Lehman, Resolution Regime Failure, and Credentialism as a Mask for Weak Arguments

It’s telling in extended blogosphere debates when one side starts resorting to cherry picking, distortions, ad hominem attacks, and projection as its main lines of attack. In his last offering on the FDIC’s paper which uses Lehman to show how it would use its new Dodd Frank resolution authority, Economics of Contempt proves only one thing: that he’s not interested in open or fair-minded discussion (see here to see what that might look like) and that he wants to put a stop to it.

So, mindful of the possibility that I might simply be feeding a modestly upmarket troll, it seems that all I can do now is illustrate how he has misrepresented my arguments; for instance, by absurdly suggesting that I missed the fact that the FDIC would be on site, in its Lehman counterfactual, when I raised a completely different issue, that their presence would become too large and too intrusive to keep secret (EoC seems blissfully unaware of the fact the word was all over the markets when the FDIC went in to kick the tires of Citi’s portfolio of loans to see-through buildings in the early 1990s).

Or I can point out that that he distorts the reason that Barclays did not buy and almost certainly never would have bought Lehman in toto ex a very large subsidy or unsecured creditor cramdown. The bank and the FSA were agreed that they’d do a deal only if it made economic sense, and the FSA was certain to be conservative on that front in the wake of the RBS-ABN-Amro fiasco. This wasn’t a matter, as EoC asserts, echoing Administration PR, of failure to communicate, nor of FSA’s stubborn insistence on UK shareholder procedures. Barclays was not about to buy a pig in the poke and the liquidity backstop in combination with the mechanics of the shareholder approval process, would allow the deal to be retraded if need be. That’s a very sensible precaution (especially for a non-US bank). Similar issues arose for BofA, which bought the believed to-be-much-sounder Merrill. When more horrors came to light, BofA threatened to exit its acquisition to secure more subsidies.

And what, pray, is EoC’s evidence that the FSA report which sets out these matters is “dubious”? It’s certainly inconvenient for EoC; in fact, it wrecks his argument: is that what he means by “dubious”? It may indeed be that the FSA’s director, Sants is a liar, and content to publish a lie (that’s something EoC’s “dubious” definitely implies); and it may be that Barclays’ then-CEO Varley simply goes along with the lie. But without the evidence for such a large claim, EoC’s affirmation is just bluster.

Another example of his method of operation: in a previous post, EoC wrote,

Criticism #2: Egregious underestimation of Lehman losses

This is a non-sequitur, and not even a good one. For one thing, Yves confuses creditor claims with creditor losses, so her so-called “gap” analysis is fundamentally flawed.

Except, it isn’t: the $300Bn of claims is a reasonably good number, and comes straight from the bankrupt estate. Against that, there are about $60Bn of assets after the derivatives counterparties got first dibs. We wrote about it here: the original claims totalled north of $1.1 trillion, and all the double claiming, negotiation and estimating has already been taken into account to reach that $300Bn figure. EoC omits that fundamental point, adding “That’s Bankruptcy 101“, to complete the slur. But he never bothers to show why he knows better than the Lehman bankruptcy overseers Alvarez & Marsal, to the tune of hundreds of billions of dollars. That reticence is either because it’s a commercial secret, or because it’s just tripe (hint: it’s tripe).

And of course, EoC also simply ignores other issues we raised, any one of which also renders the Lehman counterfactual inoperative: politics (that the Administration would find it hard to pull the trigger, and would never have done so in March 2008); the fantasy of Fuld agreeing to put Lehman on the block (he’d have to be fired, which implies a process more like that of putting Fannie and Freddie into conservatorship, which again rules out a leisurely marketing process) and the unheard of process of shopping a distressed company widely to candidates who are not only direct competitors but also significant counterparties/creditors (just imagine what would happen to Lehman’s repo haircuts if this were done without Lehman already being a ward of the state, which is what the FDIC paper sets forth). Or how about FDIC’s due diligence assumption, when that effort would simply uncover the true magnitude of the hole in Lehman’s balance sheet and the mess of Lehman’s derivatives books?

But there isn’t any point in unpacking this in further detail, because EoC’s last two posts have shown him to be relying, in lieu of substantive arguments, on the worst sort of credentialism: that as a putative insider, his jibes, in lieu of real refutation, should be treated as definitive. EoC continues to huff and puff that Dodd Frank Article II will work….basically because he and the FDIC say so. We are to take it from him: appeals to foreign regulators would trump the actions of foreign creditors. He might familiarize himself of the nasty consequences under UK law of being a director of a company found to be “trading insolvent”.

In the absence of sound logic or facts, any one can appeal to status and credentials. But when it comes to international bank resolution, one is always on sounder footing appealing to the factual existence of actual players and authorities who, however inconveniently, exist ‘abroad’. These authorities don’t agree with EoC and the FDIC at all. Inconvenient? Yes. But there it is.

For one, the Bank of International Settlements, which has access to perfectly good securities and bank regulatory experts, worldwide, begs to differ. In its Report and Recommendations of the Cross-border Bank Resolution Group the BIS said that even if cross border resolution regimes were better coordinated, (which, of course, Dodd Frank does not achieve), it “recognizes the strong likelihood of ring fencing in a crisis” due to the failure to implement cross-border burden sharing and the national nature of legal and bankruptcy regimes. It thus recommends a framework that “helps ensure that home and host countries as well as financial institutions focus on needed resiliency within national borders.” In other words, it accepts a national process as inevitable and recommends dealing with that reality.

And note also: FDIC asserts, in their Lehman counterfactual (and, they assume, in Title II resolutions generally), that the local regulator would have cooperated. Yet the FSA, in its Turner Review, has fallen in line with the BIS ring-fencing notion. The FSA is moving towards requiring local entities be better capitalized and is placing little faith in yet to be realized greater international coordination. Both documents pre-date the finalization of Dodd-Frank, which, in its obliviousness to the international dimension, simply confirms the prior BIS/FSA line.

Similarly, the Institute for International Finance, a blue chip group from the industry (meaning it has every reason to depict Article II as workable, since the alternative is structural remedies, aka breaking up banks, and/or much higher capital levels for national entities, would have a disruptive impact on their operations) has been on the same page as the BIS and has seen nothing in Dodd-Frank to change its mind: see pages 31-2 of their latest on this subject:

Title II remains problematic in the limited attention that it pays to cross-border issues…

…cooperation and coordination is, under Dodd-Frank, dependent upon the goodwill of the different parties and perceived common interest in the circumstances…

Much, accordingly, remains to be done to render the Dodd-Frank approach appropriate for application in the context of cross-border financial groups.

If EoC can persuade the BIS Cross-border Bank Resolution Group and the Institute for International Finance that he knows better than they do, he might be worth listening to. Until then, if they’re channelling anyone, it’s ‘Naked Capitalism”, not “Economics of Contempt”