The Advantage of Failing First: Bear Stearns v. Lehman Brothers
Kensil E. Sean
Journal of Applied Finance, Fall/Winter 2012, Volume 22, No.2
The collapse of the housing market coupled with the largest government intervention in the economy in US history led to a radical reorganization of the investment banking industry in 2008 culminating in the failure of two major US investment banks: Lehman Brothers and Bear Stearns. This paper examines why Lehman Brothers was forced into bankruptcy, while Bear Stearns received a government bailout. An analysis of market factors and the financial strength of these two firms and their peer group demonstrates that the problems these banks faced were shared throughout the industry, despite the different fates of the five major standalone investment banks. This paper finds the different treatments of Lehman compared to Bear Stearns by both the government and capital markets were not justified given the financial conditions of the companies. Both investment banks were very similar in terms of financial strength, and Bear Stearns was arguably in worse condition. The US government made efforts to broker a solution on behalf of Lehman Brothers, but ultimately chose to allow the firm to fail in order to prevent the spread of moral hazard. Thus, Lehman’s failure was caused more by unfortunate timing and the government’s desire to discourage moral hazard than by its financial characteristics. Ultimately, it seems Lehman’s failure cannot be entirely explained by the firm’s own assets or poor decisions, but rather Bear Stearns’ advantage of being the first to fail and the government’s subsequent decision to prevent the spread of moral hazard.
Keywords: radical reorganization, Lehman Brothers and Bear Stearns, bankruptcyAccepted Paper Series
Date posted: September 11, 2012
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