Lehman Brothers - A Casualty of Constructive Ambiguity?

Abstract

This thesis seeks to explain the US Government's role in the bankruptcy of Lehman Brothers in September 2008. It asks why Lehman did not find a solution in the market before it was too late, and why the Government did not bail Lehman out. The empirical account suggests that Lehman could have found a solution if this was its preference, and that the government did indeed, counter to the official explanation, have the power to rescue Lehman from bankruptcy. The thesis' stylized game theoretical analysis shows that the Government's choice of policy, displayed in how it dealt with events preceding Lehman's failure, provided Lehman with incentives not to find a market solution, which eventually resulted in Lehman filing for bankruptcy - the biggest in history sending shockwaves around the entire world. The analysis further shows that the Government's approach left it unable to credibly deter systemically important financial institutions from relying on a government sponsored safety net, which in the case of Lehman Brothers led to the sub-optimal outcome of bankruptcy.