John Cassidy, and following him, Felix Salmon. took aim at Ben Bernanke’s testimony last week at the Financial Crisis Inquiry Commission explaining why the central bank and Treasury stood aside in Lehman’s extremis. The problem is that both get two fundamental, and critical facts wrong, and that error makes the rest of their claims dubious.
As Cassidy reads Bernanke’s testimony, he made what Cassidy deems to be a new rationale for not saving Lehman:
“Any attempt to lend to Lehman would be futile and would only result in a loss of cash,” Bernanke said in explaining what he and his colleagues were thinking. “It wasn’t just a question of legality. It was a question of whether there was any conceivable option that would work.” The conclusion reached was “there is no way…. If I could have done anything to save it, I would have saved it.”….
Bernanke has shifted the debate onto the issue of whether saving Lehman would have been a practical option. Here, I fear, he is on much shakier ground…
Recall that right up until Sunday night, Barclays, the big British bank, was ready to take over and stabilize Lehman in the same way that, six months earlier, J. P. Morgan had taken over and stabilized Bear Stearns. The official story is that this option fell through because Barclays needed to obtain shareholder approval for such a takeover, which would have taken at least a few days, and the British government refused to waive this requirement. With the markets about to open in Asia, there wasn’t time to wait for Barclays to do what it needed to do in Britain.
But what if the Fed and the Treasury had made a public announcement that they had approved a takeover by Barclays and were willing to provide Lehman with bridging finance until the deal could be completed?Wouldn’t that have been enough to reassure the firm’s creditors and counterparties? It isn’t immediately obvious that the answer is no.
Erm, this discussion considerably overstates where Barclay’s really was. The first serious error is Barclays was NOT ready to take over and stabilize Lehman. Its senior management wanted to do that, but any deal depended on shareholder approval.
The second error is that approval would take “a few days.” But approval under the UK regime was expected to take thirty to sixty days.
And that leads us to the third error, that the Fed merely needed to lend to Lehman, or per Salmon, to guarantee the deal (Salmon provides a link to a Bloomberg story with an in passing reference to a Fed guarantee of liabilities; I don’t see any reference to this guarantee on the Fed’s Board of Governors or NY Fed websites).
JP Morgan, before trading opened in Asia on the weekend when the Bear deal was hammered out, agreed to guarantee Bear Stearns’ trades. For instance, from the analyst conference call of March 16 (Sunday) at 8:00 PM:
We are also effective immediately providing a JP Morgan guarantee to all of the trading obligations of Bear Stearns so all counter-parties facing off against Bear Stearns should understand they are dealing with JP Morgan Chase on that basis.
That’s confirmed by later documents on the JP Morgan website. There was no question of approval by JP Morgan shareholders; the guarantee to Bear was structured as the lesser of time to shareholder approval or twelve months. Note neither the call nor the announcements mention any Fed guarantee beyond the $29 billion loan to what was later called Maiden Lane, the vehicle which held some expected to be bad Bear Stearns assets.
By contrast, on Sunday morning of the Lehman weekend, after the bank consortium had agreed to take $40 billion of toxic Lehman assets and Barclays management was ready to go, the FSA indicated it would be unlikely to waive the shareholder vote requirement. Even more important, the FSA indicated that the US would need to cover Lehman’s debts, which would include its trading obligations, prior to an acquisition, and indicated if that would happen, they might look favorably upon a deal.
Now let’s see how this plays out. The problem with dealing with a trading troubled operation is you have a very basic decision to make: whether to halt trading and settle up with everyone as best you can, or to get it into stronger hands who can (somehow) enable the operations to continue trading. The sheer volume of transaction and money flows forces binary choices You have a bankruptcy or collapse with the former; some sort of assumption of the trading operations with the latter.
Remember, approval of the acquisition is not certain and AIG was hitting the wall then too. A lot of investors would presumably decide to take a bird in the hand. There is not reason to think they would not take advantage of the Fed backstop. The market would know of the selling, and with it, continued to the Lehman franchise. The odds were real that the bleeding would continue. And what if Barclays’ shareholders turned down the deal? No one would want it. Fuld had flogged his firm anywhere and everywhere and Barclays was the last taker. The US government would own a sick investment bank.
Oh, and this mess would culminate around the time of the Presidential elections.
Hindsight is always 20/20. We now know that the hole in Lehman’s balance sheet may be as large as $150 billion (the swing from a reported positive equity to losses most recently reported at $130 billion. But at the time of the Lehman implosion, the banks who had cobbled together a backstop were assuming losses of $40 to $50 billion on bad assets. The Fed and Treasury probably believed that they would have to absorb that, plus any collateral damage resulting from the market selling into their de facto unlimited backstop on Lehman.
As readers know well, I am no fan of Bernanke. But the big failing was not in the battlefield decisions the Fed and Treasury made that weekend, but the abysmal failures to act on a number of fronts in the months and years prior to the crisis. By Lehman weekend, he had few degrees of freedom due to the Fed and Treasury’s longstanding neglect.
Update 3;00 Am: Andrew Ross Sorkin has a story at the New York Times that focuses on Lehman’s final hours, highlighting e-mails among some of the authorities at the Fed (Warsh, Kohn) stating serious political opposition to any rescue. While Sorkin intimates these messages are damaging, the fact is the officialdom was broadcasting loud and clear there would be no rescue for Lehman before the terminal slide started. In addition, the messages that Sorkin highlights were not from people who were deeply involved in the negotiations (given how frantic the rescue efforts were, I would imagine that communication, even to those normally in the inner circle, was intermittent and incomplete).
But the Sorkin article puts the spotlight on a different issue: the abject failure to prepare for bankruptcy. Not enough attention has been given to something made clear in his book: no one talked to a bankruptcy attorney about what a bankruptcy filing would entail. While Lehman had retained Harvey Miller, he was out of the loop and stunned when told to file. In addition, due to the utter lack of preparation, Lehman didn’t simply file for bankruptcy, it filed on a thin form, meaning it went bankrupt in the most disorderly fashion possible. A more complete filing would have been less disruptive; this badly flawed process is remains a not-well-recognized self-inflicted wound.
Cassidy, Salmon, even Sorkin – why do these people pretend to know what was really going on? Do they really think they know all details concerning the interest of Barclays towards LEH ? Especially what kind of guarantees Barclays would have asked from Treasury/Fed and what kind of warranties concerning LEH books?
NO. Sorkin has been played as an intelligent Disinformation avenue. “Too big to fail” is a very bad book in the sense that he – at least in the book – never asks the question: “Is this logical or plausible?. He never questions motive of key players (f.e. Dick Fulds prime motive must be to spend his life and money out of jail).
The truth will never come out. It is too ugly for the public to see. Otherwise Dick Fuld and his gang would long have faced criminal charges. But they might talk and “the system” cannot allow that. So they go free. On a certain level it is a simple as that.
Exactly. The travesty is that banksters and their proxies still control the debate after all the destruction they wrought.
The real debate is whether AIG should have been rescued, not whether Lehman could have been. Letting Lehman fail may be the one thing they did right, since it exposed the whole scam to many more people.
“Other witness scheduled to testify include New York Fed General Counsel Thomas Baxter, Fed General Counsel Scott Alvarez, and JPMorgan (JPM.N) Chief Risk Officer Barry Zubrow.”
This also goes against Mr. Baxter’s testimony that Mr. Geithner was a much bigger fan of “plan over no plan” at every step.
The panel including Mr. Fuld was much more interesting excluding his testimony.
Mr. Baxter kept deferring to Mr. Zubrow, he was not that familiar with the “banking end of things”. The visual dynamic was very familiar. The regulator looking at the regulated for permission to speak.
So, was the plan to let JPM call the shots through the NY fed? Plan over no plan.
Sorkin’s piece doesn’t seem to have anything that’s different from what he already wrote in his book. It’s just more of the same. Yet here he is claiming to have a new story. Oh well, that’s what these guys do…
As for the shareholder approval, isn’t that always a heads-I-win-tails-you-lose thing, a rationale ready to be applied either way in any case based upon what you want to do?
Dimon wanted to do the Bear deal, so voila, they didn’t need immediate approval. But the FSA either didn’t like the Barclay’s-Lehman deal at all, or else were trying to bluff the Fed into guaranteeing it, so suddenly such approval was imperative. It’s like Stalin bamboozling FDR over having to answer to the Politburo.
I read this morning that Diamond has become the Barclay’s CEO. From Sorkin’s book one gets the impression that Diamond as impresario was gung-ho about the Lehman deal and made all kind of assurances on this side of the pond which the British hadn’t authorized him to make.
One of the many comedic passages is Paulson, Geithner etc. whining about how the British blindsided them. As if they hadn’t been believing what they wanted to believe all along. It said the FSA guy had been trying to get Geithner on the phone for a day to discuss this, and Geithner was just blowing him off, he was so euphoric about the supposedly pending deal. But afterward he whined, “Why didn’t they tell us about this sooner!”
In addition, Barclays needed preliminary approval from the then British Chancellor, Alastair Darling. He declined to give it “Bank of America had looked over the books and refused to take it over. It made you wonder what was wrong with it [Lehmans]” or words to that effect. Souce: RTE1 documentary Freefall – interview with Alastair Darling. With no opportunity for due diligence and a valuation, someone had to underwrite the losses – either the buyer’s government or the seller’s government. Neither was prepared to risk an open-ended arrangement.
Contrast with the hole that is AIG – the Fed and the Treasury must have known they were taking on rubbish, but they were left with little choice so soon after Lehmans. One big collapse causes turbulence that takes months to subside. A second would be too much of a risk.
I agree with Hubert, and wrote a letter to the times regarding Sorkin’s uselessness. he makes certain statements based on “convenional wisdom” that have the authority of fact when they are in fact very debate worthy.
The hedge fund article for instance when almost each and every one of the fund managers arguments don’t stand up to th elight of day. When I see sorkin I see a reporter who has apparently traded his integrity for access.
“When I see sorkin I see a reporter who has apparently traded his integrity for access.”
Plus a career. I saw him in several interviews since and he comes across much smarter than his attitude in his book. He is not a fool being used. Maybe there was not so much integrity to lose from the beginning.
Why are we worried about Bernanke’s testimony? Why are we worried about Cassidy’s shot?
I’m worried about the fact that Lehman reported repo105 as a sale with no repurchase liability to be seen or reported. I take that as an accounting missrepresentation of the true state of the Lehman Balance sheet and the true state of the firm’s finances. I’m worried that there was no regulatory challenge. I’m worried that the auditor signed off on the balance sheet.
I’m worried that Fuld etal are not going to a criminal court let alone a civil one for the act of financial missrepresentation. Fifty Billion is not chump change. Now, could it be that no one wanted to buy Lehman ‘as is’ because it was self evident that the books were a fiction?
I’m worried that no one is willing to directly say that dissoulution was the only course available because the liabilities were so large relative to tangible assets when valued at liquidation.
I’m not a Bernanke fan, but sending Lehman to the bankruptcy court was the appropriate action. The fact that they arrived in such dissary as to create a large mess is a problem attributable to Lehman’s management and not necessarily the Fed or the Treasury. The responsibility of the Fed and the Treasury lies in their willinglness to allow Lehman to over lever and to cook the books.
Too Big To Fail is a whimp mind set. So we allow bankruptcy to occur and then we get a cascade of failures and the financial system comes to an abrupt halt. That’s peachy keen. Just nationalize the bankrupts and begin the process of wiping out the share holders and unsecured creditors and then calculating the haircut that secured creditors are to receive and then selling what’s useful and workable to new, solvent, private ownership. Might take five or ten years, could have been the right solution.
Worrying about Cassidy’s miss directed blurt is like looking at the wrong clock. I worry about the fact that there has been no criminal prosecution. I worry that the Congress has enacted legislation without the benefit of reasoned inquiry and which legislation may prove to be ineffective in curing the problem.
Agree w/everything you said.
additionally, in larger context: the complete record of FED/TREASURY “deliberations” in this episode is woefully incomplete. Your mention AIG aspect, but there’s a record of ongoing daily conversations between Big Ben/Hank and GS prior to decisions, yet little more then a couple leaks as to precise content of those conversations.
The gap between what’s known of AIG/GS intertwined liabilities and factual disclosures is too wide a chasm to close given available information.
My view of things is, deal with what is… what happened. Lehman got the boot. AIG-GS conglomerate got the bailout. I’d like to see (though I accept it likely won’t happen, at least in my lifetime) a reliable documentary record of how those decisions were made.
I’d also like to see the docs publicly distributed – particularly anything related to AIG (and AIGFP).
Siggy, thanks for this:
Too Big To Fail = wimp mind set.
I’ve never seen it stated so succinctly.
We are in agreement. see the last para before the addition re Sorkin. There were massive regulatory failures well before Lehman finally hit the wall. Focusing on “coulda woulda shoulda” that weekend, and particularly the debate over whether Lehman should have been rescued, conveniently diverts attention from the real issues.
And of course all those problems with responsible regulatory oversight have been resolved, right? Name one of any substance!! Nothing in that wonderfully gutted financial reform bill. Nothing has been fixed.
Keep up the good work Yves. Hound the dog(s)until it is fixed.
You are absolutely right. We’ve merged moral hazard and TBTF into a perpetual loop. We’re all working for the bankers now.
In terms of any kind of perp walk, the Supreme Court might have made that superfluous in its June 2010ruling on the “honest services” anti-fraud law, freeing Jeff Skilling, Conrad Black et al. It’s not enough to argue that employees or public officials weren’t doing their jobs honestly:
I don’t know how you’re going to convict any white collar criminal with that kind of standard of proof. Maybe under “fiduciary duty”.
The week before, was the RNC’s convention where Sarah Palin was introduced. The McCain/Palin ticket took a 7 point lead over the domocrats. First lead in the election.
That Sunday night, the decision was made my the NY Fed to allow Lehman to fail.
By Monday, news was out. And Obama now had the 7 point lead.
Who was the person at the NY Fed that made that decision? Our newly Obama appointed Treasury Secretatry.
You’ve got that conspiracy theory wrong. Geithner is an elite bureaucrat. conservative in his decisions. He was not driving the bus on this one, despite being head of the New York Fed. Paulson was very opposed to another bailout, early on, and that in turn came from the REPUBLICAN reading of the politics, the Bear bailout had been hugely controversial, particularly with their base. Paulson’s nickname has long been “the Hammer.”
The Paulson/Bernanke plan was clearly to kick the can down the road to the new administration. That is why they had so little in the way of plans.
And you think an AIG bailout, which would have happened regardless (there is no way they authorities would let the biggest financial institution in the world, when you factor in the value of its guarantees go bust, fail) would not have produced a similar backlash regardless?
Your post is full of conjecture and opinion. My “theory” is fact, not theory.
“His appointment will not pass without some criticism from those who blame him for persuading Mr Paulson not to bail out the ailing bank Lehman Brothers, which went to the wall as the financial crisis was escalating.”
No, your “theory” merely looks at two data points and assumes causality. Correlation is not causation. That’s a often a basic error in statistical analysis. For instance, there is a close correlation between the salaries of Presbyterian ministers in Massachusetts and and the priced of rum in Havana. Tell me logically why the two should have anything to do with each other.
Geithenr was not capable of independent action on a matter of the scale of the Lehman rescue. He’d have needed consent of the Board of Governors to undertake any rescue. Just read any crisis chronology. Paulson, Bernanke, and Geithner were working fist in glove the entire time. I and others were tracking this closely over the entire crisis period. It was obvious Lehman would not be rescued. This message had been conveyed loudly and clearly for months. Paulson had even managed to bully banks into putting up billions to take Lehman bad assets, and effectively enrich a competitor, Barclays. The rescue cratered over the Sunday refusal of the FSA to play ball (and the bigger strategic error of not conferring with them sooner). Considerable effort was devoted to a “rescue Lehman” effort, one which failed at the eleventh hour. The tactical mistake was the lack of a parallel plan for a longer form bankruptcy filing which would have reduced the impact of a collapse.
As Yves basically said, your theory is so far from “fact” that it might as well be residing in a different universe. Facts and conclusions, not the same thing.
A dictionary is your friend. Consult it if you’re unsure as to the meaning of a word. Starting with “fact” is as good a place as any. Look for it under the “F” tab.
“And you think an AIG bailout, which would have happened regardless (there is no way the authorities would let the biggest financial institution in the world, when you factor in the value of its guarantees go bust, fail)”
Even when they’re selling smoke?
To clarify, How did AIG backstop their guarantees?
This crisis is the economic war similar to WW’s 1 and 2. Why is no one asking that USA and via them their banks/non-banks pay reparations for causing the economic war?
And to add, why is no one saying USA is TBTF country.. If folks write of banks as TBTF, why do they stop writing of USA as the key TBTF country..