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IAI Actuarial Core Principles · Business Economics · Recent macroeconomic history

The collapse of Lehman Brothers in September 2008 is best described as a turning point because it:

Lehman's failure showed that even a major institution could be allowed to collapse, which intensified fear about counterparty risk. Banks stopped lending to one another, interbank spreads widened and credit markets froze, turning a housing and subprime problem into a full systemic crisis.

  1. AEnded the rise in US house prices, which had begun falling only afterwards
  2. BShowed that large institutions could fail, sharply raising counterparty distrust and freezing interbank lendingCorrect
  3. CImmediately restored confidence because markets believed in moral hazard
  4. DLed to a fall in interbank interest rate spreads
  5. Caused the US Federal Reserve to raise rates sharply

Explanation

Lehman's failure without rescue signalled that even major institutions could default. Banks became unwilling to lend to each other, so interbank spreads widened and credit froze. House prices had already begun falling in 2006-07, so the first option is wrong.

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