Hank Paulson killed Lehman, says Laurence Ball in a new NBER forensics paper.
This paper seeks to set the record straight on why the Fed did not rescue Lehman Brothers. I conclude that the explanation offered by Fed officials is incorrect, in two senses: a perceived lack of legal authority was not the reason for the Fed’s inaction; and the Fed did in fact have the authority to rescue Lehman. I base these broad conclusions on the following findings:There is a substantial record of policymakers’ deliberations before the bankruptcy, and it contains no evidence that they examined the adequacy of Lehman’s collateral, or that legal barriers deterred them from assisting the firm.
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 do not appear to be accurate.
From a de novo examination of Lehman’s finances, it is clear that the firm had ample collateral for a loan to meet its liquidity needs. Such a loan could have prevented a disorderly 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 rescued it from its liquidity crisis. Lehman might have survived indefinitely as an independent firm; it might have been acquired by another institution; or eventually it might have been forced to wind down its business. Any of these outcomes, however, would likely have been less disruptive to the financial system than the bankruptcy that actually occurred.
If legal constraints do not explain the non-rescue of 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.