The Fed’s Mysterious $87 Billion Loan To Lehman


Andrew Ross Sorkin’s column today examines the peculiar loan that the Federal Reserve made to Lehman Brothers after it went into bankruptcy. Why did the Fed and the Treasury insist they couldn’t rescue Lehman and then turn around and make a giant loan?


In the early hours of Sept. 15, after the government refused to rescue the foundering Lehman Brothers, something odd happened. The Federal Reserve lent tens of billions of dollars to a subsidiary of the newly bankrupt bank.

In other words, government officials who had refused to risk taxpayers’ money on Lehman before it collapsed did just that after it collapsed.

On Monday the Fed lent the Lehman unit $87 billion through JPMorgan Chase. After being repaid on Tuesday, it lent another $51 billion — putting the bailout, arguably, in the same league as the initial $85 billion bailout for the American International Group.

This mystery loan is just one piece of the larger Lehman puzzle. Who lost Lehman? Why, and how? Three months later, those questions still nag.

This seems much less surprising to us than it does to Sorkin. Prior to the authorization of the TARP funds by Congress, it seems likely that the Federal Reserve and the Treasury actually did believe they lacked the authorization to make anything but temporary loans against good collateral. If the government believed Lehman’s assets were so bad and its liabilities so large that it could not reasonably expect a return on money lent to Lehman, the refusal to rescue the bank makes sense.

So how could the Fed justify the loan after bankruptcy but not before? Look at it as a debtor-in-possession loan. It seems the government honestly believed, way back in September, that there was genuine value to allowing failed businesses to collapse. This is, for instance, what economic historian Anna Schwartz recommends. But after the firm had entered bankruptcy, it made sense to ameliorate the ripple effects by providing enough liquidity to allow an orderly wind down.

Just because the government seems to have abandoned this view doesn’t mean it wasn’t correct.