Opacity is a necessary condition for a bank run.  In the case of Lehman Brothers, not only was the investment bank opaque, but so too were a sizable portion of its exposures.

It was this opacity that proved lethal.

Why?

The Information Matrix explains why.

Information Matrix

Behavioral economists have shown people like a good story.  This is true whether the investment Wall Street is telling them the story about is in the Perfect Information quadrant or in the Blind Betting quadrant.

The key difference between investments in the two quadrants is in the Perfect Information quadrant investors can Trust, but Verify Wall Street’s story.  In the Blind Betting quadrant, opacity (the absence of the necessary information) prevents investors from being able to verify Wall Street’s story.

Whether the story can be verified or not results in a vastly different response when Wall Street’s story is called into doubt.  In the Perfect Information quadrant, the story can be verified and the doubt dismissed.  In the Blind Betting quadrant, the story cannot be verified.  Not only is the doubt not dismissed, but the logical follow-up question arises:  is the investment worth anything?  This too cannot be verified.  Investors recognize this and, as behavioral economics suggests, naturally panic.  The result is a “run” to get their money back.  It is the lost of funding that is lethal to a financial institution.

Lehman Brothers was an opaque investment bank that invested heavily in opaque securities.  It was prone to a run should the value of the securities it was invested in or the bank itself be called into doubt.

In 2008, there was substantial doubt about both.

Investors recognized this and started cutting back on their exposure to Lehman Brothers.

As funding dried up, Lehman Brothers turned to the Fed for support.  The Fed declined.

Left unsaid was the doubt about the value of Lehman Brothers’ assets was so substantial it likely had a sizable impact on the Fed’s decision not to perform its Lender of Last Resort role.  One of the requirements on the Lender of Last Resort is it not put taxpayer money at risk.  As a result, the Lender of Last Resort must independently value the collateral it receives in exchange for a loan so it always lends less than third parties would pay for the collateral.  In Lehman’s case, the Fed couldn’t value the opaque securities Lehman had available as collateral.  The Fed, like Lehman, also couldn’t find buyers for these opaque securities.