidence that letting Lehman fail caused those bad things.