Thursday, October 16, 2008

The Lehman Myth

The idea has taken hold in France--promoted first by Christine Lagarde and now relayed by Le Figaro--that Lehman was deliberately allowed to fail in order to set an example for the financial industry and put an end to the "moral hazard" critique addressed to the Fed, and, furthermore, that if this had not been done, the whole crisis of the last few weeks could have been averted. If Ben Bernanke is to be believed--and I, for one, believe him--this is not what happened. Here is a relevant excerpt from his testimony, which can be read in its entirety here:

Q: Many market participants I talk with think that the way Lehman was allowed to fail caused substantial damage to confidence and to the access to credit of other financial institutions. Do you think that criticism has some merit, and if so how might it have been done differently, and could it be done differently if there were a similar situation under the TARP?

Mr. Bernanke: So, Lehman was not allowed to fail that in the sense there was some choice being made. There was no mechanism, there was no option, there was no set of rules, there was no funding to allow us to address that situation. The Federal Reserve's ability to lend which was used in the Bear Stearns case, for example, requires that adequate collateral be posted so that we are not taking credit risk, we are lending against collateral. In this case that was impossible. There simply wasn't enough collateral to support the lending. From the Treasury's perspective, unlike the FDIC, deposit insurance fund, there were no funds, there was no option. We worked very hard over one of those famous weekends, with not only some potential acquirers of Lehman but we called together many of the leading CEOs of the private sector in New York to try to come to a solution. We didn't find one, and therefore we were unable to do what we wanted very much to do, which was to prevent the failure of the company.


Boz said...

It's the same as the storyline about the 2006 bombing of the mosque in Samarra. The Bush administration likes to claim that it was that one disaster that set off the terrible waves of sectarian violence in Iraq, conveniently ignoring the months if not years of increasing violence beforehand under their watch. If Lagarde can point to that one instance, it's easy to blame it all on Bernanke and Paulson and forget everything that led up to it, as well as the various mistakes made on both sides of the Atlantic. Not that they don't deserve blame, but..

Anonymous said...

Hmm, but in the Bear Stearns case, the Fed arranged for a takeover by agreeing to limit the acquirers losses. The form of the limit was a non-recourse loan against Bear's mortgage securities. If the Fed was willing to call that sort of toxic waste "adequate collateral", then it surely could have found something Lehman held to lend against. Given a sufficient guarantee against losses, there would have been a buyer for Lehman. (After all, one emerged as soon as it was bankrupt.) So I'm skeptical of Bernanke's explanation.