Tomorrow is the tenth anniversary of Lehman Brothers going bust.
All this week we've been looking at various aspects of the crisis primarily the legacy of the crash, and whether anything has changed.
Today, as the series draws to a close, I want to take a look at exactly why Lehman itself went under.
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Should it have been saved? Could it have been saved? Would things have been any different if it had?
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For the impatient, I'll give you the TL;DR (too long; didn't read) on those questions right now no; not in that political atmosphere; no.
Here's why.
By the time Lehman went bust, the dominoes were already tumbling
By the time Lehman Brothers went bust, it was squarely in the market's sights. Throughout 2007, mortgage lenders across the US had been going bust as the housing bubble deflated. HSBC issued a massive subprime-related shock profit warning near the start of the year.
By the middle of the year, the "credit crunch" had started in earnest. French bank BNP Paribas warned in August that it had shuttered three funds due to "the complete evaporation of liquidity in certain segments of the US securitisation market".
In other words, the money gusher was drying up as trust dried up. Banks were growing unwilling to lend to each other for any period of time, because they didn't know if they'd get the money back.
The following month, Northern Rock had to be bailed out by the Bank of England. Not because the UK housing market was turning bad (though it was) or even because it had lent out money carelessly (though it had remember the 125% mortgage?).
The real problem was that Northern Rock was totally dependent on a constant supply of funding from global money markets. And that's where the real bank run had already started funding was drying up entirely, and Northern Rock was one of the first casualties.
Perhaps a better way to look at it is as a global "margin call". Everyone had loaned money to everyone else, but suddenly the collateral staked against those loans was looking shaky. So everyone was demanding their money back or that better quality collateral be staked.
To be clear, this does not excuse any of the people who ran these banks. Nor does it give any validity to people who try to claim that the 2008 crisis was a panic that came out of the blue, or due to an irrational downturn in "animal spirits".
A basic point of risk management (as any inexperienced spread better rapidly learns) is to avoid getting into a situation where your entire portfolio can be destroyed by a small position turning against you in a big way.
In other words, while banking is inherently vulnerable to runs (if everyone took their money out at the same time, the bank wouldn't have enough to pay it all back, which we are all well aware of), the point is to manage that risk so that you won't get wiped out at the slightest sign of turbulence.
Anyway the next victim of the global margin call was Bear Stearns. It was one of the "also-ran" investment banks and had tried to boost its position by embracing the mortgage-backed securities boom wholeheartedly. As a result, it was seen as the worst potential credit risk of the US investment banks, and so was frozen out of money markets first.
It had to be bailed out in March 2008, although in the case of Bear Stearns, it was bought over by JP Morgan Chase in a deal that was backed by $29bn of US taxpayer money.
And of course, as things continued to get worse, trust evaporated all the more rapidly, until it was getting hard for even "good" banks and financial players to raise funds. In effect, the only collateral that was seen as good enough to lend against, was US government debt and debt explicitly backed by the US government.
And everyone knew, after Bear Stearns, which bank was next in the firing line: Lehman Brothers.
The collapse of Lehman Brothers
The value of Lehman shares had already collapsed by more than 70% by the time September 2008 came around. People knew that the bank was hideously exposed to the subprime debacle and it really was just a matter of time before push came to shove.
By the time of the bust, Lehman effectively had more than $30 of exposure to the US property market for every $1 it had on its balance sheet. In other words, it would take a drop of less than 4% in the value of its assets to put it in negative equity in other words, to be insolvent.
Lehman was not only massively exposed to the market, but had also been using a questionable (to put it incredibly forgivingly) accounting convention called "Repo 105" to make its balance sheet look healthier than it really was.
In short, this was a badly run bank and it thoroughly deserved to go bust, regardless of all the revisionism going on today, ten years later (which, of course, is what happens when you decide to "bail out now, ask questions later" and then don't get round to asking the questions).
The only surprise for markets was that the Federal Reserve allowed Lehman to go to the wall. The assumption after Bear Stearns was that this wouldn't happen. However, it wasn't for want of trying. At one point, the Fed even tried to dump Lehman on Barclays, but (as Adam Tooze points out in his recent book "Crashed") the UK government basically told them no, because they wondered just how toxic it had to be that no US bank would touch it.
There's no question in my mind that, had the Fed realised the consequences of letting Lehman go bust, it would have tried harder to act. But at that point, the US Treasury under Hank Paulson had run out of political capital.
(Yes, believe it or not, there were still some politicians who thought that bailing out banks was not really fair, or a good example of free markets in action they've had that idealism kicked out of them by now, of course.)
To be clear, I still think it was ultimately right that Lehman was allowed to go bust. Would things have been different if it had been bailed out? I suspect not. At some point, push would have come to shove another bank would have been deemed too big or too toxic to save, and then we'd have ended up in the same place, just by a slightly different route.
As financial blogger and wealth manager Barry Ritholtz put it back in 2016, "Lehman Brothers did not "precipitate" the financial crisis. The better metaphor is that Lehman was the first trailer in the park to be destroyed by the tornado."
