2.1What the classical doctrine asks for
The doctrine of the lender of last resort has a long history, and its modern readers disagree about its core. In the reading notes of the parent study, Bagehot's rule is that in a panic the central bank should lend freely, at a high rate of interest, on good collateral, and should announce beforehand that it will do so, so that confidence is restored; Bagehot also criticises the thinness of the reserve held against deposits and argues that the Bank of England's duty to the market was not clearly accepted or understood (Bagehot 1873). Henry Thornton, in 1802, had argued that the Bank, as holder of the nation's reserve, should support the banking system by lending in a crisis of confidence while limiting issue in ordinary times, and that a failure of credit can spread from one bank to others (Thornton 1802).
Humphrey's survey traces the idea through Thornton and Bagehot and shows how it was refined and contested; in his presentation the classical lender protects the system by lending to solvent institutions, not by rescuing insolvent firms (Humphrey 1989). Michael Bordo sets the classical view beside other positions and argues from the historical record that a credible lender of last resort can stop panics from spreading, and that banking systems with one tended to have fewer panics (Bordo 1990). Charles Goodhart's institutional history holds that central banking grew out of the needs of the banking system, and that the case for a central bank rests on its role in stabilising the system and lending in a crisis (Goodhart 1988). Charles Kindleberger and Robert Aliber, in their survey of crises across centuries, hold that a lender of last resort is needed to stop a panic from spreading and that the timing and wording of its announcement matter (Kindleberger and Aliber 2005).
Against this lineage Mehrling sets a market-based view. Modern finance, he argues, runs on money-market funding, repurchase agreements and securities dealing; Bagehot's idea has to be updated to that world, and the Federal Reserve's response to the crisis of 2007 to 2009 was that of a dealer in the market (Mehrling 2011). Gary Gorton, from another direction, argues that the panic of 2007 was a run on the repo market and related instruments, a run on short-term debt of the same kind as the bank runs of the nineteenth century (Gorton 2012). A repurchase agreement, or repo, is in general terms a short loan secured by a security. The Board's release of 2008, as Section 6 shows, is written almost entirely in this vocabulary.
2.2Could the Federal Reserve have lent to Lehman?
The second debate is narrower and sharper. The Federal Reserve Act of 1913, in the parent study's note, governed the lending powers of the reserve banks in its section 13, which was later amended, notably in 1932, to allow emergency lending to non-members in unusual and exigent circumstances (United States Congress 1913).
Ball's position is that the power was there and could have been used: the Federal Reserve could have judged Lehman solvent, had the means to lend, and chose not to, so that the decision was one of policy and not of legal limits; he draws on records and testimony, and his reading is disputed by some officials involved (Ball 2018). Bernanke's memoir gives the participant's opposing view, that Lehman could not be saved lawfully for lack of collateral, set within a description of the support of Bear Stearns, the choice not to rescue Lehman, the rescue of American International Group, the emergency lending facilities and the asset purchases that followed (Bernanke 2015). The Financial Crisis Inquiry Commission's report describes the failure of Lehman Brothers and the rescues of others; it concludes that the crisis was avoidable, and the report carries dissenting statements by some commissioners (FCIC 2011). Adam Tooze widens the frame: the crisis was global, European banks' dollar funding was central to it, and the Federal Reserve acted as an emergency lender on a global scale, including through swap lines to foreign central banks (Tooze 2018). Barry Eichengreen holds that knowledge of the Depression helped the Federal Reserve and other central banks act quickly to support the financial system in 2008 and after (Eichengreen 2015).
Skeptron's record of Lehman holds two entities, keeping the holding company's bankruptcy of 15 September 2008 apart from its dealer subsidiary's use of the Federal Reserve's existing credit facilities, and this study does not say that Lehman as a whole received or was refused a loan.
2.3Rules, legitimacy and moral hazard
The third argument is about how emergency lending should be governed. Tucker's answer is that independent agencies such as central banks need a clear mandate, limits on what they may do, transparency and accountability to elected bodies; he applies this to emergency lending and holds that rescue decisions are political choices that need rules set in advance and a framework agreed with the government (Tucker 2018). Douglas Diamond and Philip Dybvig's model of a bank shows that a run can happen without any fundamental weakness, because each depositor expects the others to run; a lender of last resort or deposit insurance can remove that bad outcome, though such arrangements raise problems of incentives (Diamond and Dybvig 1983). Those problems of incentives are what writers on the subject call moral hazard: the worry that help given in one crisis encourages more risk before the next.
The LTCM episode is the classic case of an authority organising a private solution. Roger Lowenstein's journalistic narrative describes the fund's highly leveraged trading, the way its losses spread, and the New York Reserve Bank's convening of the creditors to arrange a private rescue and recapitalisation in September 1998; the book is often used as a case of leverage and of the role of authorities in organising a private-sector solution (Lowenstein 2000). Donald MacKenzie discusses the collapse of LTCM as one of the episodes where financial models and their wide use affected outcomes (MacKenzie 2006).
2.4The debates side by side
| Question | One position | Another position | What the primary texts of 1998 and 2008 can speak to |
|---|---|---|---|
| What does the classical doctrine ask? | Lend to solvent institutions on good collateral at a penalty rate; do not rescue insolvent firms (Humphrey 1989); a credible lender stops panics spreading (Bordo 1990) | The central bank is now a dealer of last resort for markets (Mehrling 2011); the panic of 2007 was a run on repo (Gorton 2012) | Whether the authorities wrote their help as help to firms or to markets, and on what collateral |
| Could the Federal Reserve have lent to Lehman? | It had the authority and means; not lending was policy (Ball 2018) | Lehman could not be saved lawfully for lack of collateral (Bernanke 2015) | Whether the public texts of the weekend state a legal limit, a collateral test, or neither |
| How should emergency lending be governed? | By rules set in advance and a framework agreed with government (Tucker 2018); announce beforehand (Bagehot 1873) | Timing and wording of the announcement matter (Kindleberger and Aliber 2005) | What the authorities wrote about where their involvement ends, and when |
| Does help create moral hazard? | Arrangements that remove runs raise problems of incentives (Diamond and Dybvig 1983) | The episode of 1998 is the case of an authority organising a private solution (Lowenstein 2000) | Whether the authorities named who bore the loss, and how they weighed moral hazard in their own words |
The first two rows are disputes in which the positions are opposed. The last two are better described as different emphases. The article's own question sits across all four: the notes describe none of the works in the table as reading the authorities' public wording line by line for its statement of power and limit.