How could the US government let Lehman Brothers fail? Few questions have been discussed as often in recent economic history, with as much fervor or bewilderment. Following the collapse of the investment bank on 15 September 2008, the financial crisis that had built up for more than a year rippled through the global economy with breathtaking speed, destroying $700 billion in value from retirement plans, government pension funds, and other investment portfolios in just one day, and over $11 trillion during the duration of the entire crisis.¹ Banks everywhere found themselves in great difficulties as liquidity dried up completely, and...

The decision to bail out banks is difficult for all governments. At no time was this more evident than the weeks in September and October 2008, when politicians and central bankers in most industrialized countries tried to avoid the collapse of their banking systems after the fall of Lehman Brothers on September 15. The simultaneity of the responses makes bailouts a fascinating study for crisis management in different political and economic contexts. This chapter begins with a brief history of the crisis until its zenith in September 2008, when international financial markets were effectively frozen. It then present an overview...

Despite many disturbing details about the financial elite’s shortcomings, misjudgments, and pure arrogance, financial institutions were bailed out with taxpayer money in all affected countries. In some cases, these decisions brought the entire country to its knees. How could financial institutions be given so much money when everybody agreed that the difficulties were of their own making?

Scholars and popular press alike quickly proposed a simple answer: it is because of the power of the financial industry. This does not get us very far. Arguing that bailouts were granted because the financial industry is powerful, in general, is obvious and...

To bail out or not to bail out? The fundamental question troubling policymakers seems to be this choice between government support for failing financial institutions or the refusal to intervene. An extensive literature in economics theorizes the disadvantages of government support, most importantly by demonstrating that the possibility of future bailouts leads banks to behave in a less cautious manner. Known as “moral hazard,” this problem is at the heart of policy debates about bailouts, and proponents prescribe no intervention in order to maintain stability through market discipline.

More recently, an alternative perspective has called attention to the increasing complexity...

Wall Street and the City of London are arguably the two most important global financial centers and both the United States and the United Kingdom pride themselves on being liberal markets where government policy supports capital market finance. To those concerned about the undue power of the traditional banking elite, the capital market systems in the two Anglo-Saxon countries were considered the ideal to strive for, since competition supposedly replaced the importance of insider networks.¹

Historically, the financial markets in both countries developed early and without direct government support or ownership. As a result, the banking sector was traditionally fragmented...

Did things happen differently in continental Europe, where stakeholders have a tradition of economic coordination? Certainly, many aspects in the political and economic organization of the financial systems of France and Germany are comparable. To begin with, both continental European countries are often cited as a prime example of the universal-banking model, in which financial institutions combine retail and investment banking, as well as insurance activities. Both have a high degree of bank intermediation, in particular compared to the United States and the United Kingdom. Moreover, both have a long tradition of government intervention, even though the German state remained...

The final analysis pairs two small European countries with substantial financial development, a homegrown housing market bubble, and a great dependence on international wholesale markets for bank funding. Ireland and Denmark were among the first European countries to announce that the government would step up to support the banking sector, issuing a public guarantee on all deposits on 30 September and 5 October respectively, as the panic swept over the two open economies. Both Ireland and Denmark were outliers in Europe by guaranteeing existing unsecured bank bond debt as well.

While the fate of Ireland has garnered much attention, little...

The banking crisis of 2008 took even the best-prepared governments by surprise. In weekend meetings and overnight sessions around the world, public officials and financial industry representatives tried to find the most appropriate responses to an evolving set of problems. Evaluating the precise consequences of individual decisions, policy choices, and rescue arrangements will consume the time of economists, historians, and policy analysts for years to come. This study seeks to contribute to the debate by focusing on the nature of business-government relationships in a variety of countries. In particular, it has demonstrated that the participation of the financial industry in...