Former Treasury Secretary Hank Paulson, Federal Reserve Chairman Ben Bernanke and New York Federal Reserve Bank President Timothy Geithner in September 2018.
Opinion: Ten years on, the Fed’s failings on Lehman Brothers are all too clear
By Laurence M Ball, The Guardian, 3 September 2018
In 2007 Fortune magazine ranked Lehman Brothers investment bank number 1 on its list of “most admired securities firms”. Just a year later, on 15 September 2008, the financial world was shocked when Lehman, with $600bn (£463bn) of assets, filed for bankruptcy, causing chaos in financial markets: stock prices plummeted, credit flows froze, and markets feared that even larger financial institutions – from Morgan Stanley to Goldman Sachs and Citigroup – might fail.
The Lehman bankruptcy was shocking in part because it was unique. Other financial institutions, such as Bear Stearns and AIG, also experienced crises in 2008 and surely would have failed if not for emergency loans from the US Federal Reserve. On the eve of its bankruptcy, Lehman sought similar aid from the Fed but the policymakers at the time – Fed chair Ben Bernanke, Treasury Sec. Henry Paulson and Timothy Geithner, president of the Federal Reserve Bank of N.Y. – said no. Ever since, Bernanke, Paulson and Geithner have given a consistent rationale for their decision, one they are now reiterating at events commemorating the 10thanniversary of the financial crisis: the trio wanted Lehman to survive but rescuing it would have been illegal, and they were unwilling to break the law.
How could it be legal to rescue Bear Sterns or AIG, but not Lehman? The 2008 decision-makers say that the Federal Reserve Act requires that Fed loans be secured by collateral, which protects the Fed and taxpayers from losses if the loans are not repaid. According to Paulson and colleagues, the firms rescued by the Fed had enough collateral for the loans they needed, but Lehman Brothers did not.
Lehman executives have bitterly contested this story, saying their firm could have survived if only the Fed had treated it the same way it treated other financial institutions. More importantly, there is a vast amount of publicly available information on the Lehman bankruptcy, much of it gathered by the Congressionally appointed Financial Crisis Inquiry Commission. These and other public records provide good reason for people not to believe Paulson, Bernanke and Geithner: their story isn’t true.
Many emails and memos document the discussions among Fed and Treasury officials in the days before the bankruptcy, and they make it clear that the discussions had nothing to do with the Fed’s legal authority or Lehman’s collateral. Instead, Lehman’s fate was determined by officials’ views of the political and economic consequences of a Lehman rescue or a Lehman bankruptcy.
The deciding factor was politics: the decision-makers, especially Paulson, were unwilling to endure the intense criticism that would have followed a Lehman rescue. Having experienced the backlash from politicians and the media against the Fed’s loan to Bear Stearns in March 2008 and the government takeovers of Fannie Mae and Freddie Mac in early September, Paulson told the others: “I can’t do it again. I can’t be Mr Bailout.”
Another factor was that policymakers did not fully anticipate the severe damage that the Lehman bankruptcy would inflict on the financial system and economy. Today, Paulson, Bernanke and Geithner claim they knew in advance that the event would be a “catastrophe”, a “calamity”, and an “epic disaster”. But, once again, their claims are contradicted by the real-time record.
But what about the collateral issue that is central to the official Lehman narrative? If one examines Lehman’s finances on the eve of its bankruptcy, it is clear that the firm did have ample collateral to borrow the cash it needed to stay in business, a fact that officials would have discovered had they actually looked. Because Lehman had ample collateral, a short-term loan from the Fed would clearly have been legal, and would have created very little risk for the Fed or taxpayers. With help from the Fed, Lehman might have weathered the financial crisis and be a healthy firm today. Even if Lehman had proved to be unviable in the long run, temporary assistance would have given it time to wind down its business in an orderly way, which would have lessened the disruption of the financial system, the severity of the recession and the loss of jobs.
The events of 2008 will not be the last financial crisis in US history. Sooner or later, another major financial institution will find itself in trouble, and policymakers will have to decide whether to rescue it. We can hope that the Fed’s officials have learned the lessons of 2008, so that they stand ready to rescue the next Lehman Brothers.
Laurence M Ball is the writer of The Fed and Lehman Brothers: Setting the Record Straight, Cambridge UP.
For more on the subject, please watch this interview with Laurence M Ball:
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