On Monday, Laurence Ball, professor of economics at Johns Hopkins University, charged that the United States Federal Reserve was partially responsible for the 2008 bankruptcy for neglecting to bail out the Lehman Brothers. The lecture was in Hutchins Hall to a group of about 30 students.
Lehman was the fourth-largest investment bank in the United States when it declared bankruptcy. A combination of falling stock prices, rating downgrades, increases in credit default swaps premiums on its debt and negative commentary in the media would result in the largest bankruptcy filing in U.S. history.
In his remarks, Ball emphasized that the bankruptcy played a role in the economic recession that began in 2008, saying that despite other large investment firms also failing around the same time, he believes Lehman’s bankruptcy was particularly consequential.
“I think it’s quite possible to likely that the financial crisis would’ve been less severe had Lehman been rescued,” Ball said.
Citing the disruption, he challenged the Federal Reserve's choice not to bail it out, saying the reserve could have kept all of the Lehman Brothers Holdings Inc. in operation for months with well-secured liquidity support.
Instead, he said Federal Reserve officials claimed they did not have the legal authority to lend Lehman the money it needed to survive. The Federal Reserve used Section 13-3 of the Federal Reserve Act, which states Federal Reserve officials cannot take on substantial financial risk, to justify their decision. But Ball said his calculations show they could have prevented Lehman’s bankruptcy with negligible risk, because Lehman had $570 billion of available collateral. Only an $88 billion loan would therefore have been necessary to substantially aid the Lehman firm.
He also charged that they chose not to bailout Lehman because of intense political opposution and a waning hope that the damage could be contained.
“My assessment of the Fed is that a lot of the claims they make are contradicted by evidence,” he said. “Their reasoning would not go over well on an undergraduate banking test.”
Ball also noted that the political attitudes of many citizens in 2008 included a wariness and distrust of Wall Street and large investment corporations.
Some of the students present said they respected the tenacity with which Ball analyzed the numbers behind a potential Lehman rescue. Engineering freshman Aniket Wankhede said he agreed with Ball’s argument.
“He talked more about the inner workings of the Fed with respect to the Lehman crisis,” he said. “And the discussion about the investigation that ensued was very interesting. More than political were the economical implications and everything that happened afterward.”
Shomik Ghosh, a Law School student, said he approached Ball’s speech analytically. While he said he thought Ball’s approach was original and interesting, he also noted that many approaches to the Lehman bankruptcy puzzle exist.
“I think Ball presents a novel hypothesis that this decision may have been far more volitional and consequential than even the Federal Reserve may have known,” Ghosh said. “But in Lehman there was an actor that possibly misrepresented its own holdings and has engaged in really risky financial behavior. I think if he accounted for how Lehman might’ve been a bad actor, a separate angle may be that the feds had concern over whether saving them would’ve perpetuated what you may consider a disease in the system.”