It is two years today since Lehman Brothers became the biggest bankruptcy in US history. A $600bn corporate monster, the world’s third largest bank, disappeared overnight.

Lehman brothers

Lehman Brothers collapsed, in the first instance, because it had borrowed massively against what turned out to be a series of bad gambles on the US housing market. During the 2000s, encouraged by the US government, banks had made full use of weak regulation to fuel a massive expansion of borrowing. Property prices, fuelled by rising access to mortgages, rose rapidly on the back of this, from around 3 times average income in 1990, to nearly 5 times by 2007.

And as those prices rose, they encouraged more borrowed cash into the property market. Speculators came hunting for quick profits on the back of rapidly increasing prices. If richer households were becoming saturated with loans, new customers would have to be found.

Banks started loaning money even to those incapable of paying the loans back – the very poor; those without jobs; those without any income at all: the so-called “sub-prime” customers. Often, those loaning money were smaller banks – the cowboys of the market.

But behind them stood the pillars of finance, like Lehman Brothers. The respectable financial institutions loaned money to the cowboys, who in turn passed this cash on to their borrowers at fat rates of interest.

Sub-prime lending rose 232 per cent, from $332bn in 2000 to $1.3tr in 2007.


Lending like this could only make sense if property prices continued to rise indefinitely. In the middle of a property boom this fantasy could be briefly sustained. But the real risks were substantial. Sub-prime borrowers were likely to find themselves unable to meet their monthly repayments.

The major banks thought they could deal with this risk. To the banks, a mortgage represented a stream of future income – the mortgage payments. The mortgage therefore had a value. So mortgages, and other loans, could be bought and sold. Banks traded mortgages and other loans amongst themselves.

Exploiting weak regulation, fast computers, and complex maths, the banks had learned how to tie different kinds of mortgages together, making the whole bundle of loans more attractive than the individual parts. Sub-prime was high-risk, but could be cunningly mixed up with low-risk US government borrowing, making the new package of loans appear to be less risky overall.

These new packages were the now-infamous “collateralised debt obligations”. The big banks produced and traded them in vast quantities, speculating on their future value. And they borrowed money off each other to do so.


Risk became disguised, hidden in these, and other, increasingly complex new packages. The result was that banks began to lose sight of the risks they were taking on. But with the bubble still growing, there was no incentive to examine their finances too carefully. Banks did not check. Regulators did not check. The credit ratings agencies, supposed to assess the risk of financial problems, handed out clean bills of health all round. And the US government continued to relax legislation on banking.

Because no-one really knew what was happening, and no-one cared to check, the banks carried on making riskier and riskier loans. They were gambling on increasingly dangerous bets, with bigger and bigger loans. Something was bound to give.

The bubble began to deflate as early as autumn 2005. US house prices abruptly fell 3 per cent. Sub-prime borrowers began defaulting on their loans.

As they defaulted, the smaller banks and institutions they borrowed from were pushed into difficulties. Merit Financial, Inc., was the first to go under, filing for bankruptcy in May 2006. House prices continued falling. Sub-prime loan delinquency continued to rise, to around 13 per cent of all sub-prime loans by spring 2007. The largest sub-prime lender, New Century Financial, went bankrupt in April that year.


A creeping fear set in amongst the major banks. They were estimated to hold well over $1tr of packages containing sub-prime loans. Each sub-prime loan was now a potential unexploded bomb. They could not know for sure which ones would go off.

They became too frightened to lend money to each other. They could no longer raise funds on the separate, interbank market they used for their own borrowing. The disappearance of credit pulled down UK bank Northern Rock in September 2007.

Fear turned to panic throughout 2008 as losses rose. Major investment banks Bear Stearns and Merrill Lynch were both hastily acquired by other banks in an effort to stop them going under. Both had taken on exceptionally large amounts of repackaged debt.

Lehman was less fortunate. It had held onto its repackaged sub-prime debt longer than most. Its losses became astronomical: $2.8bn announced in June; $3.9bn more in September. Its share price had collapsed. And no private buyer could be found.

In the early hours of September 15, 2008, Lehman Bros declared itself bankrupt.

Right up until the last moment, its bosses continued paying themselves astronomical sums. $2.5bn was set aside for bonuses that autumn.


The financial system is like a web. Every single part of it is connected to every other by debt and credit. Over the years, investment banks like Lehman Bros had accumulated a vast number of links, spreading across the globe: from the poorest sub-prime borrowers in the US, to the other mega-banks.

As the boom continued and lending grew, this web became increasingly dense. The major financial institutions became more and more enmeshed into the system.

Lehman’s links to the sub-prime market pulled it down. But its collapse threatened the whole system.


Outright terror now gripped the markets. The US stock exchange slumped. The world’s largest insurer, AIG, which had also been up to its neck in repackaged mortgages, was threatening bankruptcy.

The US ruling class appeared shell-shocked. A furious argument raged. Hardline free-marketeers thought Lehman Bros should have been allowed to crash, along with any other financial institution caught up.

Their solution to the crisis was to knock it all down, and start again.

Others, fearful of the grim consequences of further bankruptcies, argued for emergency bailouts. AIG was granted $85bn of US Federal assistance two days after Lehman Brothers went to the wall.

But a plan to create a $700bn bailout fund was reject by the House of Representatives on 28 September.

With no clear strategy on offer, the spiral downwards continued. And it began to spread.

Banks across the world were failing, while stock markets collapsed. By “Black Friday”, 10 October, the US market had fallen 40 per cent from its 2007 peak, capping the worst week in its history. The London stock market fell 21 per cent. Tokyo was down 24%.

At the centre of it all were the banks – the collapsed heart of the system.


Capitalism was peering into the abyss. For an economy like the UK, so heavily financialised, a social catastrophe was looming. Andrew Rawnsley’s account of Gordon Brown’s time in Number 10 makes graphically clear just how close it was to a total collapse:

By the end of Black Friday, says John Gieve, then deputy Governor of the Bank of England, HBOS and RBS had “run out of money”. Alastair Darling agrees “they had run out of capital”. Treasury officials confirm that these two massive banks would not be able to open their doors on Monday morning.

This was a stunning development for the bankers and the politicians. If both HBOS and RBS went down, it was thought highly likely that they would tip over Barclays, which would in turn crash Lloyds TSB. The chain reaction could topple the majority, even perhaps all, of the major British banks. Sober experts like the economist John Eatwell “thought there was a real possibility of a total banking collapse. That is, the banks actually shutting their doors and all the cash machines stopping, which would be a complete disaster.”…

That would be a cataclysm without precedent. Cheques would be valueless. Credit cards would be useless. With the cash machines shut down, families would not be able to buy food. “Literally you wouldn’t have any cash. The money would disappear,” says one leading economist. Most of those things regarded as the essentials of modern society would cease to function.


This was the nadir of the crisis. The system slowly stabilised from here onwards. The US government finally made its $700bn bailout available to the banks in early October. Plans across Europe, beginning with the UK and France, to “recapitalise” the collapsed banks by pumping full of cash were being implemented from the weekend of 12 October.

The injections of cash, and the promises of further support, restarted the system. The US stock market rose on Monday 13 October. The downwards spiral was halted. By the London G20 meeting of April 2009, a new consensus had been built for the ruling class: bail the financiers out now, worry about reforms later.

Order was steadily being restored, but at an exceptional price. The bailouts mobilised the financial resources of the states involved on a scale and with a speed rarely seen outside of wartime. Colossal amounts of borrowing and future liabilities were created. Mervyn King, governor of the Bank of England, estimates that the total cost for the UK to be £1tr.

That exceptional assistance is now expected to be paid back. Public services are being attacked to pay for the bankers’ greed and stupidity.


By mobilising the states resources to rescue the financial system, governments have transferred the costs of the crisis to the public sector.

This crisis is not, however, solved. It has been transformed: from a crisis of the financial system, to a crisis of the state. Stability in the financial system has been bought at the price of instability of the state.

Europe is the place worst affected by this. Its banks were as bad any others in devising new and more complex ways to hide risk. And, where the US had sub-prime mortgages, European banks had the smaller European economies to lend to. Massive amounts of debt had built up across the continent, as a recent report shows.

The European sovereign debt crisis follows directly from this. It was European banks who loaned money to the so-called PIGS: Portugal, Ireland, Greece and Spain. It is European banks who are now most threatened by one of the PIGS defaulting on its debt. EU bailouts are on standby for the banks, while simultaneously unprecedented cuts are demanded in public services.

The political strains in attempting to drive through austerity measures will be immense. General strikes have already occurred in France and Greece.


There is a further complication. The banking system is in no meaningful sense reformed. Agreement has finally been reached, this week, on the “Basel III” international rules for banks.

These are supposed to regulate financial institutions, preventing them taking on excessive amounts of risk. But they are absolutely feeble. The new capital requirements, forcing banks to hold more capital back in case of emergency, do not have to be completely implemented before 2019.

And those requirements are still dismally low, below even the expectations of the major banks themselves. The financial system, beyond some tweaks and moves to ban the more obnoxious practices, remains essentially unreformed.

As the return to fat bonuses shows, the status quo has been restored. Nothing fundamental has been changed.

The bankers have got away with it. They drove the entire world economy into the ground, and they have been rewarded for it.

But like spoilt brats everywhere, leaving the bankers unpunished means they will behave exactly as they always have done – if not worse.

Already, in January, the Bank of International Settlements – something like the central bankers’ central bank – was warning of “excessive risk-taking” by the major financial institutions.

The twin crises

So the system is unreformed. The chances of another financial crisis are high. Another bailout may soon be demanded.

But states last time nearly bankrupted themselves attempting to stabilise the financial system. Recession still dogs much of Western capitalism.

They cannot afford another bailout.

The Bank of International Settlement’s most recent annual report made this absolutely clear:

“…events coming out of Greece highlight the possibility that highly indebted governments may not be able to act as a buyer of last resort to save banks in a crisis.”

Balance sheets in France, Germany, Spain and the UK may all be too “fragile” to cope.

Having pushed the crisis out through one door, the ruling class may find it comes back in through another. This would be a twin crisis: a failing financial system, with crippled states unable to cope.

A weak system

That menacing possibility helps explain the frantic drive by our own Coalition government to smash up public expenditure. Aside from their own ideological inclinations, they desperately want to clear some space on the public sector balance sheet in case of another financial crisis.

Underlying this malaise is a real weakness in British capitalism. Growth is too weak, productivity too low. It is in no shape to afford both a welfare state, and a financial sector.

Both require public expenditure. Only one can be provided. The Coalition of the rich has chosen, predictably, to back finance and the City of London. We need to force the opposite choice on them.

Opposition to the cuts is rising. But whilst building that opposition, socialists must argue that permanently stopping the cuts will mean breaking the City. The two are inextricably linked.

A serious tax on wealth, controls on the movement of capital, and investment in creating green jobs would be a start. It will mean building a movement to not just stop the cuts, but to challenge the rule of finance and capital.

James Meadway

Radical economist James Meadway has been an important critic of austerity economics and at the forefront of efforts to promulgate an alternative. James is co-author of Crisis in the Eurozone (2012) and Marx for Today (2014).