There is certainly room for debate, but we see the question of whether Lehman’s net worth was negligible or sharply negative as ancillary to the real issue. In important ways, lending to a bank of doubtful solvency is little different from lending to one that is certainly so. It will continue to put other institutions, and therefore the system, at risk. In this case, central bank lending to Lehman, an institution widely thought to be bankrupt, would have tarnished everyone else.
Pointer from Mark Thoma. My thoughts:
1. For those of us inclined to agree with this point, an implication is that Citigroup should have been allowed to fail. In fact, the whole bailout policy was misguided. Remember how some banks were forced to take bailout funds even if they did not want them? The idea was exactly to “tarnish everyone else” in order to avoid tarnishing the insolvent banks!
2. Regardless of the merits of letting Lehman fail, one of Ball’s main points still stands. That is, Bernanke and others have been lying by claiming that the decision was based on legal considerations. Ball did not find any evidence that the Fed made a judgment based on such considerations. In fact, it appears that it was not the Fed’s judgment at all, and instead Hank Paulson was calling the shots.