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Lehman – lemon: “too connected to fail” as a policy construct

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The consequences of banks and other financial firms being regarded as being “too connected to fail” (TCTF) and of bailing out their senior bondholders include austerity, political dissent and a deepening of moral hazard – bondholders are effectively invited to back further risk-taking at public expense. The commonly given justification for bailouts is not simply that the insolvency of Lehman Brothers had negative consequences but that those consequences exceed those of bailouts of other firms, such as Bear Stearns and AIG. This paper argues that such a policy stance is, in Akerlof's terms, a “lemon”: unverifiable, disputable and having undesirable consequences. Systemic consequences of bailouts and insolvencies differ little; however, the costs fall differently on public and private actors. The progressive decline of the market throughout 2008 was a response to the continuously emerging bad news about the condition of the financial system, as one bailout followed another. When there arose political resistance within the US Congress to their continuation, Lehman's surprise insolvency offered to the administration an opportunity to engage in hyperbolic commentary, stampeding Congress into authorising more public funding. The possibilities for overcoming TCTF beliefs are critically explored, with reference to the Volcker Rule, the Vickers Report and Special Resolution Regimes.

Document Type: Research Article


Publication date: July 1, 2012

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  • Law and Financial Markets Review is a new, independent, English language journal devoted to providing high quality information, comment and analysis for lawyers specialising in banking and financial market issues and to others with interests in legal and regulatory developments affecting the financial markets. Published bi-monthly LFMR contains articles written by leading experts providing a forum for practical guidance on, as well as reflective and topical analysis of, all major jurisdictions, with a particular focus on the interaction between the law and market practice and behaviour.

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