The Lehman Collapse -- One Year Later

Sep 15, 2009 | Budgets & Projections

This week marks the one year anniversary of the Lehman Brothers collapse, an event that both seriously destabilized and ominously ruptured the U.S. and global financial system. Beginning in 2007, losses in mortgage markets weakened the balance sheets of large banking institutions.

In an effort to maintain their capital ratios (the percent of a bank’s capital to its risk-weighted assets), these banks reduced their lending and liquidity support for the economy. Given the financial system’s interconnectedness, problems at individual institutions severely reduced confidence in the system as a whole.

Officials within the Bush administration and the Fed allowed Lehman Brothers to fail but decided to rescue AIG a day later, and Bear Sterns, Citigroup, and Bank of America not long after that.

In order to avert a collapse of the financial sector, in the weeks and months following the Lehman collapse, the Bush administration, the Obama administration, the Fed, and Congress have established several unprecedented programs to restore confidence in the financial system. Here is a list of the most notable programs and actions:

  • The Federal Reserve reduced interest rates from over 5% to a target range between 0-0.25%
  • The Fed also more than doubled the size of its balance sheet by provided new types of loans and credit facilities while engaging in credit swaps, equity and debt purchases, purchases of mortgage-backed securities, and rescues of major financial institutions (see the Fiscal Roadmap Project's paper The Extraordinary Actions Taken by the Federal Reserve)
  • The Bush Administration and Congress created the Troubled Asset Relief Program (TARP), which the Obama Administration has built upon. So far, TARP has injected well over $400 billion (although some has been paid back) into hundreds of banks, as well as insurance company AIG, car companies Chrysler and General Motors, and struggling homeowners.
  • The Fed, FDIC, Department of Treasury, and others have entered into over $2 trillion in guarantees, including of bank assets (Bank of America and Citigroup), student loans, and medium-term bank debt (as with the FDIC's Temporary Liquidity Guarantee Program.

 

Overall, the general consensus has been that the extraordinary actions taken by the Fed and government have averted financial catastrophe. Yet, this has come at the cost of enormous government commitment to the financial system.

For in-depth information on the costs and history of Fed liquidity programs, TARP funds, and other government guarantees of the financial sector, visit our own Stimulus.org. There you can browse and search through the many government actions taken to alleviate this crisis -- including by clicking on an item for more information or clicking the green arrow next to them in order to "drill down" into sub-categories and actions.