Now let the reviewer immediately acknowledge that in 2008 and 2009 the investment banks were in a right old pickle. They had been incompetent and greedy in fomenting a bubble in securitised housing finance, and had losses running into tens of billions of dollars. At the worst moments the scale of the losses was uncertain, and these organisations — including Goldman Sachs — had lost much of their creditworthiness and could not fund their assets from market sources. In the event Goldman Sachs and Morgan Stanley had to have themselves re-classified as commercial banks, so that they could borrow from the Fed, while the three other big investment banks (Bear Sterns, Lehman and Merrill Lynch) had either to be taken over by other banks or, in the egregious case of Lehman, go "belly up". 

But what does the phrase "belly up" mean? Much of the trouble in this crisis has stemmed from the sloppy journalese in headlines, the morphing of headlines into factoids ("the banks were bust"), and the tendency of key players to go along with the factoids. The concept of bankruptcy is actually very complex. According to its balance sheet on Friday September 12, 2008, Lehman Brothers had positive equity of over $15 billion and hence could pay all its creditors in full. On the morning of Monday  September 15, 2008, Lehman Brothers ran out of cash and sought protection from its creditors in the world's largest-ever bankruptcy, with over $600 billion at stake. How can that make sense? How can an organisation with positive equity above $15 billion "go belly up"? 

The answer is that over 95 per cent of the $600 billion of Lehman assets were financed by borrowing. As a result, when some of Lehman's lenders stopped providing it with credit facilities, it could no longer repay its other creditors with cash. But was the balance sheet on September 12 lying? Well, yes and no, but not entirely. It is now over five years since the Lehman default, and the accountants and lawyers in charge of the debt work-out can begin to see daylight. The outcome is that unsecured creditors may well achieve a full 100 per cent return on their money. Major disputes between Lehman affiliates scattered all over the world are being settled on much better terms than expected. In autumn 2008 the value of Lehman's assets was indeed above that of its total liabilities minus equity, just as the balance sheet said. 

 

Throughout the crisis the big quarrel between the bankers and the regulators was about the nature of the underlying problem. The bankers claimed that they were in difficulties because they could not finance their assets readily, even though most assets were of good quality and their businesses had positive equity. They did not need more capital. By contrast, the regulators insisted that banks' financing strains were attributable to market distrust of banks' capital adequacy. The immediate remedy was therefore for the banks to raise more capital, while over the long run they would have to operate with stronger capital shock-absorbers than in the past. 

As the affairs of the failed institutions of 2008 come closer to final resolution, the truth is being clarified. In the US at least the bankers were substantially right. Their organisations may have found it difficult to finance their assets during the most testing months, but this was a problem of liquidity, not of solvency. In mid-2008 the overwhelming majority of the American banking system did have enough capital to cover such losses as were to be reported over the next two or three years. (Ireland, Iceland and Cyprus were different, or at any rate they became so as the crisis evolved.)