Treasury Notes

 The Lehman Bankruptcy Seven Years Later

By: Adam Hodge


Seven years ago today, Lehman Brothers filed for bankruptcy. The bankruptcy — the largest in U.S. history — was catastrophic for the firm’s shareholders, creditors, counterparties, and employees. But what made this bankruptcy different — the reason that we mark its seventh anniversary — is how extremely disorderly and destructive it was, sending shockwaves around the world’s financial markets, driving other financial firms to within inches of collapse, and plunging the economy into the Great Recession, which hurt millions of people and businesses.

Lehman was not an isolated incident. That autumn, a number of other entities failed, received hundreds of billions of dollars of extraordinary government support, or were placed into receivership, including AIG, the Reserve Primary money market mutual fund, Wachovia, and Washington Mutual. All told, economists estimate that the 2008 financial crisis cost our country trillions of dollars in lost economic output.

To help prevent a repeat of 2008, President Obama signed the Dodd-Frank Wall Street Reform and Consumer Protection Act into law. The historic reforms took unprecedented steps to enhance financial stability, increase market transparency, improve market functioning, and protect consumers. As a result, today our financial system is safer, stronger, and more resilient, and our economy is growing and creating jobs at a rapid pace.

And yet, five years after these historic reforms were put into place, some in Congress and on Wall Street continue to fight to tear apart the very protections lawmakers fought to put in place to plug the holes in our system that Lehman and other firms exposed. For example, Wall Street Reform subjects the largest bank holding companies to higher capital and liquidity requirements, stress testing, and resolution planning. One bill being considered would limit this oversight to just six firms. However, seven years ago we saw how interbank lending markets — one barometer of financial stability — deteriorated even more in the days surrounding the failure of Washington Mutual, a firm that was not one of the largest, than they did in the days following the bankruptcy of Lehman Brothers, a firm more than twice its size.​

The Financial Panic in the Interbank Lending Market

Source: 2011 FSOC Annual Report

Other bills currently being considered in Congress would hamstring regulators in identifying and responding to risks to financial stability and would allow large, complex financial firms to avoid appropriate supervision designed to protect the financial system. For example, Wall Street Reform created the Financial Stability Oversight Council (FSOC) to bring state and federal financial regulators together, face-to-face, to ask tough questions, close oversight gaps, and respond to emerging threats to financial stability, wherever they may arise. One of the FSOC’s responsibilities is to designate individual nonbank financial companies, like Lehman, for supervision by the Federal Reserve. But now Congress is considering burdensome new requirements that would tie the FSOC in knots and tip the scales in favor of Wall Street, including potentially preventing the FSOC from acting to address threats for up to four years after identifying a risk. The lesson of September 2008 is that we must be able to identify risks as they emerge, take timely action to address threats to the financial system, and impose appropriate supervision on all firms that pose risks.

On this seventh anniversary, it would be unwise to turn our backs on the progress we have made. After all, a safer financial system and a strong economy go hand in hand  unemployment is down to 5.1 percent, lending is up, and businesses have added over 13 million jobs over 66 straight months, the longest streak on record. Secretary Lew has made it clear that he would recommend that President Obama veto any legislation that would leave the American people more vulnerable to another crippling crisis. We cannot allow the opponents of reform to eliminate the safeguards Congress created just five years ago to help prevent the next financial crisis — either by reducing funding for our regulators, hindering the FSOC’s ability to prevent another large financial company from threatening the whole system, or by reducing capital, liquidity, stress testing, and living will requirements for the nation’s largest banking organizations.

Adam Hodge is the Deputy Assistant Secretary of Public Affairs at the U.S. Department of Treasury. 

Posted in:  Financial Reform
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