To hear Hank Paulson tell the story, the collapse of Lehman Brothers was partly do to the fact that the UK financial authorities stepped in to block a rescue bid by Barclays. Paulson has said that during a transatlantic phone call UK chancellor Alistair Darling said he didn’t want to import the American “cancer” into Britain.
The Guardian is now reporting that all three important UK financial authorities—the Treasury, the Bank of England and the Financial Services Authority—believed that the US government would step in with a financial backstop for Lehman. The belief seems reasonable enough—the US had been stepping in to support Fannie Mae, Freddie Mac and Bear Stearns.
What they didn’t realise was that US regulators had concluded that they lacked the legal authority to back the insolvent Lehman and that the serial bailouts were endangering the health of the markets.
Some of this looks like a big game of chicken. The UK authorities seem to have believed that when push came to shove, the US would back Lehman. They were wrong.
The UK authorities may now regret their decision. Even without a pre-bankruptcy acquisition of Lehman by Barclays, the “cancer” was imported into the UK. During the week after Lehman failed, HBOS had to berescued by Lloyds TSB. A month later RBS, HBOS and Lloyds were propped up with an unprecedented £37bn of taxpayer funds.
“Without the future market shock created by Lehman Brothers’ collapse, RBS may not have failed,” says Hector Sants, the chief executive of the Financial Services Authority.
It seems that the UK authorities are convinced that the failure of the US to rescue Lehman Brothers set off a tidal wave of financial trouble. If so, they bear some responsibility for that tidal wave.
Fortunately, that’s probably not the case. The evidence indicates that it is far more likely that rather than the bankruptcy causing the events that followed, the collapse of Lehman Brothers was both a sign that the financial system had already frozen up and a signal to the markets that many of our huge financial institutions were on the brink of insolvency. A rescue probably wouldn’t have concealed this reality—and to the extent it did, it may have made the eventual reckoning even worse.