On Bailouts, Lehman, and History

The lingering economic crisis has resurrected questions on the level of government involvement necessary to sustain the economy.  In particular, the issue of Lehman's demise (against the backdrop of the rescue of AIG and others) has garnered additional attention, with a Reuters piece in the NY Times positing yesterday that a package of $25 billion in shareholder warrants (to offset $25 billion in losses) could have saved the 121-year old Wall Street giant.  See "Are 'Bail-Ins' The Answer?", NY Times (Sept. 20, 2010).

But it would seem that a prerequisite to macro-economists, regulators, and creditors embracing maverick solutions in the future is a thorough understanding of what happened in the recent past.  Much light has been shed on the tumultuous fall of 2008 by a range of economic reporters seeking to reconstruct events at locales ranging from boardrooms to corporate jets to government offices.  That prose has supported the notion that the government "let" Lehman fail.

For example, in The Sellout, Charles Gasparino recounts Treasury's stance against rescuing Lehman ("I'm being called 'Mr. Bailout'" - Treasury Secretary Henry Paulson) and contemporaneous view at the Federal Reserve that government assistance was still feasible ("We could have done something if Lehman had a buyer," according to "one senior Fed official").

Meanwhile, In Fed We Trust by David Wessel details the unsuccessful offer by the Lehman CEO to the New York Fed to save the day by splitting the firm into salvageable halves, "if only the government would come up with $4 billion."  Mr. Wessel's version reiterates the government's dependence on a private sector solution but adds the following:

Despite all of Paulson's assertions, {Tim} Geithner, {Ben} Bernanke, and  {Fed official Kevin} Warsh all expected the Treasury to endorse a Bear Stearns-style loan by the Fed if Barclays and the Wall Street firms couldn't come up with enough money.  The numbers kept changing, but in the end, other Wall Street firms and the government would have to come up with roughly $10 billion to close a gap that would remain if Barclays did the deal.  The eight firms agreed to pitch in about $4 billion basically to protect themselves from the consequences of a Lehman bankruptcy.             

House of Cards by William Cohan tells a tale culminating in the refusal by the Fed to guarantee a portion of Lehman's assets:

The Barclays [bailout] deal required the blessing of the Financial Services Authority in London - the UK equivalent of the SEC.  So Paulson spoke with his UK counterpart, Alistair Darling, the Chancellor of the Exchequer, and to the FSA.  He then summoned McDade, Lehman's president...and told him...'Deal's off.  The FSA has turned it down.'  The FSA would not comment on its decision, but the reasons given...ranged from 'the overall size of the potential exposure'...to the fact that 'the FSA was looking for some kind of a cap to avoid a UK contagion, and the Fed had just said, "No assistance for Lehman."'          

Strikingly Mr. Bernanke recently told Congress that the Federal Reserve could not have prevented the Lehman bankruptcy in September 2008, while acknowledging that he may have without intention "supported this myth that we did have a way of saving Lehman."  See Sewell Chan, "Bernanke Says He Failed to See Financial Flaws," NY Times (Sept. 2, 2010).

Perhaps the primary lessons are that "government rescue" is eye in the beholder, and that economies have become so global as to elevate regulators everywhere.  Others may cite to the need for caution in press statements (and testimony before Congress), or the overall futility of poring over embers after a fire.  To me, the salient moral is that, despite election year rhetoric on bailouts and socialism, even intervention by the mighty Federal Government is conditioned upon the good faith cooperation of the private sector.  In these complicated times of internecine capitalism, such should serve as a guidepost for measures ranging from billion dollar bailouts all the way down to brokerage rules requiring internal enforcement.  And the Lehman disaster - whatever its proverbial last straw - must serve as a haunting reminder of what happens when both the regulators and the regulated fall victim to fears as ephemeral as public perception, or as indefensible as ideological intransigence.       

--JSC, 9/21/10