In September top government officials confronted an excruciating choice. Lehman Brothers, one of America's most important financial institutions, tottered on the brink of bankruptcy. Rescuing it would signal to other large institutions that they, too, could count on an implicit government safety net, no matter how risky their financial excesses. However, allowing it to fail risked setting off a cascade of bankruptcies and market disruptions.
Forced to make a quick decision, officials let Lehman fail. In part, they believed that financial market participants had long been aware of Lehman's weaknesses and had limited their exposure. However, that decision turned out to be a grave misstep. Financial firms worldwide were tightly linked to Lehman's fate by a poorly understood web of derivative contracts. Within hours world credit markets seized up. The economy, already shaky, began its horrifying downward spiral.