The Relationship Between Too Big To Fail， Financial Stabilityand Financial Regulation—Based on the Analysis of Lehman Brothers’ Bankruptcy

Zhao Shuang

【Abstract】Too Big To Fail was proved by the financial crisis， which swept the globe in 2008. But actually， this phenomenon is a more reflection of the significance of the financial stability and regulation. This passage will try to prove it from the case of Lehman Brothers. I will try to explain what role the government played in it， too.

【Key words】Too Big Too Fail； financial stability and regulation； Lehman Brothers

1. Definition

a） Too Big To Fail

Too big to fail， this phrase describes a phenomenon that some companies， especially for the financial companies， are so essential that the local government have to deliver a hand for avoiding their failure. If the local government just look at them and have never done anything， they will fail and be a catastrophe for all over world. So， the awkward situation was appeared—Too Big To Fail.

Above mentioned is the situation as the economy is depressed. It seems a very big problem in the financial word. But when the economy is booming， these companies can get more competitive advantages than the small firms. Finally they will get bigger than bigger. See？ It seems so unfair. However， the bigger ones usually burden more. They are always the backbone of one country. This phenomenon also proves that the financial regulation by government is invalid， especially when the economy is depressing.

b）Financial Stability

Financial stability is a global issue. This industry has been growing so rapidly in recent years that it is surprising to note that the term itself is a relatively recent coin. Bank of England made the first use of the term in 1994. And the Bank of England was the first institution to launch a financial stability review in 1996.Since then， the term has become one in general and pervasive use.

Now， people is generally believed that financial stability is the main component of the financial system and its determinants to good operation， and can withstand the impact of the external and internal system， so as to promote the economic development of a dynamic process. But normally， it is hard to say the finance is stable in reality. Opposite， people always propose the concept on financial instability to trace back the financial stability. It is a vivid phrase to describe a property of finance. The financial system is inherently unstable. This property was proved by many theory and facts.

c）Financial regulation

Narrow sense of financial regulation refers to the financial regulatory authorities finish the regulation of the whole finance management. Generalized financial regulation also includes the internal control and audit of financial institutions， trade self-discipline organization regulation， and social intermediary organizations regulation and so on.

As we seen from the meaning of financial regulation， financial regulation need to solve the problem well of 5W （Why， Who， Whom， What， How）. I mean 5W is the cause， subject， object， content and means of the financial regulation.

There is no doubt that financial regulation is so important. But， it is so powerful， too.

2. Case Background – Lehman Brothers

a）Lehman Brothers

The Lehman Brothers Ltd is an investment banking to provide all-round and diversified services to meet the financial needs of the global corporations， governments， institutions， and investors.

Because of Lehman Brothers' business ability has been widely recognized， so the company has included many world famous company customers， such as Alcatel， Time Warner Inc.， Dell， Fuji， Intel， IBM etc. This one-and-a-half-century history investment banking is a Big Mac of Wall Street. However， this company did go bankruptcy in the financial crisis in 2008.

b）The process of bankruptcy

The financial report， released by the Lehman Brothers on June 16th of 2008， shows that the quarter （to 31st， May） the company's loss of $2.87 billion. And this is the first time since the company listed in 1994. Lehman Brothers net income was negative $668 million， while in the same period in the same period last year was $5.51 billion. Chief Executive Officer （CEO） of Lehman Richard Fuld takes some effective actions immediately. Through the issuance of new shares， the company rises up to $6 billion of funds. On June 16th， Lehman Brothers share index rebound， but the stock has fallen by 60%. On September 9th， the acquisition negotiation between the Korea Development Bank （KDB） and Lehman Brothers was stopped. Lehman's share index fell 45%. On September 10th， Lehman Brothers announced third quarter performance report and several strategic restructuring plans. And then， Lehman's share index fell 7% immediately. At the beginning of this year， Lehman's share index is more than $60. And after this report announced， Lehmans share index fell to $7.79. Just for nine months， Lehmans share index had plummeted nearly 90% and its remaining market value is just about 60 billion U.S. dollars. On September 14th， the U.S. government refused to provide a guarantee for the acquisition. Bank of America， Barclays Bank， and other potential acquirers have quit the negotiations one by one. The company with 158-year history has to face to be bankrupt.

c）Summary

It is consistent with the description of Too Big To Fail. What happened next just proved the lethality of it nakedly. For the United States and the whole world economy， its influence is very big. Its range is very wide spread. Its influence spread to a long time. Many researches have analyzed from Lehmans internal and external causes. So next， I will focus on a little bit different aspect to analyze the cause of Lehman Brothers bankruptcy – the market and government reason.

3. Case analysis

First of all， the failure is the result from the invalid regulation of U.S. government. Because the U.S. economic follows the Anglo-Saxon model， liberalism displays incisively and vividly in the United States market economy. The U.S. market is too liberty to lack of the financial regulation from government.

The Anglo-Saxon Model emphasizes the market economy too much. Market liberalization of excessive government intervention can lead to things too little. Excessive weaken the role of the visible hand， allows the market to internal supervision， but unable to realize self-adjusting from within. Market failure and no external supervision or external supervision is weak. The United States government cannot be achieved for the American market strong external regulatory functions. Financial industry elite institutions problems the government should not timely and cannot timely. This causes since Lehman Brothers on the American market and even the global economy can't contain， the profound influence of the irrevocable， and even led the global financial crisis. The fourth-largest investment bank Lehman Brothers， although is only the United States， but it is too big to fail， not pour， fail. Lehman， the butterfly only one fan wings， the global financial crisis.

Of cause， U.S. government cannot help Lehman， either. Barclays and bank of America has a great interest on acquiescing Lehman brothers. But in the end， the cause that they chose to give up is， there is not the U.S. government or other Wall Street firms promising for provide protection of Lehmans potential assets losses. Face to the plight of Lehman brothers， the U.S. Treasury Secretary Henry Paulson said that government will not be for its bailout. That is to say， the U.S. government has abandoned Lehman. What is the reason the U.S. government for Lehman so ‘cruel？ One reason is that the government cannot face the congress and the taxpayer. Because the U.S. government had used taxpayers' money to the stock market and the Bear Stearns rescue， to Fannie MAE and Freddie MAC backstops， etc. The U.S. congress expressed the strong displeasure. And at the same time， Lehman is not the last one financial institution in need of help. To rescue again， the U.S. governments own finances were pulled into the water sooner or later. Second， a lot of financial institutions are pulled into financial crisis. The government save them all is impossible. Sure， it will not save well. Besides， Lehman Brothers was ranked 9th in 2008 revenue of ranking of the world's top 10 investment Banks. Such a performance point of view， Lehmans competitive position in Wall Street， is no so important any more. As a result， the U.S. financial system no longer need to Lehman Brothers.

4. Revelations for China

China is an ancient socialist country with Chinese characteristics. The Anglo-Saxon model is not suitable for China. Of course， the opposite lane model is not suitable for China， either. They are for the capitalist countries. Lehman what happens in America only as experience to draw lessons from instead of fully absorbing. For these experiences， we also need to transform them into Chinese model， combining with the actual situation in China. Is the main regulator only a government regulation， for Chinese economic， financial and market？ It is worth us having more carefully thinking.

In addition， we might have to re-examine what the visible hand can do. In daily life， the government may be supporter of market mechanism. It seems that there is no useful of government； especially that it is marketing economy today. But what it is in fact？ At that time， if the U.S. government can intervene to its market powerfully， the financial crisis may come more early warning； if the government can really to Lehman brothers holding my hand， the financial crisis might be a little bit later. It is， of course， we must admit that the government's role is limited anytime in any case. The American political system and its national spirits determine the U.S. government will be launched by constraints in all decision-making and implementation process. China does not have this concern. But we need to alert. Try not to get too much where the government should have a strong effect to limit the ability of the government. But this will get stuck in another trouble： who to oversee the regulators？ I mean， if the government did wrong， how do we go to find and then to put a stop to the government？ However， this is probably another difficult problem. Here we aside.

Stability is relative. Dynamic stability should be determined by perfect and powerful supervision system. When the economic is booming， large enterprises help to maintain financial stability. In the market， it will be the advocates of supervision system， the stability of the guarantor. When it is the recession， the force of the large enterprises is destructive for financial stability because of too big to fail. Should the government reach out to big surviving enterprises？ When and how？ These questions are testing the government's wisdom. It depends on the governments recognize of financial stability and financial regulation， as well as their relationships.

5. Conclusion

In general， a slight move in one part may affect the whole situation. We can say that it is domino effect. This phenomenon， too big to fail， it is two-way influence on financial stability. The result is doomed. And financial stability ensures that the financial regulation system has the soil of existence and growth. On the other hand， financial regulation determines financial stability. Financial stability protect the enterprise can be big enough. Then the big enterprise wiill be bigger and bigger. Thus， it is too big to fail. Their relationship is complicated. The one is with another entangling. If understand them separating from single aspect， there will be many misunderstandings.

And where is the government？ It is not a dispensable. On the contrary， it plays an extremely significant role in this chaos. Maybe in the future， we should try to give the government more confidence.