Sarajevo, Lehman Brothers, and the Panic of 2008

The assassination of Austrian Archduke Franz Ferdinand at
Sarajevo on June 28, 1914, is commonly cited as the “proximate trigger” which
ushered in World War I.  The
resolution of this first Great War led not only to the collapse and fragmentation of the Austro-Hungarian Empire, the Russian Empire, and the Ottoman Empire.  It also sowed the seeds for World War II, and, in redrawing
the map of the Middle East, laid the foundations for the strife that continues to plague
this entire region today.

In my view, financial historians will commonly cite the death
of Lehman Brothers on September 15, 2008
 at the hands of Treasury Secretary Henry
  (with the consent and support of other US financial policy makers), as America’s
Financial Sarajevo.  The death of Lehman will become generally recognized as the “proximate trigger” which led to the financial Panic
of 2008
. Images

Why? In short, the Lehman Brothers bankruptcy brought home
the reality that counterparty risk actually mattered in the murky world of
financial derivatives and the now infamous trade known as a Credit Default Swap
.  The demise of Lehman, in
one fell swoop, changed everything in the opaque world of the CDS, fueling a
cascading contagion of fear between buyers and sellers of all types of
derivative securities. 

Most damaging, the reality of Lehman’s failure brought
global financial markets to a virtual halt by causing banks to fear trading
with each other, essentially draining the oil that lubricates global bank
liquidity.  The second order impact
of Lehman’s failure was to ravage the razor thin balance sheets of CDS
underwriters from AIG on down
, requiring massive infusions of government
capital to prevent a post-Lehman domino effect of insolvent financial
institutions around the globe.

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