6. Markets After Lehman

The failure of Lehman Brothers negated the market’s conventional expectation that regulators would serve as deposit guarantors for shadow banking conduits, leading to convention uncertainty. Convention uncertainty caused a systemic bank run and flight to quality. Regulators’ interventions restored market confidence that they would serve as deposit guarantors of shadow banking conduits, reducing interbank funding pressures. Their multifaceted response focused on the locus of precrisis fragility, including stabilizing short-term funding markets; rehabilitating bank health transparently; and reflating asset prices. The authorities’ memories of the Great Depression and the extension of the United States’ sovereign credit to the financial system explain the successful bailouts. Common critiques of the crisis response, including that Lehman fail was a mistake; the response was politically illegitimate, and authorities adopted premature austerity are interrogated.