The Federal Reserve and the Decision to Let Lehman Brothers Fail: A challenge to the legal explanation put forth by the Fed, and an exploration into the real reasons for their decision.

Abstract

In the most dramatic moment of the Great Recession, the Federal Reserve (the Fed) withheld an emergency bailout from Lehman Brothers, a peer investment bank among other firms infamously deemed “too big to fail.” In light of Lehman’s banefully consequential bankruptcy, the Fed’s decision remains a most controversial one. Yet Ben Bernanke, former Chairman of the Fed, and other key players maintain that they made the right decision. They submit the argument that there was no alternative to Lehman’s failure because the Fed lacked the legal authority to provide a bailout. The Fed’s account of the Lehman decision is wrought with erroneous economic and legal arguments. To illustrate this, I inspect the language of Section 13(3) of the Federal Reserve Act to determine the Fed’s true legal bandwidth, and Lehman’s balance sheets to assess if the bank really was insolvent. The second dimension of this paper explores the real reasons the Fed chose to let Lehman fail. The Fed made a subjective decision to allow Lehman’s bankruptcy. They had their reasons why, but a legal constraint was not valid reason among them. Instead, it was a combination of legitimate financial constraints and political and social concerns. The conclusion of this investigation goes beyond the fact that the Fed’s otherwise spectacular response to the crisis is tainted by what appears to be deceit; this study lends credence to the idea that, as both accountability and transparency are indispensable for the overall wellbeing of the American economy, there is work to be done.