Anyone attempting to understand the legacy of Lehman Brothers could start with two phrases that bookend the biggest bankruptcy in American history. The most famous is "too big to fail." The most important is "quantitative easing."
During the decade since Lehman collapsed, TBTF appeared in 2,241 articles on the Bloomberg terminal and became the title of a bestseller and a movie. QE shows up in more than twice that number of news articles. The lopsided difference helps explain lessons from Lehman's demise.
Before Sept. 15, 2008, when the 158-year-old firm filed for Chapter 11 and thereby precipitated the deepest economic deterioration since the Second World War, few believed that the authorities would allow a behemoth like Lehman to trigger other insolvencies and shutter much of the global financial system. The stock market lost almost $10 trillion within a few months because too many people couldn't imagine the contagion of toxic debt poisoning investors on several continents. When the fourth-largest investment bank after Goldman Sachs & Co., Morgan Stanley and Merrill Lynch & Co. did go under, credit evaporated and there was nothing preventing its larger peers from descending to a similar fate.
That's when the Federal Reserve Bank of New York, acting as the agent for the U.S. Treasury, initiated its unprecedented and most controversial monetary policy during the final quarter of that year. Its quantitative easing program involving the monthly purchase of immense piles of bonds not only reversed the largest-ever plunge in U.S. gross domestic product, it also sowed the seeds of the ensuing 105-month expansion that has all the signs of becoming the longest in U.S. history. The immediate result was interest rates and inflation well below their combined level preceding every downturn since 1955. American companies, measured by their debt ratios, became the healthiest since such data was compiled by Bloomberg in 1995.
For the first time since it was founded in 1913, the Fed acquired all kinds of financial assets that were frozen after the Lehman default. It kept overnight borrowing costs at zero and allowed Goldman Sachs and Morgan Stanley to become commercial banks benefiting from such liquidity. This coincided with government interventions to prop up Bank of America and Citibank, insurer AIG, mortgage originators Fannie Mae and Freddie Mac, General Motors, and Chrysler. And it finally discouraged Wall Street from taking ever-increasing risks with the money of shareholders and depositors.
QE was accompanied by "stress tests" for U.S. financial institutions in 2009 that were conceived by Treasury Secretary Timothy Geithner, a former New York Fed president. They showed how much capital the 19 largest banks needed to survive another Lehman-style debacle.
The Fed ended QE in 2014, increased interest rates seven times since 2015 and last year began reducing its $4 trillion balance sheet as debt acquired during the bond-buying program matured. The Fed's preferred measure of inflation, the Personal Consumption Expenditures Core Price Index, now sits at an annualized rate of 1.98 percent. At the same time, the big and small companies included in the Russell 3000 index saw their net debt to Ebitda ratio — or total debt minus cash divided by earnings before interest, taxes, depreciation and amortization — diminished to the lowest on record in 2015. It remains 2.2 percentage points below the Russell 3000 debt ratio of 2000.
It's doubtful that the economy's robust health would have occurred without QE. But the academics, billionaires and politicians who denounced the policy as ruinous in a public letter with 23 signatures in 2010 still haven't acknowledged QE's role in the recovery and subsequent prosperity. The group, led by Stanford University Prof. John Taylor, billionaire hedge fund manager Paul Singer and U.S. House Speaker John Boehner, predicted that the monetary stimulus would provoke runaway inflation, damage the dollar's special role as the world's reserve currency and send bond prices plummeting. They were wrong.
