One year later, and what have we learned?
The strong, almost unanimous, consensus in hindsight is that letting Lehman Bros. fail was what precipitated the global financial meltdown, or what at least accelerated and deepened it. But what if that consensus is wrong?
I ask because Joe Nocera, a gifted business columnist for The New York Times, had a front-page piece over the weekend titled “Lehman Had to Die so Global Finance Could Live,” which questions the conventional wisdom and asks what would have happened had the government and the investment banking industry found a way to keep Lehman alive.
First, consider the immediate events of one year ago this week:
- Very early on the morning of Monday September 15, 2008, the news broke that Lehman was declaring bankruptcy;
- The stock market proceeded to drop more than 500 points that day;
- Two days later it dropped another 450 points;
- The Reserve Primary money market fund “broke the buck;”
- AIG nearly collapsed and got an $85-billion loan from the government;
- Both Morgan Stanley and, even more shockingly, Goldman Sachs, were rumored to be next, and shortly thereafter turned themselves, defensively, into bank holding companies.
So much is history. Now the question is what does it mean.
Nocera suggests that Lehman “was in the wrong place at the wrong time,” and victim of a strongly time-specific confluence of events including Treasury Secretary Hank Paulson’s refusal to be seen as “Mr. Bailout” (Congress having taken over Fannie Mae and Freddie Mac only the week before, at Paulson’s urging). And this is the real reason Nocera suggests Lehman had to die: Because there was no consensus or urgency in Congress to pass meaningful legislation until something fairly cataclysmic happened.
A few months ago I read a pre-release copy of In Fed We Trust, by The Wall Street Journal‘s David Wessel, and the sensitivity of both Paulson and Fed chief Ben Bernanke to Congress’ appetite for serious commitments to reviving the financial system is a strong, ongoing, palpable theme. When would be too late and when would be too early is a constant question in their minds. Nocera writes:
Although Mr. Paulson would later say that he had no legal authority to save Lehman Brothers, it seems pretty clear from Mr. Wessel’s account that he wasn’t really looking for any authority. He wanted to send a message. That Monday morning, in announcing the Lehman default, Mr. Paulson told the media: “I never once considered that it was appropriate to put taxpayers’ money on the line” to save Lehman Brothers.
Indeed, Nocera’s argument for letting Lehman fail is even stronger: That a bigger, more embedded, more interconnected firm (Merrill? Morgan Stanley? AIG?) would have failed had Lehman been saved. In other words, while the failure of Lehman may have been the financial equivalent of the fire-bombing of a city in war-time, the failure–inevitable, Nocera writes, and I concur–of yet another more intertwined firm would have been a nuclear bomb.
Nocera–and I–believe that unless a marquee firm on the order of Lehman collapsed, that Congress wouldn’t act. Nocera again:
Almost everyone I’ve ever spoken to in Hank Paulson’s old Treasury Department agrees that without the immediate panic caused by the Lehman default, the government would never have agreed to make the loans needed to save A.I.G., a company it knew very little about. In effect, the Lehman bankruptcy caused the government to panic, which in turn caused it to save the firm it really had to save to prevent catastrophe. In retrospect, if you had to choose one firm to throw under the bus to save everyone else, you would choose Lehman.
It would be nice to be able to say that officials at Treasury and the Federal Reserve understood this at the time. But of course they didn’t. Throughout history, people have stumbled their way through crises, not fully understanding the potential consequences of their actions, hoping the choices they make turn out to be the right ones.
Here’s where it gets interesting.
Is that at all like anything you’re facing in your firm?
There are actually two strands of thought at play here.
First is whether, if you feel you’re facing uncharted waters, there’s enough of a sense of urgency among your partners to actually do something about it. The story of In Fed We Trust is largely this story: When did Paulson and Bernanke think that Congress might actually act because, as Nocera puts it, “the government [finally] panicked.” Sometimes that’s what it takes: Panic.
My strongest greatest fear by far, if it’s not too soon to look to the “other side” of this financial system meltdown and general economic interregnum, is not that things in law-land will look overly different when we emerge but that they won’t look different enough.
Already we hear the optimistic drumbeat of “green shoots” and economists’ consensus that we may be technically out of the woods: A recession is over, after all, and by definition, when GDP stops contracting. And there’s every reason to believe that may be the case in the US in 3Q2009. A school of thought is out there that embraces these indicators with alacrity, ignoring the enduring effect of historically high unemployment and frozen credit markets.
In other words, it’s more tempting than ever to embrace the canonical advice of “What, me worry?” You recall, of course, that the author of that timeless counsel was Alfred E. Neuman, sarcastically fictitious cover boy of Mad magazine. If you choose to rely on his attitude for your approach to this crisis, all I can say is “Godspeed.”
The second strand of thought is actually the intersection of two notions:
- The subtitle of In Fed We Trust could well be “whatever it takes.” This became Paulson and Bernanke’s operative mantra. But what goes unspoken in this seemingly obvious (in hindsight) piece of operative wisdom is how hard it is to actually conduct yourself that way. We far prefer to rely on the proven, techniques with precedent, reactions we’ve tried before. “Whatever it takes” implicitly brings with it the probability of the unknown, the untested, the untried. This takes courage and something else: Creativity. How strong are those virtues of courage and creativity in your firm’s executive suite?
- To work your way through this, you may have to try lots of different things. Recall Hank Paulson’s three-page double-spaced memo (with wide margins) addressed to Congress early on in the crisis asking for $300-billion and giving him unfettered discretion on how to spend the funds–including immunity from subpoenas for the Treasury Department? Well, suffice to say that didn’t go over too big on Capitol Hill. But it was a start and it was, arguably in retrospect, better than something more timid.
In other words, experiment. A characteristic of experiments is that they often fail. But the state of science would be not medieval but pre-Athenian Greece if science didn’t revel in experimentation.
Finally, the “what if we’d saved Lehman?” thought experiment reminds us of another element of decision-making: The counterfactual. It may be easy, in other words, for people to find fault with what did happen. But what if what they’re critiquing had not happened? Then what? Are you confident it would have turned out better? On what basis?
A related concept is one of the economist’s favorite tools: Opportunity costs. If we do this, what else can we then not afford to do?
I’m not suggesting the failure of Lehman was the optimal decision in a perfect world. It could be that Paulson & Bernanke & Co. benefited more from being “lucky than good.”
Then again, I strongly suggest there are lessons in how the stars aligned to let Lehman fail: Lessons for how your firm might be responding in what is still the midst of a crisis.
- Courage
- Creativity
- Experimentation
Update (15 September, 10:00 am):
The estimable Niall
Ferguson has a column in
the FT today, “Why a Lehman deal would not have saved us.” Blisteringly
tongue in cheek, he trots out all the repercussions, in a parallel universe
where Lehman was saved:
- no credit crunch;
- no near-Depression
- no Democratic landslide in November and no President Barack Obama (” It
was the severity of the economic crisis after September 15 that really doomed
Mr McCain – not least because he himself had earlier confessed his ignorance
of economics. “) - no “public option” in healthcare reform and “no town hall hysteria about
socialist ‘death panels’.” But, as he puts it, why stop there?: - ” If only Lehman had been saved and the stock market had not tanked, Michael
Jackson would not have needed to commit to those 50 comeback gigs in London.
He would not have felt so stressed and would not have taken all those sedatives.
If only Lehman had been saved, Jacko would still be alive. “
Of course, Ferguson is making the point that a decision to bail out Dick Fuld
& Co. “would almost certainly have had worse consequences than letting him
and his company go under.”
Paulson’s decision (and it was primarily Paulson’s) not to invoke the Fed’s
powers in “unusual and exigent” circumstances to save Lehman was the right
thing, even if it might have been unwitting. Why? Again, as above,
because it created “what had hitherto been lacking: the political
will for a wholesale bail-out of the US financial system.
Aaah, so, you’re saying right around this point: All is for the best?
Not so. And here is where my fear about early, self-indulgent, unwarranted
complacency comes in–no matter how comforting it might appear in the
short run. The problem is that there was no follow-on to TARP in the
form of a clear and convincing Congressional and/or regulatory statement that
“too big to fail” has been repealed. The problem is that the
few, even more enormous, financial institutions left standing feel even more
secure than ever that the government will, when push comes to shove, ride to
their rescue. As Ferguson puts it, “who would now risk ‘another Lehman’?”
Lessons learned?
To be sure, but not all of them correct.
