It was a game of chicken.

In a conference room in the New York Federal Reserve Bank building, in lower Manhattan, the leading figures of the U.S. financial system — government and private — faced off.

On one side of a large conference room table sat Treasury Secretary Henry Paulson, Fed Chairman Ben Bernanke, and NY Fed head Tim Geithner, asking, begging, demanding.

On the other side sat the heads of the world's largest banks asking, begging, demanding for the opposite.

Both sides were afraid that Lehman Brothers would collapse and send the global financial system into chaos.

 

The government side wanted the private banks to step up and buy Lehman. The government said: no more. We're not bailing out banks anymore. You guys have to do this.

The private bank side wanted the government to put some money on the table. They said Lehman Brothers had too much ugly debt. There was no price they were willing to pay. Each of the banks said they would only buy Lehman if the government guaranteed that they wouldn't lose money.

This is classic game theory.

At any point, the private banks thought there was a decent chance that the government would blink at the last second and put real taxpayer dollars on the table. So there was little incentive for any private bank to buy Lehman before that moment. Why pay now, if the government would create a much better deal in 10 minutes?

The government folks knew that, if they did blink, they'd be back at this same table, bailing out some other bank down the road.

Maybe it was more a game of poker than a game of chicken.