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.