The people in charge in 2008, from Ben Bernanke on down, have said repeatedly that they wanted to save Lehman, but could not do so because they lacked the legal authority. . .
I conclude that the explanation offered by Fed officials is incorrect, in two senses: a perceived lack of legal authority was not the reason for the Fed’s inaction; and the Fed did in fact have the authority to rescue Lehman. I base these broad conclusions on the following findings:
- There is a substantial record of policymakers’ deliberations before the bankruptcy, and it contains no evidence that they examined the adequacy of Lehman’s collateral, or that legal barriers deterred them from assisting the firm.
- Arguments about legal authority made by policymakers since the bankruptcy are unpersuasive. These arguments involve flawed interpretations of economic and legal concepts, and factual claims that do not appear to be accurate.
- From a de novo examination of Lehman’s finances, it is clear that the firm had ample collateral for a loan to meet its liquidity needs. Such a loan could have prevented a disorderly bankruptcy, with negligible risk to the Fed.
- More specifically, Lehman probably could have survived by borrowing from the Fed’s Primary Dealer Credit Facility on the terms offered to other investment banks.
In short: Bernanke lied, Lehman died.
My thoughts:
1. Whenever you look at government policy in financial markets, assume that the primary goal is to allocate credit to preferred borrowers, particularly toward governments themselves. This goes for regulatory policy and so-called monetary policy.
2. I am inclined to interpret the decisions made in 2008 as credit allocation decisions based on Hank Paulson’s personal whims. Note that Ball says
The record also shows that the decision to let Lehman fail was made primarily by Treasury Secretary Henry Paulson. Fed officials deferred to Paulson even though they had sole authority to make the decision under the Federal Reserve Act.
The decisions helped some investment banks, including Goldman Sachs (the “AIG bailout” was mainly a funneling of short-term Treasury securities to Goldman and other investment banks). The decisions hurt Freddie Mac, Fannie Mae, and Lehman. I think that is what Paulson wanted to see happen.
3. Whereas Ball seems to suggest that the Fed should have bailed out Lehman, I am more inclined to believe that the government should have allowed institutions to go through bankruptcy or to make concessions among themselves. By the latter, I mean that if nobody bails out AIG, then maybe Goldman and the others decide that “collateral calls” are only going to hurt themselves in the long run, so they allow AIG to keep some near-term liquidity, and it ultimately survives.
4. The consensus story from the establishment is that Bernanke and Paulson saved the country from another Great Depression. Maybe that story is right, but with my heterodox views I do not believe it. I think that many ordinary citizens do not believe it, either. The widespread suspicion of the establishment gave rise to such phenomena as the Tea Party and, arguably, Donald Trump. It would be easier to defend the establishment if you could say that Bernanke was telling the truth.
It isn’t about having adequate collateral, but adequate unpledged collateral. The Fed did encourage Lehman to do a deal which Lehman was in denial about, so it wasn’t just the Fed, but where to draw the line is always a political decision, and lacking cover was one they wouldn’t take, but it was about forcing buy in by congress which is the most appropriate venue for political decisions. Even Goldman did a deal which bought it time.
Yes, bankruptcy is expensive, but given the 15% payout, does anyone really think the Fed was unjustified or that such loans would have been good?
Please explain?
Lehman bondholders obtained 15% of their money back from bankruptcy, 85% losses. Does that sound like mere illiquidity? Yes, the Fed could have made them whole, but it would be the Fed making them whole, not Lehman, and wouldn’t everyone be pleased with that?
The Fed could have offered Lehman billions for 90% of the equity but as we saw from AIG, no one would have been happy about it, not even equity holders who would only be looking at their losses.
I am of the simple opinion is everything was so bad, no matter make direction the Fed or Treasury moved the Financial Crisis still occurs. If Lehman is saved then Merrilyn Lynch or AIG freeze credit markets.
In terms of your solutions, I suspect the crisis still happens and credit market freeze in October.
But THEY didn’t think that. They let Lehman go on purpose thinking the problem was moral hazard. I know we can’t believe a word they say unless by accident, but this is what they said and I believe they believed it. Then they opened the floodgates for others.
I always assumed leaders did not believe it would freeze markets that much. We would have a rough six months but not complete frozen markets.
So…they were just disastrously wrong about their job?
Their job is to start tapering WAY beforehand so that they are loosening when they were still tightening. They demand that job, and we let them have it on the basis that they can halt the panic as the lender of last resort. Nothing excuses any of their failures, they just get to not be punished due to their privileges.
To be explicit, IMHO you can’t say “the credit crunch was just going to happen anyway” in the sense that it is their job to do whatever it takes to prevent it. Not only do they have the authority, they have the power, and they demand the monopoly entitlement to it. They just cut and run like a child from a broken vase, but they have no excuses. If the only way to do it is to set up an NGDPLT market, then where is it?
To me, it’s not even a question. Google “Fed Funds Rate and Mortgage rates” If they didn’t cause the boom then the bust they were certainly trying their damnedest, and it certainly looks like it, and it is obviously the null hypothesis.
Then, they saved Bear Stearns, but didn’t save Lehman because…[reasons]. And when what everyone knew was going to happen happened they got away scott free. Not only that, the banks got even bigger.
You can’t broker deals in a real-time panic because (1) It didn’t work and (2) “working” is the banks get bigger.
So, where is their next idea?
“saved the country from another Great Depression” <> $500 bln in 2007 >> down to $200 bln after Mortgage Secs & CDOs drop).
1) Depositors get 100% up to $250 000; after that they are like other short term creditors. (Let’s say it’s $10 bln)
2) The other $100 bln short term plus $400 bln creditors split the $50 bln in short term cash (& equivalents) plus get New Equity in re-capitalized firm whose debt becomes equity shares of the $200 bln ($450 bln in prior debt becomes $200 bln ownership capital).
{A better example of debt to equity would also be welcome.]
The point is, no new gov’t money was needed UNLESS the reckless lenders of $500 bln needed to be saved from their losses.
And the Fed could easily have let the smaller banks have more cash to make new loans. This means that any Main Street company needing a bank loan could go to a smaller or mid size bank.
The lending market could have continued without the temporary loss of loan-making by the Big Banks while their reckless equity owners reap the losses they deserve from their careless bubble fueling loans (with high fees! and bonuses!).
Supporting Paulson’s bailout of reckless Big Banks was Bush’s worst mistake; but John McCain and Barack Obama also made it.
Please also note that from 2006 – 2007 – early 2008, the CDOs & mortgage based securities were dropping in value. Home building stopped in 2006, the peak passed and the small speculators who had been flipping soon stopped buying; all home-buying “investors” stopped buying.
There are not good numbers for how many illegal immigrant workers stopped making construction money, but it was probably around 1 million, undocumented and NOT showing up in the unemployment numbers. Their HUGE loss of income started a bottom drain trickle away of many cash only businesses, which reduced the buying of the fully taxed & tracked markets.
This is why the tracked markets of 2006-early 2008 didn’t show the rot — unemployment hit the illegals first, and very hard. Scott Sumner claims the GDP growth of this time means the problem was not a house bubble pop problem.
But the MBS & CDO prices and Mortgage broker companies started hurting in 2006. Many went bankrupt in 2007. Failure of the Big Banks and the Fed to see these warning signs and take action is totally their incompetence / arrogant pride / herd mentality-herd protection. Dr. Michael Burry (The Big Short) had difficulty creating a market to short these securities, because the arrogant Big Banks didn’t think it worthy — once created, he made about $1bln thru shorting them (and lost the friendship of lots of investors).
Moral Hazard is real. According to Too Big to Fail, the head of Merrill Lynch sought refuge with Bank of America only when he realized the Fed was not going to bail out Lehman.
The failure was not in bailing out Lehman; the failure was in bailing out Bear Stearns.
If they bailed out one why not the other?
The solution probably shouldn’t be to force consolidation.
So, the perhaps the failure is not having a non-bailout solution heavily advertised long before implicit bailouts that don’t happen make people panic.
“gave rise to such phenomena as the Tea Party”
Not really. It gave rise to a new name for the John Birch Society which had always been a part of the GOP. Combine the crisis with a black president and the birchers once again had a huge seat at the table.
Strangely enough, the chief funding sources of the Tea Party were also birchers, as they took over the political part of the family business.
So, we note that you don’t recognize the anti-establishment trend. So, we take note that you believe the trend driving all marginal geopolitics just isn’t a thing. Presumably the Tea Party arose because the John Birch Society wanted a new name. And it was successful, because simply changing names took them from an obscure bogeyman to actually achieving national prominence, influence, and seats in Congress. And Occupy Wall Street must just be the Weather Underground’s re-branding campaign.
We have noted your position. Now back to the actual conversation about The Fed and bailouts of banks.
The reason is that I see no such “anti-establishment” trend in the Tea Party.
They just want their 1950s back.
I understand that you don’t see it. But that’s all that means, you don’t see it.
They obviously arose at the time they did and for the reasons they did not because they just realized after 60 years that it isn’t 1950.
You see, we here don’t focus on Occupy being a bunch of unregenerate communists, even though that is actually true.
We are interested in what it means, not strawmen for hack partisan politics.
They did not arise, they were always there. They made the mistake of being too obvious in the early 60s; the Southern Strategy masked their thoughts; and the election of a black man made it politically correct to be openly racist instead of just “states’ rights” coverups.
And that begat Trump.
Of course they arose, and they did so at the time they did for reasons.
You guys are so funny. Probably more of you guys know buzzwords like “Kock Brothers’ and “John Birch Society” than the Tea Partiers.
The Tea Party movement began when Rick Santelli called for a Tea Party, using the words Tea Party, in response to government bailouts.
I talked to a banker once who used to work at Lehman but left to work at Credit Suisse. He told me Lehman had a reputation on ‘the street’ (his words) for not employing any lobbyists. In other words, they didn’t get the bailout, because they didn’t have a senator in their pocket whining about them to Paulson and Bernanke. I should note this particular banker was a libertarian…