Bernanke gives insights into Lehman failure

US Federal Reserve chairman Ben Bernanke has provided some answers to a question many have been asking: why was Lehman Brothers allowed to fail where others were saved?

Bernanke, speaking yesterday in New York, explained why big names including Fannie Mae, Freddy Mac and AIG could be saved through government intervention when Lehman Brothers could not.

Bernanke said that in the cases of Lehman and AIG, the US Treasury and the Federal Reserve “sought private sector solutions, but none [were] forthcoming”.

But even a public sector solution for Lehman was “infeasible”, Bernanke said, as the firm couldn’t post sufficient collateral to persuade the Federal Reserve that its loan would be repaid, while the Treasury didn’t have “the authority to absorb billions of dollars of expected losses” in the case of Lehman’s acquisition by another firm.

“Consequently, little could be done except to attempt to ameliorate the effects of Lehman’s failure on the financial system,” Bernanke said.

In the case of AIG, however, the Federal Reserve and the Treasury “judged that a disorderly failure would have severely threatened global financial stability and the performance of the US economy”. It also determined that the emergency credit given to AIG would be secured by the group’s assets.

Bernanke said the Federal Reserve believes that, “whenever possible, the difficulties experienced by firms in financial distress should be addressed through private-sector arrangements”.

“Government assistance should be provided with the greatest reluctance and only when the stability of the financial system, and thus the health of the broader economy, is at risk,” Bernanke said.

But when this is the case, intervention must be undertaken forcefully and without hesitation, Bernanke said.

The chairman said the new financial rescue legislation would give the Treasury better choice and resources to prevent the failure of a financial institution if need be.

On the US economy, Bernanke said “much work remains”.

“Stabilisation of the financial markets is a critical first step, but even if they stabilise as we hope they will, broader economic recovery will not happen right away.”

Bernanke said weakness in the housing market, slowdowns in consumer spending, business investment, and the labour market were of concern. He said credit markets “will take some time to unfreeze”, while US export sales “very probably will slow as well”.

Bernanke did, however, note the favourable effects of lower prices for oil and other commodities on household purchasing power, and the potential for lower interest rates.

He said although “more difficulties surely lie ahead”, he remains confident in the future of the American economy and its ability to emerge from this crisis with “renewed vigour”.