What if... Lehman Brothers had not collapsed?

On the weekend of 13th-14th September 2008, the heads of international finance struggled to find a buyer for Lehman Brothers. Without one, it would fail. For a moment it looked as if Barclays, the British bank, would buy Lehman. But that deal never went through, blocked by authorities in the UK who did not want to saddle the UK taxpayer with Lehman’s bad debts. And so, on Monday September 15th, Lehman failed, and the worst phase of the financial crisis took hold.

But, as the anniversary of this great event draws near, it is worth asking what would have happened if on the afternoon of 14th September 2008, Tim Geithner, the President of Federal Reserve Bank of New York, had received the call he had been waiting for? What if Callum McCarthy, head of Britain’s banking regulator, the Financial Services Authority had called to say that Alistair Darling, the Chancellor, had given approval to Barclays’ cut-price bid for Lehman?

Barclays would have had to provide Lehman Brothers with large injections of capital and a new management team to keep it afloat. Bob Diamond was head of Barclays Capital and the Barclays board, chaired by Marcus Agius and under the leadership of the patrician John Varley, were so much in awe of Diamond that they would have had little doubt he could rescue Lehman.

Moreover, by doing the United States government a favour, they would have assumed an easy regulatory ride on Wall Street as they sought to build Barclays Capital, the investment banking arm of Barclays, into a world class outfit. The deal would have been done with the minimum of “due diligence.” (The process under which the buyer scrutinises every aspect of the target business.)

When the markets opened on Monday 15th September, to the news of the Lehman rescue, there would have been an enormous collective sigh of relief. The crisis had been resolved, the slide in the shares of two other big American investment banks, Goldman Sachs and Morgan Stanley, would have been halted, and the authorities on both sides of the Atlantic would have apparently regained control of a deteriorating situation.

The calm would have been an illusion. Behind the scenes, the Royal Bank of Scotland and HBOS would have been the subject of a wholesale run on their deposits as other banks refused to lend or do business with them. Mervyn King, Governor of the Bank of England, would have had to make more than £60bn of loans to RBS and HBOS to stop the cash machines drying up. With those banks in trouble and Lloyds being primed for a forced merger with HBOS, the financial markets and hedge funds would then have turned their fire on Barclays.

To protect Barclays from assault, Diamond would have underplayed any idea that Barclays might be in difficulty. But in New York, the BarCap bankers would eventually have gained access to the Lehman books and recognised that its problems were not simply those of liquidity, which Barclays could deal with because the markets regarded it as among the safer institutions. The problem was of solvency too. Lehman had made many property loans on the basis of atrocious overvaluations. The Barclays investment bankers would have found Lehman’s books stuffed with worthless, toxic subprime mortgages. Barclays would have then required tens of billions of new capital, fast.

Barclays, desperately short of capital, would have needed assistance speedily. The British authorities would have initially refused to bail-out a bank on the other side of the Atlantic. Having passed on the problem to the Brits, US officials would have seen no reason to put taxpayer money at risk.

The fight to save Barclays-Lehman would have been desperate, and Diamond would have dispatched teams of bankers to the Middle East and Asia in search of cash to keep the 300-year-old Quaker-founded bank alive. But it would have been a lost cause. The temporary reprise to confidence provided by the Lehman rescue would have a short term blip. All around the globe bank shares were plummeting, lending had halted and economic confidence and activity would have been shattered. The UK government would have had no alternative but to make a massive capital infusion into Barclays.

In exchange for 95 per cent of Barclays share capital the UK government would have injected £60bn into Barclays and insisted on a new leadership, perhaps installing former Standard Chartered boss Mervyn Davies as Executive Chairman.

Markets would have breathed a sigh of relief, but with stockmarkets down 50 per cent and in the US bank shares, including those of Goldman and Morgan Stanley, continuing to plunge. The US government would have had no choice but to launch a British-style rescue scheme for its banks.

There would have been a worldwide meltdown, even if Barclays had bought Lehman. It would also have led to a rift between the British and US governments which the first G20 summit, called by Prime Minister Gordon Brown, would have failed to resolve.