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Lehman Brothers, Hank Paulson and me
October 13, 2008
I have been feeling a bit guilty recently about whether I am partly to blame for the global financial crisis.
My guilt relates to the column I wrote on September 10 - which seems like an eternity ago - urging Hank Paulson, the US Treasury Secretary, not to rescue Lehman Brothers. Since then, the received wisdom has become that Lehman’s demise set off the crisis that is still unfolding.
The FT has a long and thorough analysis this morning of the Lehman question and the criticism of Mr Paulson (and, by extension, me) for being reckless in not propping up what was the fourth biggest US investment bank.
It includes the assessment by Christine Lagarde, the French finance minister, that the Lehman decision was “horrendous” and describes how it led to a crisis of confidence in US money market funds and financial institutions.
With hindsight, it is fairly clear that Mr Paulson’s impulse - to try to avoid having to prop up the entire banking system by taking a chance on what would happen if the bank failed - did not work as intended.
On the other hand, just because something does not work does not mean it was not worth trying. It clearly would have been preferable in terms of moral hazard and public budgets to have let Lehman collapse, provided that if a systemic crisis could have been avoided.
The ultimate question is whether it made any difference - whether things would have been better if Lehman was still with us. Somehow I doubt that. The forces building to a global financial crisis were so overwhelming that I cannot believe they would have been halted in their tracks by a Lehman rescue.
It is far more likely that the US government would have kept getting pushed back to the position it is in today: having to organise a $700bn bail-out package and perhaps having to nationalise banks.
Meanwhile, it is politically tempting but lacking in credibility for European governments to pin the blame on Mr Paulson’s Lehman decision.
I dont think it was wrong to let Lehman perish. I dont believe that it was Lehmans demise that created the present crisis. The crisis is bigger than any one company or even country. Nothing wrong with letting a bank fail to send a message.
Posted by: Tom | October 13th, 2008 at 6:08 pm | Report this commentHello Mr. Gapper,
If efforts to save Lehman Brothers had been made, then everyone would have wondered who was next and would there be money to save them.
If Lehman Brothers failed as it did, then everyone would have wondered who was next and would there be money to save them.
Regards,
Posted by: Gary Marshall | October 13th, 2008 at 6:54 pm | Report this commentGary Marshall
Don’t you feel just a bit self-regarding claiming that it was your column, alone of the many other possible factors, that led Paulson to let Lehman swing?
I always figure that as columnists, our job is to do our research, do the best analysis we can, and then express our considered judgment without fear or favor.
Whether people take our advice is completely their responsibility. Don’t spend any time beating yourself up over this, but carry on trying to do the best analysis and writing that you can. (The Buddhist doctrine of non-attachment to the fruits of your labors is possibly helpful.)
Posted by: Helena Cobban | October 13th, 2008 at 7:47 pm | Report this commentWhile I do not think the Fed should be bailing out any company but to let one go down and then rescue all others is unfair. It’s unfair for all those people to lose their jobs and scramble because the Feds wanted to make an example of them.
Posted by: Nicole | October 13th, 2008 at 7:50 pm | Report this commentLehman’s demise was a catastrophe. It revealed the weakness and in some ways the corrupt ways of the American banking system.
Nevertheless, when everyone in the class misbehave, its not fair to expel one student to make sure that the other start behaving.
A lot of families, careers and lifetime of savings have gone down the drain. I for one lost everything I earned and I was only a worker ant not a top ranking manager.
We who went down with Lehman can only hope that there was a greater good in this.
Posted by: ech | October 13th, 2008 at 11:12 pm | Report this commentThe first rule of civilization is equal protection of the law. Lehman is the only institution that was ordered to fail despite the fact there was a willing buyer as the FT article today pointed out. The need for government support was noted as “temporary” and the problem was a “tussle” between the FSA and Paulson. Your comments are self serving. Paulson made a mistake. Christine is right. Had there been a women in the room on that fateful Sunday afternoon, perhaps the hyperactive male egos could have seen their way to navigating the deleveraging of the global banking balance sheet without preciptating a collapse of the global money and credit markets which was directly caused by the Lehman collapse. It does seem odd that the only bank to be forced to fail is Lehman Brothers and is so ordered by the former Chairman of its arch rival Goldman Sachs, especially with a buyer, Barclays, in the wings. What really happened that Sunday afternoon and what were the motives of the actors.One thing is sure, 28,000 people, the employees of Lehman, paid a very high price and so did the rest of us as the credit markets collapsed. And now we have a former Goldman CEO as Treasury secretary, a former Goldman exec as Chief of Staff to the President, two former Goldman execs as top advisors to Paulson and the “new” 35 year old TARP Czar. Can you “conflict of interest”.
Posted by: Steve Williams | October 14th, 2008 at 3:37 am | Report this commentPlease do not take it personally.
I suppose many people who should know better are guilty of not understanding what is happening in the financial markets. The crisis is a wake-up call for all in the financial world - not least journalists who largely fail to perform their critical function. More people should be prepared to admit poor judgement and open their minds.
If Lehman had not gone bust then the wider world would still be thinking that the problem was caused by sub-prime mortgages. Instead, we now begin to accept that the problem is systemic:
- bankers no longer checking credit worthiness
- reliance on short-term money to finance long term investment
- incentives to speculators to make short-term gains
- directors not understanding the products their young traders are selling.
- stock markets becoming casinos
- financial institutions becoming bigger than national governments
- regulators failing to regulate or even stand up for common sense
- borrowing for consumption (first world) versus saving in lieu of real investment (in second world), instead of commitment to the sustainability of the planet and real long term value creation.
When historians look back on this episode I suspect they will be amazed that we muster enormous resources in no-time to bail out banks while we are unable to finance renewable energy and save the planet.
We should now realise that the causes of the crisis run deep. While everybody wants to get back to business-as-usual as soon as possible, we need to seize this once-in-a-generation opportunity to construct a financial system appropriate to a global free market economy that is bringing millions of people out of poverty and enabling a standard of living much higher than ever achieved in the past.
Posted by: Chris J | October 14th, 2008 at 8:27 am | Report this commentBy way of a dissenting view on Lehman Brothers from a non-economist, it is not worth applauding the fact that there was at least one irresponsible Wall Street institution that got exactly what it deserved?
Posted by: algasema | October 14th, 2008 at 9:26 am | Report this commentThe history (not the origin) of this crisis was that the Western banks knew by October 2007 that they collectively needed $400-600 billion new capital. They raised around half but refused to pay the market price for the rest. By June 2008, the need to force them to take up the missing capital was evident. No national Treasury acted.
By September 2008, given the political reluctance to force bank recapitalisation, trying to scare the banks into action by letting Lehman fail was the best option available. It nearly worked. Goldman Sachs accepted Warren Buffet’s terms. Morgan Stanley nearly accepted the Japanese quasi-takeover terms. But panic set in too quickly.
The failure of the Paulson Plan to stop the panic later in September opened the way for the British Treasury to overcome the political resistance to doing the obvious. Once that precedent was set, we were on our way out of the woods.
As an economist, I thought that letting Lehman fail was the best anti-crisis move that Governments would accept at the time. I also agree with algasema - one Master of the Universe getting what it earned is a worthwhile signal to give to the future.
Posted by: David Heigham | October 14th, 2008 at 1:42 pm | Report this commentStrange. i wonder if they have thought far enough before making decision on not to help Lehman bros. a month ago, paulson was so firm that he would not use govt money to help trouble institution. before that, i believe he should have thought good enough to see the chain reactions.
today, US govt money was used to inject into 9 banks. really wonder if the so called - policy maker did think carefully enough before they make a decision. or they are so short sighted.
how can the objective be changed totally in such a short period of time?
Posted by: chris hk | October 14th, 2008 at 2:37 pm | Report this commentThe financial system and the crisis are both very complex and non-static. Letting Lehman go was morally correct, and if it was saved that would have just led to another “disaster” - difference in timing and nature but probably causing even more damage. You should be proud of your view because it was the right one. The current bail out program and all artifical supports to prevent the down-sizing of the economy will have long lasting negative unintended consequences - I hope you share this view and will write about it for all our sakes.
Posted by: Takashi Ito | October 15th, 2008 at 7:49 am | Report this commentI disagree with the sentiment behind the 8th comment. I find rejoicing over the downfall of the once-mighty nothing but juvenile, whether the targets are bankers or politicians from a Party we oppose.
Sentiments of such nature should not drive government policy, much less be funded by taxpayers.
I DAMN CAPITALISM, DAMN DEMOCRACY
Capitalism, like democracy, is horrid–with the exception of everything else that has been tried.
II DAMN ELEPHANTS, DAMN DONKEYS
Recall that similar events have occured, and with largely similar responses, no matter which one animal at each instance occupied one end of Pennsylvania Ave or which herd controlled the other end.
Could it be because reality is stubbornly consistent?
III THE DOMINO TEST
A country with a people who cherish their freedoms to the extent that Americans do leaves their government no choice but to adhere to the fundamental rule:
| neither investors losing their shirts
| nor employees losing their jobs
| per se
| obliges government to intervene
–freedom of choice comes with the duty to face the consequences of the exercise of that freedom, and does not impose upon third-parties the responsibility of shielding you from those consequences.
Government is compelled to intervene only when third-parties need to be shielded from those consequences.
Mr Gapper is right–more than would saving Lehman have saved everyone else (or would the latter have fallen anyway), the question is would abandoning Lehman have itself caused others to tip over?
This and only this should determine whether and when government should intervene–until the day comes when taxpayer funds cease being a finite resource.
Posted by: J Michael AJP Llamas, ex-private banker, 39 | October 17th, 2008 at 3:27 am | Report this commentIf you believe as I do that the current problem is atleast as much a lack of trust as it is fundamental, then allowing Lehman to fail was ‘the’ fatal error. Lehman’s failure compouned the problem of lack of trust - many times over.
Another reason - What were the rules of the bailout game that Governments and regulators were playing? They allowed one institution to fail and helped others to survive. Without any clarity, how did you expect the markets to behave? Uncertainity - widening spreads and huge increase in VIX (Volatility Index) - is the answer.
What could have been averted by about $25 billion bailout has now required trillions of dollars from all around the world - due to the amount of counterparty / collateral damage inflicted.
I am certainly no advocate of government support but governments should either let the markets decide independently or intervene with some common sense / semblance of a rule.
MS that lost about 90% of its stock price would have certainly gone through the same fate were it not for Government help.
If markets were allowed to decide, the result would have been a very painful albeit shorter recession.
A planned relief or baiout based on some sense of common rules would have made the recession longer but perhaps less painful. In both cases, however, the excesses and extra leverage built into the system were required to be washed out.
By allowing one big institution to fail while helping others, Hank Paulson has chosen the worst of both cases for the world - a long and painful recession.
Don’t try to rationalise your admission of the mistake in the later part of your blog. Benefits can be found for the worst of decisions / happenings, if only for experience sake, but is it worth it?
Nonetheless, Hank Paulson would have faced huge criticism from journalists and public alike, had he saved Lehman. Viewed this way, it was a more political rather than economic decision.
Though a minor point, a far larger amount than the required bailout, i.e. $65 billion of securities of investors is locked up in the Lehman brokerage accounts - now with PWC. It seems like a joke but PWC says it still needs atleast 1 year before giving the custody of securities back to the investors - however it wants to issue margin calls and wants investors to deposit additional capital if markets move against the positions. So while investor have lost the right to get out or realise any gains made, they are liable for any losses. Welcome to the new markets. Invest if you still have confidence.
Posted by: Abhisar | November 13th, 2008 at 10:15 pm | Report this comment