Why Some Investment Banks Are Allowed to Fail While Others Are Bailed Out

The answer to this question is often rooted in political motivations, rather than a clear-cut, straightforward answer. Knowing the right questions is more important than having the right answers. In this analysis, we will explore why some investment banks are allowed to fail while others are bailed out, with a specific focus on the cases of Lehman Brothers and other banks during the 2008 financial crisis.

The Case of Lehman Brothers

One of the most notable examples is the failure of Lehman Brothers, which occurred in 2008. This case is particularly interesting because it was allowed to fail, while other banks like Bank of America (BOA) were bailed out, despite both being large institutions.

The Emergency Economic Stabilization Act of 2008 provided a framework for the government to support banks in times of crisis. However, the decision to allow Lehman Brothers to fail was a complex one. Lehman's exposure to Collateralized Debt Obligations (CDOs) was so significant that no buyers could be found, which made it impossible for the bank to be saved by a conventional merger or acquisition. The Fed and the government even tried to rescue Lehman Brothers, but the scale of the problem was simply too immense, and no buyer was found to take over Lehman Brothers as a whole.

Factors Behind the Decision to Bail Out or Allow Failure

Several factors explain why some banks were allowed to fail while others were bailed out:

Size Effect

One of the most significant factors is the size of the bank. Banks that are too big to fail, like those mentioned, are often bailed out by the government to prevent a systemic risk to the economy. If a large bank such as Lehman Brothers were to fail, it could lead to a domino effect, causing widespread financial instability and even a depression. Conversely, smaller banks are often allowed to fail because their failure would not have as significant an impact on the economy.

Timing Effect

Another factor is the timing of the decision to bail out or allow a bank to fail. If a bank is in trouble just when potential buyers still have cash or stock to buy the bank, it is more likely to be rescued. In Lehman's case, the timing was critical. When the financial crisis hit, many potential buyers were already occupied with other issues, making it impossible to find a buyer for Lehman Brothers.

People Effect

The quality and influence of the management of a bank can also play a role. Companies with better management and stronger negotiating skills may be more likely to receive government aid. In Lehman's case, the management might have been less effective in negotiating for a bailout, whereas other banks had better management that could leverage political and market influence more effectively.

Simple Luck

Finally, luck plays a role. In the chaotic environment of the 2008 financial crisis, many factors beyond the control of individual banks influenced the outcome. Some banks simply got unlucky in a high-stakes game.

The Political Motivation Behind Bank Rescues and Failures

While the government does not pick favorites, the financial industry wields significant political power and can sway decisions to its advantage. The motivations behind rescuing or allowing the failure of banks reflect the relative power at the time. Take, for example, the fates of Bear Stearns, Lehman Brothers, and Bank of America (BOA). Bear Stearns was bought out by JPMorgan Chase, while Lehman Brothers was allowed to fail, and Bank of America acquired Merrill Lynch. These outcomes were not arbitrary but were influenced by the political and economic landscape.

Goldman Sachs, on the other hand, navigated the crisis with a skilled team that capitalised on political and market opportunities. This highlights the hypocrisy that often surrounds the bailouts, as principles and rules are often bent to suit those with the greatest political influence.

To understand what's happening in the government today, one must study the power dynamics and the influence of different players. What happened with Lehman Brothers, Bear Stearns, and the others was not an anomaly but a reflection of the power struggles within the financial industry and the government.

In conclusion, while the reasons for allowing some investment banks to fail and bailing out others are multifaceted, political motivations and the relative influence of the banks and the financial industry play a significant role. Knowing this is crucial for understanding the complexities of financial crises and the bailouts that follow.