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Lehman Failure: was it Hank Paulson who said "Bolivar cannot carry double"?

Note: The quote "Bolivar cannot carry double" is from famous story by O Henry. The Roads We Take

[Sep 21, 2010]   Getting Lehman Profoundly Wrong By Vincent R. Reinhart

September 21, 2010 The American

The bankruptcy of Lehman Brothers is widely misunderstood: We have inverted a morality tale about individual recklessness to become one about collective culpability through inaction.

This month marks the second anniversary of a colossal failure that has shaped financial officials’ response to the ongoing global crisis, legislators’ attitudes toward reform, and the public’s perception of fairness. The failure is the fundamental misunderstanding of the events surrounding the bankruptcy of Lehman Brothers. We have inverted a morality tale about individual recklessness to become one about collective culpability through inaction.

Lehman failed as it should have failed. That we have ex post made it the fulcrum of the financial crisis misrepresents events in three material ways.

First, while it is hard to remember, prior to March 2008, no one really believed that the Federal Reserve would lend to an investment bank, in part because it had not done so in sixty years. We still do not know why the Fed lent to Bear Stearns. Were there alternatives short of lending to a nondepository? Fed officials have never explained why they twisted its discount window away from its original purpose. The Fed’s lending facility, which was designed to deal with illiquidity, became an equity-acquisition vehicle to cope with insolvency. This was the first step of a journey in which the nation’s central bank would undertake fiscal policy—that is, put taxpayer funds at risk. It was also the first of several missteps caused by treating a solvency problem as one of illiquidity.

Fed officials have never explained why they twisted its discount window away from its original purpose.

Lending to Bear Stearns put a spark to the notion that many institutions were too big or too interconnected to fail. Therein lies the second problem with stories that put all their weight on Lehman. As the crisis wore on and the bailout tab got bigger, appointed officials recognized the need to get the approval of Congress. Since the political system does not get into gear easily, that required saying no to someone, sometime. The Fed drew the line at Lehman. They might have been able to let the process run a few weeks more and let the tab get bigger, but ultimately they would have to stop. And when they did, expectations would be dashed and markets would adjust. If Lehman had been saved, someone else would have been left to fail. The only consequence two years later would be when we commemorate the anniversary of the crisis, not that there would be a crisis.

Third, not helping Lehman shifted market participants’ perception about the perimeter of the safety net. Within the week, government officials would act in a way that elevated uncertainty about the form of intervention. In the putative resolution of Wachovia, regulators arranged that debtors would be kept whole. At the same time, different regulators required haircuts for the facilitated takeover of Washington Mutual. Those actions, well within the regulated sphere, were as consequential as Lehman’s failure for the interbank market. Moreover, subsequent official comments to justify their actions and to build support for congressional legislation to fund a bailout seriously damaged confidence.

Government officials acted in a way that elevated uncertainty about the form of intervention.

But we like neat stories and a tight timeline. We also are at the mercy of event studies. If stock prices go down, we need to trace our path back for a trigger. But Lehman’s failure was a mistake of our own making that marked the culmination of a process involving decisions by unelected officials. And it was not an isolated policy misstep.

There has been another casualty caught in the wreckage of Lehman Brothers over the past two years: Financial authorities have surrendered some of their credibility. As a case in point, Federal Reserve Chairman Ben Bernanke has offered three different descriptions of the rationale for not extending unusual support to the investment bank. He first told a congressional committee in the immediate aftermath that “counterparties had had time to take precautionary measures.” Inaction was described a year later in another congressional appearance as an unavoidable calamity, in which “The Federal Reserve fully understood that the failure of Lehman would shake the financial system and the economy. However, the only tool available to the Federal Reserve to address the situation was its ability to provide short-term liquidity against adequate collateral.” That is, the government had an inadequate range of tools to the circumstances. In the past month, however, the Financial Crisis Inquiry Commission was told by the Fed chairman that “any attempt to lend to Lehman would be futile and would only result in a loss of cash.” Evidently, it was not that markets were prepared or that nothing could legally be done. Now we have been told that nothing would work.

Recognize that this is not a Rashomon effect, the same events remembered in different ways by different people. Nor is this a refined understanding brought about by unearthed information. This is the same person, at different points in time, characterizing policy makers' thought processes in mid-September 2008. By default, it must be that convenience dictated this sequence of “needn't, couldn't, and shouldn't.” This sequence, unfortunately, is informative of the reliability of future public disclosure.

Selected comments (from Getting Lehman Profoundly Wrong (Right) The Big Picture)

d4winds: September 21st, 2010 at 11:57 am

Reinhart’s entire essay is outstanding & well worth the very short read. He is among the seeming few pundits (BR is another) to correctly see the 2008 financial crisis as one of solvency not of liquidity. As he notes, the bail-out process started before Bear Stearns’ well-cushioned fall with the Fed opening the discount window to investment banks (& subsequently with the dodgiest of “collateral”) and continued with FDIC full/partial guarantees to bondholders of Wachovia/WaMU. He justly eviscerates Bernanke for his contradictory (ergo, mendacious) ex post justifications for the same events. It’s a good read

Petey Wheatstraw:
“We have inverted a morality tale about individual recklessness” into something entirely different “about collective culpability through inaction.”

Yeah, there’s that, if you want to keep it shallow by framing it as an issue of morality and shared culpability.

It’s not a morality tale. It’s a complete and total acceptance of institutionalized moral turpitude of the highest degree and most dangerous form: Organized crime.

In reality, it should read like this: We have abandoned the rule of law, and allowed individuals (natural and corporate “persons”) continue to profit from their massive, ongoing, and blatant criminality. While we, the general public, aren’t culpable for the crimes directly, we never raised a hand to stop them from victimizing us (we’re strong enough, but alas, too stupid), and, in that sense, we get what we deserve.

Most of what ails us is, always has been, and will continue to be, situations best dealt with by law enforcement. Too bad we don’t have anyone enforcing the law. Who is running the FBI nowadays? That used to be a high-profile position. Treasury and Justice Depts. and their agents/lawyers have already been captured by the Corporatists.

There is no such thing as individual recklessness when you can hide behind a corporate shield.

Mark E Hoffer::


nice point, though, remember, no matter how “Big” the “Picture, there are, always, Frames.. ~~

and, here:

 “Reinhart’s entire essay is outstanding & well worth the very short read. He is among the seeming few pundits (BR is another) to correctly see the 2008 financial crisis as one of solvency not of liquidity. As he notes, the bail-out process started before Bear Stearns’ well-cushioned fall with the Fed opening the discount window to investment banks (& subsequently with the dodgiest of “collateral”) and continued with FDIC full/partial guarantees to bondholders of Wachovia/WaMU. He justly eviscerates Bernanke for his contradictory (ergo, mendacious) ex post justifications for the same events. It’s a good read.”


some things should be re-read..


Vincent Reinhart says that he still doesn’t know why Bear Sterns was saved by the Fed.

So, since we’ve figured out that Lehman’s (disorderly) liquidation was the right thing to do, what about Bear? Or was it *really* about saving Bear, or about saving JPM????

And isn’t it a fact that unlike Bear/JPM, Lehman’s collapse only removed another competitor of GS?


[Sep 07, 2010] Lehman: Doomed By Short Term Funding By Barry Ritholtz

September 7, 2010
Amongst the items coming out of the FCIC hearings last week were new docs that revealed exactly how over-reliant LEH was on daily, short term funding to cover their longer terms costs. It was a recipe for disaster, a trailer park in search of a tornado.

Here is the WSJ:

“In looking last week at Lehman’s demise, the Financial Crisis Inquiry Commission produced testimony and documents that suggest the firm’s short-term funding was a serious problem well before its Sept. 15, 2008 crash. The new Lehman material is a brutal reminder of the flightiness of short-term debt. And it begs the question: Why didn’t Dodd-Frank do more to limit banks’ use of things like repo markets, in which banks take out short-term collateralized loans?

It was in the repo market that Lehman experienced stress from early 2008. J.P. Morgan Chase, which plays a central role in the “triparty” repo market, decided to introduce a reform in early 2008 aimed at making the market safer. The firm decided that borrowers would have to start providing collateral that slightly exceeded the intraday amounts it had advanced them. This extra collateral is called margin. When discussing the change, a Lehman executive called it “a problem,” in a February 2008 email contained in FCIC documents.”

There are many other factors that the FinReform did not address — I have a post coming up on that for the anniversary of LEH’s demise.

What has always mattered most to financial firms are base capital amounts and leverage. Plunging headlong into both residential and CRE funding in a mad dash for profits led to firm’s having too little of the former and too much of the latter. That, in the simplest of terms, is why Lehman died. Everything else written about the deceased is merely noise . . .

Lessons of Lehman’s Flighty Funding
WSJ, September 7, 2010

September 7th, 2010 at 10:23 am

not seeing much useful from the FCIC and a lot downright misleading.

like this.
no doubt liquidity fleeing and unreplaced was the coup de gras.
but the other side fuld etc just argued we were ONLY illiquid.
and “you” killed us by withholding liquidity you gave others?

sources for proof of Lehman insolvency are Valukis, Jim Chanos calculating $150 bio underwater, even Paulson conceding “capital hole. ” Bonds settling for less than 10 cents on dollar. thats the last word.

September 7th, 2010 at 10:43 am

Interesting point.

The Texas S&L crisis in the 1980′s was based upon very similar concept: they used short term debt to finance long term assets. That didn’t work out so well.

Will we ever learn? (Rhetorical question… my own answer to that is “no.”)

September 7th, 2010 at 10:45 am

but don't want to dismiss the repo market prob.
you are right there.
they were repoing garbage and JP morgan, who knows what its doing, realized they needed extra collateral.

Mark E Hoffer:

maybe, We should remember this

MAY 23, 2006

Intelligence Czar Can Waive SEC Rules

Now, the White House’s top spymaster can cite national security to exempt businesses from reporting requirements

President George W. Bush has bestowed on his intelligence czar, John Negroponte, broad authority, in the name of national security, to excuse publicly traded companies from their usual accounting and securities-disclosure obligations.

Notice of the development came in a brief entry in the Federal Register, dated May 5, 2006, that was opaque to the untrained eye. …


Short-term funding to make long-term loans i.e. maturity mismatch is the profit mantra of any bank, isn’t? Why have precious capital tied up in long-term (and expensive) funding costs?


Barry: “Plunging headlong into both residential and CRE funding in a mad dash for profits led to firm’s having too little of the former and too much of the latter.”

Those two are the consequences of regulatory capture and accounting fraud. Fix that and you will never have “too little of the former and too much of the latter”


what? you mean Dick Fuld is – being disingenuous!? But…
“Fuld has consistently refused to accept that he did anything wrong at Lehman. [He] has previously said he would wonder “until the day they put me in the ground” why the US government allowed Lehman to go bust”


Fuld continued to increase his exposure to the risky assets in res/com RE thinking he was going to be positioned for a big win when the RE market stabilized and turned around — he bet wrong, he bet the company and he lost the company. Fuld hid LEH problems from the public, the regulators, the rating agencies and the analyst through the repo 105 off balance sheet manipulation.

The american people will wonder “until the day they are put in the ground” why Fuld and the other banksters are not in jail and debarred from holding an executive or director position at a public company until they are put in the ground.


The short term funding issue that LEH… and all other broker dealers and specialty finance companies, such as GMAC and GE, had. Maybe more pronounced in some cases than others.

But I have no doubt that BSC, MER and LEH would have survived, if they had had access to Fed liquidity sources as GS and MS did.

Remember that in those ugly days of October 2008, hedge funds were pulling their money out of GS and MS like crazy, a run on the bank. At least, John Mack had the humility to recognize past mistakes and appreciate the hand received from the govt.

I think the question that Congress is conveniently avoiding is why govt decided to save GS and MS while forcing LEH into bankruptcy and BSC and MER into sales.

Coming from Argentina, I have experienced a few banking crises and I have never seen such an unfair distribution of the costs as in the US. I’m still scratching my head when I see that some of the key players have not lost a penny in the worst financial crisis since the Great Depression.

Don’t get me wrong, Congress should hang Fuld, but by pointing our fingers to LEH, we’re relieving other players of their responsibility in this mess (including other bankers, geithner and bernanke). And if we do that, we’ll be just removing a tumor, not curing the cancer.

[Sep 07, 2010] CrowdQuery Greatest Mistake of the Crisis By Barry Ritholtz

September 7, 2010 | The Big Picture

In this morning’s NYT column — Lehman’s Last Hours — Andrew Ross Sorkin wrote:

“But what is clear is that the politics of the moment played a factor — or at least was discussed among senior and junior staff — in the decision not to lend to Lehman Brothers, perhaps the greatest mistake of the crisis.

While there is no question that our leaders at the time worked around the clock to find a private market solution for Lehman — and I have praised them in this column for staving off another depression in the wake of the panic that followed Lehman’s collapse — its failure should go down in history as a gigantic misstep. (In truth, though, no one has yet to offer up another option for the government.)”

Andrew’s book does a good job in describing what happened; but I am more interested in Why this happened.

Hence, I disagree with his conclusion. I suspect that the bailing out of Bear Stearns was the worst mistake of the crisis.

Why? It allowed banks to forestall raising capital; Almost as bad, it affirmed to bankers that they would be rescued by Uncle Sam from the results of their own follies (assuming they could create a big enough systemic risk). The Bear rescue created a huge moral hazard. It is likely why Fuld turned down Buffett’s capital offer.

But this is merely my view. Was Lehman the biggest error? Fannie/Freddie Nationalization? Something else in entirely?


Crowd Query: What do you think was the biggest error of the crisis?

Selected Comments


 The repeal Glass-Steagall.

FrancoisT :

The biggest mistake came right after Bear Stern’s bailout. This event should have triggered an all out tsunami of Audits-From-Hell (the Japanese are consumate experts at that…just ask Yves Smith) thrown at the big banks. The egregious problems would’ve been discovered on time and in all likelihood, the worst of the crisis could have been averted.

But nooooooooooooo! The cluster of Grand Fucktards at the Fed were too busy schmoozing with the banksters and listen to themselves dissecting the ethereal and vapid nuances of their neoclassical economic theories within their private echo chamber.

BTW, they still do not understand the very nature of this Great Recession. See Steve Keen (winner of the Paul Revere Award) flame-throwing post about this here: 

call me ahab :

While there is no question that our leaders at the time worked around the clock to find a private market solution for Lehman . . .[allowing] its failure should go down in history as a gigantic misstep.

of course -- this all plays into the mindset that all must all continue as before-

I say fuck that


I forgot to add, I agree with Simon Johnson, former IMF Chief Economist, that things won’t be fixed until the corrupt elites which broke the economy get broken themselves.


What do you think was the biggest error of the crisis?

thinking that our potent directors could stop it. (this is ongoing)


Biggest mistake at the time was saving the shareholders and creditors instead of just saving the businesses, followed closely by failure to require full financial records data from all companies receiving bailout funds or guarantees (with the understanding that the data could be used for criminal prosecutions and SEC investigations).

Biggest mistake now is the near total absence of criminal prosecutions, SEC investigations, and shareholder lawsuits to bring people to account for practices that crossed the line – starting with the pay-for-rating crapola at the ratings agencies.


“…. Crowd Query: What do you think was the biggest error of the crisis?…?

Interfering with the natural selection of the market place…..

There was and still remains a huge overcapacity in the banking sector. It would have been far preferable to have liquidated those banks that could not attain capital from private investors than to keep them on life support and competing with the healthy banks. Sure it would have hurt, however by now we would be well past the hurting. The actions that were taken by the Treasury and the Fed, and the continuation of those policies have irreversibly damaged this nation to the point of turning it into a disabled state.

Lehman was a fraud and deserved to fail, that I profited handsomely from this failure is not material.

The real error and failure of the current administration has been not to pursue, capture or kill the men and women who committed this huge fraud on the American Taxpayers. Today, it can only be said that the current administration and congress are coconspirators in the greatest crime in the history of the World.

Best regards,



Our biggest mistake in this crisis and as a nation has been to get away from our trust-busting roots. We have allowed monopolies to take over in almost every aspect of our national landscape.


Bailing out Bear and AIG.

AIG was fraudulent under Hank Greenberg (I sold at $61/sh). Why would I want to bail out the counter parties to AIG, namely Goldman et al.

As a taxpayer I resent the Federal Reserve and US Treasury, Congress and the both Presidents. I longer think government can solve problems because of its conflicts of interest and the actions taken in this crisis.

Creative destruction should have been allowed for all participants.


Believing that

1) preventing / minimizing painful consequences is good and is a purpose for government

2) saving the financial system is the same as saving financial companies and their stakeholders


The largest mistake was allowing H. Paulson’s emotional dislike for D Fuld to sway his decision-making about Lehman Bros. Had he, or anyone else had an inkling as to the size of Lehman’s positions, etc. then perhaps they would have picked a different fatted calf to sacrifice at the alter of public perception.

Someone HAD to go down for the perception of “no moral hazard”…Lehman was simply the wrong choice, but the one that Paulson was going after with an axe to grind…

Perhaps the other mistake was forcing all TBTF banks to take TALF money to confuse or misdirect who was truly “stressed” and who wasn’t. Then, of course, allowing them to pay it back and allow for the “great” earnings in the following quarters… Let’s just throw some lollipop pitches to my son so he can easily crank the ball out of the park…


I agree the BS gov’t assisted deal with JPM reinforced the moral hazard by the gov’t stepping in to backstop financial institutions. Since BS was the smallest of ibanks, when the gov’t backstopped the deal they set the motion implicit gov’t support for the other banks moving forward.

FNM/FRE moving into conservatorship may be one of the best decisions , especially removing the top executives (perhaps the mistake may be in that the gov’t didn’t take action sooner). Conservatorship was the right thing to do as these institutions had failed and there was no other option to consider here. However, the actions taken after conservatorship are may rank as a top mistake in the crisis as private sector RMBS and CMBS were purchased to set up trillions of $$ in backdoor bailouts to the TBTF banks.

The biggest mistake was not allowing the banks to fail, the gov’t would have prevented a bank run on insured deposits through the FDIC and explicit gov’t guarantees for anything beyond the capacity of the FDIC. This would keep the traditional bank side of the bank operational. The gov’t did provide the liquidity programs to keep the banks alive, this should have been continued to then perform a orderly unwind and resolution of the failing institutions (or their subsidiary failing business units). Since this was not done, then the biggest mistake was not performing a quick and just post crisis remediation to restore confidence to the american public that when a business fails to the degree that the gov’t needs to step in and use taxpayer $$ to support a backstop, guarantee, bailout (call it what you want) that corrective action and behavior modification WILL take place.

Post Crisis (bailout) remediation should have at least had the following framework:

#1 – Replace top executive management at all the failing organizations (e.g GM, AIG) #2 – disgorgement of compensation and bonuses for the illusory gains (this would be a job stimulus for forensic accountants and assistants – there has to be a huge paper trail for all of this mess). #3 – All funds injected via preferred share purchase, secured loans should have been mandated to be repaid via operational cash flow – this would have prevented a quick payback of the TARP using gov’t (taxpayer) $$ through indirect or backdoor cash flows or low interest gov’t subsidized loans. #4 – No conversion of preferred to common – This is another of the top mistakes — taxpayer $$ injected should have been at the top (and stayed at the top) of the capital structure (SECURED loan), even the use of preferred shares was a compromise to the best interest of the taxpayer. #5 – Charge market rate for gov’t guarantee’s (warrants to purchase stock does not adequately compensate for the value that the gov’t backing provided) #6 – investigate, track down and prosecute everyone, start at the top and move through the organization to find those that violated the law or ethics of their position resulting in: * debarment from the industry, restriction from holding an executive or director position for any public company * disgorgement of ill-gotten gains from bonus and compensation based on illusory revenue * jail time for any violation of the law (enforce the Sarbanes-Oxley and securities laws)


Allowing them to lever beyond 12-1/

Allowing i-banks to become commercial banks (though that was after some other bonehead moves).

Broken :


I get the same feeling that there was some personal animosity involved in the Lehman decision. It seemed like an outlier in the way the Fed-Treasury usually works.


Electing Ronald Reagan.


The biggest mistake?

Well, I guess it’s pick your own “Mt Everest”…


Allowing any bank and i-bank and prop tarder who took US Taxpayer money to save themsleves (or otherwise) to keep their current management and top 500 employees and to NOT enforce real compensation changes.

They all should have been fired en masse and for cause. Period.

(We heard the talking heads and bank managers drone on about “talent”, irreplaceable, too much knowledge, competition, blah, blah. Gimme a freaking break — these overpaid clowns drove their trucks right into a brick wall, and then got paid to fix the truck they wrecked, and to drive it to the next wall to boot. I just can’t believe that — it’s like a some weird parallel universe where everything that’s bad is good…)

the bankster:

September 7th, 2010 at 7:41 pm The mistake (once the crisis was in motion) was doing nothing after the Bear Stearns failure to decouple the remaining TBTF firms. I worked at a relatively well-run bulge bracket firm in CDS trading where some thought the BSC rescue meant that LEH was backstopped, others figured the Feds had a master plan, and still others didn’t want to even talk about LEH counterparty risk for fear of having their fingerprints on the eventual losses.

When the Fed arranged an eleventh-hour emergency netting session that fateful Sunday night it became clear that they had done nothing, and I mean that literally, to prepare for another failure. The British were better prepared for Dunkirk. I sat at my desk saying is a joke, what have they been doing for the last six months, ignored the special trading session, and just braced myself for London to open. Sorkin’s wrong: the story is the nonfeasance over the summer, not the nonfeasance that weekend.

Mark E Hoffer:

 “I forgot to add, I agree with Simon Johnson, former IMF Chief Economist, that things won’t be fixed until the corrupt elites which broke the economy get broken themselves.”–msaroff, above+ the 1st one, earlier

and, “Our biggest mistake in this crisis and as a nation has been to get away from our trust-busting roots. We have allowed monopolies to take over in almost every aspect of our national landscape.”–from ‘nathanbutnet’ ~~

Frederic, could you tell us wtf is afoot?

“…In fact, it is the same in the science of health, arts, and in that of morals. It often happens, that the sweeter the first fruit of a habit is, the more bitter are the consequences. Take, for example, debauchery, idleness, prodigality. When, therefore, a man absorbed in the effect which is seen has not yet learned to discern those which are not seen, he gives way to fatal habits, not only by inclination, but by calculation…” ~~

as an aside, it’s too bad that A.R. Sorkin isn’t, also, an Esquire..

VennData :

 They saved the guys who fund those “independent” Swift Boat, Birth Certificate, “Obama will take Your Guns,” “He’s a Socialist!,” “Obama bailed out Wall Street – not Bush,” and Tea Party movements.

Shnaps :

Meant to write ‘the repeal OF Glass-Steagall’.

The worst mistake was allowing the problem to grow and risk causing a crisis in the first place.

But yes, I have to agree w/BR, that once the fertilizer started hitting the ventilator, setting the precident of coming to the aid of BSC was the first crucial mistake we’ve seen yet ‘during’ the crisis.

jjay :

It looks like we are all in agreement here. The outrage directed at the current Corporate/Political criminal system is coming to a sharper and sharper point. Hopefully a highminded leader will arise soon to help us turn things around before it gets any worse. There is at least a glimmer of hope for us!

philipat :

Bear Stearns was the problem as it created a new mindset. Austrian economics sets forth a better course to leave things alone, allow failure where due (aka avoiding moral hazards) and let everything settle down and work itself out. It should be perfectly clear by now that undue intervention has NOT helped, nor will further intervention.

balanceact :

The single most egregious mistake was not putting consequences in the 2008 – 700Billion bailout. When the government gave loans and in essence took a big position in all the failed institutions and the big banks, all top management should have been dismissed. All compensation packages should have been revoked for non-performance. The moral hazard this “free money” inspired has set us up for a second more serious recession all too soon.

Obsvr -1’s extensive list is excellent.

The most egregious mistake that Obama has made was continuing to keep all of the greedy fools who helped precipitate the financial bubble as government employees or advisers, Summers, Geithner, Rubin.

Mark E Hoffer :

QOTD: “One swallow does not make a summer, neither does one fine day; similarly one day or brief time of happiness does not make a person entirely happy. —Aristotle (384 BC – 322 BC)

for some add’l co-ordinates 

at the very min., more Proof that MIT is not Hartford..

subscriptionblocker :

Wall Street’s *survival* was the neutron bomb which tanked the economy. We are, and have been paying for it ever since.

Try to imagine through the consequences of 50 million on food stamps, families without a breadwinner, or kids now “uneducatable” due to the parasitic class.

And the ones still standing are just walking wounded, barely able to fend for themselves – let alone families.

Think we all know who won the battle here…possibly even the war. Some day perhaps, an author will “imagine” such a story as fiction. It’s that incredible.

Andy T :

“ben22 : September 7th, 2010 at 6:17 pm What do you think was the biggest error of the crisis?

thinking that our potent directors could stop it. (this is ongoing)”

Indeed! The hubris of believing that the largest credit bubble in the history of mankind could be unwound in an orderly way….

Arequipa01 :

“Regrets? I’ve had a few…”

The Primary Broker Dealers have the US Federal Govt by the short hairs. End of story.

David Merkel :

The Federal Reserve attempting to create permanent prosperity through monetary policy, combined with their lack of oversight over the credit conditions they were creating at the banks with bad underwriting.

RW :

Hard to point to the biggest error — there were so many mistakes — but if I had to choose it would be the initial and ongoing assumption that those who caused the crisis should be given any benefit of the doubt, that the system was okay except for a few bad apples who got bailed out or (re)elected anyway.


“Venndata doesn’t care what goes down as long as Obama is in power …”

Ad hominem and insult only add more smoke while decreasing IQ. Just turn it around and it becomes obvious: “Call me ahab” doesn’t care what goes down as long as blah, blah …Don’t know “call me” well enough to know what s/he really cares about and I’m pretty sure s/he doesn’t know Venndata much better than that.

Hmmmm, maybe that wasn’t really OT; think I had a gestalt moment.

Biggest mistake of the crisis: Too many people (with too much power) relied upon too little information before making some significant decisions which said lack of information also contributed to their inability to appropriately judge just how big the decision was.

DL :

Letting Lehman fail was by far the best decision that Hank Paulson made as Treasury secretary.

The mistakes were numerous. Among them would be the bailing out of AIG. What I think Paulson could have done in the case of AIG is to inform all their customers that they’ve got just 30 days to find another insurance company. And a fund of, say, $10B could have been set up to smooth things over, if necessary, for individuals who had trouble collecting on their claims, and for those with annuity contracts. Corporations would be left to fend for themselves. I fail to understand what sort of bad things would have happened, had we done that. Yes, it would have been a little inconvenient for some people. But it would have sent a powerful message to financial companies that, in the future, they will have to pay for their mistakes, and not the U.S. government.

Also, as I posted (here) several times back in Q4 of 2008, the initial TARP should have been much smaller. Perhaps $200B. Give them the money, see what they do with it, then give them more, if it is really true that we were facing Armageddon.

wunsacon :

I wish Sorkin were joking or that this was April 1st. Really, letting Lehman go bust was arguably the single event *best* event during the past 2 years. Keeping fraud alive on Wall Street happens at the expense of everyone else and is no way to run a country.

I don’t read the NYT. I only see a few articles here and there, either “in-band” from the paper or “out-of-band” from its contributors. But, examples like this corroborate my suspicion that I’m not missing anything. Blogs, wikis (e.g., Wikileaks), email, and Bloomberg are doing the job the rest of the MSM does not.

Guest Post: Recent Lehman MD Reviews "A Colossal Failure of Common Sense":a>

Submitted by Arthur Doyle, a managing director at Lehman Brothers until the summer of 2008.

When an apple has ripened and falls, why does it fall? Because of its attraction to the earth, because its stalk withers, because it is dried by the sun, because it grows heavier, because the wind shakes it, or because the boy standing below wants to eat it?

Extra points if you recognize this selection from the beginning of Tolstoy’s “War and Peace,” his critique of the “Great Man” theory of history, in which he argues that events follow organically from the circumstances of peoples rather than from the actions of kings who are “the slaves of history.” In contrast, historians such as Thomas Carlyle argued that “the history of the world is but the biography of great men.” Carlyle’s view held great sway for much of the 19th and 20th centuries, only gradually giving way after World War II with the rise of new disciplines such as social and economic history.

Some ideas, however, die more easily than others. Though the “great man” theory has lost its hold on Ivy League history departments, it lives on in popular culture. And nowhere is it stronger than in business journalism, with its breathless accounts of heroes and villains…the crazed homophobic Jimmy Cayne, the bloodless executioner Hank Paulson, the naively overreaching Ken Lewis, and so forth.

In this tradition comes “A Colossal Failure of Common Sense: The Inside Story of the Collapse of Lehman Brothers,” by former Lehman trader Lawrence McDonald and best-selling ghostwriter Patrick Robinson (Crown Brothers, New York, 2009, $27.00). McDonald traded high yield bonds for Lehman from 2004 to early 2008. He worked for, and admired, Mike Gelband and Alex Kirk who were Lehman’s heads of fixed income and high-yield trading. Gelband and Kirk were known within Lehman to be critics of CEO Dick Fuld’s strategy of aggressive expansion of the firm’s real estate business during the late stages of the credit bubble. Both men left Lehman in 2007 after losing internal political struggles over the direction of the firm (and its excessive leverage), only to return in its final days in a doomed effort to steer the Titanic away from the iceberg.

Mr. McDonald’s tale, as told by Mr. Robinson, is a thriller. However you may disagree with his premise (that Lehman was a firm filled with heroes and geniuses, lain low by the treachery of a handful of stubborn fools), it is impossible not to get caught up in the narrative. McDonald has a somewhat unorthodox rise, from community college to pork chop sales to retail stock brokerage to, finally, a coveted place on a Wall Street trading floor. And the Lehman Brothers he finds is everything he hoped it would be: razor-sharp analysts teaming with gutsy traders, taking million dollar risks and earning multi-million dollar paydays. We are, predictably, regaled with tales of wildly extravagant spending on meals and toys, huge casino wins and huger losses, all absorbed with aplomb.

Mr. McDonald and his merry band, Larry McCarthy, Rich Gatward, Alex Kirk, and the rest, move from one success to the next: at one moment shrewdly buying Delta Airlines bonds when the firm goes into bankruptcy (on the advice of researcher Jane Castle, who knows so much about the airline she “could tell you what meal they served in first class on this morning’s flight from JFK to Berlin”), the next moment shorting the bonds of Calpine, the electric utility.

But it doesn’t take long to get our first indication that all is not well at the House of Lehman. McDonald never meets the firm’s reclusive CEO, Richard Fuld. Not that unusual for a vice president…but then he reveals that his boss has never met Fuld either, and that his boss’s boss, Mr. Kirk, has only “seen” Mr. Fuld on a couple of brief occasions. McDonald has very little idea about what kind of person Mr. Fuld is, other than anecdotes retold by colleagues or clippings from the press, but what little he knows makes him nervous: Fuld is reclusive, zipping from his chauffeured Mercedes to a private elevator directly to the 31st floor executive suite, never stopping to mingle with the troops along the way. And Fuld, it seems to McDonald and his colleagues, is under the spell of the firm’s largest profit generators, the mortgage and real estate groups. Mr. McDonald doesn’t know these folks well, either, but once again what little he knows he doesn’t like: the mortgage traders are said to resemble Hollywood divas, making late entrances to meetings due to their supposed fondness for “long walks on the lake at Central Park.”

Some time in 2006, Mr. McDonald and his bosses begin to sense cracks in the housing market, and begin to worry that residential mortgage securitization will freeze up and leave Lehman Brothers holding millions of mortgages, originated by its partners, that it will be unable to sell on to hedge funds, pension funds and other clients. This could weigh down the firm’s balance sheet and profit stream, and potentially put the firm’s survival in doubt. The traders begin to take short positions in homebuilders and mortgage brokers, to try to offset this risk, but soon realize that the scale of the potential problem is too large to be addressed by their desk alone. When their attempts to persuade the mortgage guys to “slow down” are met with mockery, Gelband, head of the fixed income division, goes to Fuld himself to try to get the firm to take steps to protect itself against the downturn.

Predictable results ensue: the ignorant Fuld and his jealous deputy Joe Gregory attack the bearers of bad news and call for more and faster growth. As though determined to go to ground as spectacularly as possible, in mid-2007, a full 18 months after the beginning of the real estate downturn, Lehman buys Archstone-Smith, one of the largest residential apartment owners in the country. The rest follows inevitably: from the collapse of sub-prime, to Bear Stearns’ failure in Mar 2008, to Fannie & Freddie’s nationalization, to Lehman’s final collapse in September. Mr. McDonald’s account, though interesting, adds little to what is publicly known about Lehman’s last days. This may be because he left the firm in March of 2008, shortly after his mentor, Larry McCarthy, had resigned.

Ultimately, Mr. McDonald’s view is that Lehman’s collapse was an unfortunate and totally preventable disaster caused by a failure of leadership. Mr. Fuld, a trader from a different era, used the wrong playbook for the 21st century, and his personality defects (jealousy, arrogance, hubris) prevented him from taking counsel from those who could have helped steer him clear of trouble. He chose to listen to those who flattered him and those who delivered the largest short-term gains, and blinded himself to the risks of leverage.

This is clearly what Mr. McDonald and his colleagues believe happened to Lehman, but is it the truth?

In a narrow sense, yes, since it was Fuld’s specific decisions regarding the real estate and mortgage businesses that led the firm to fail.

But in a broader sense, Fuld is irrelevant. Given the combination of the credit bubble and the availability of cheap, plentiful leverage, along with an asymmetric reward structure (which paid out huge bonuses to managers from profits generated from that leverage but had no mechanism to punish those managers for taking risks that led to bad outcomes), wasn’t Lehman’s outcome inevitable? Doesn’t the fact that all of Lehman’s close peers--Bear Stearns, Merrill Lynch, Citigroup, Bank of America—either collapsed along with it or were saved through quasi-nationalization argue that there is something a little fishy about making Fuld, obnoxious as he was, into the lone gunman in the Lehman homicide?

To take it a step further, what might have happened had Fuld elected to sit out the latter stages of the mortgage securitization and leveraged loan booms? Lehman didn’t have Goldman’s strength in proprietary trading or Morgan’s banking franchise, so the firm’s profit and return on equity would have lagged behind peers. Gasparino and Cramer and the rest of the TV donkeys would have called for Fuld’s head instead of praising his “brilliance” and “toughness.” With a smaller bonus pool and weaker stock, Lehman’s talent would have been easy picking for hyper-aggressive peers like Deutsche Bank and UBS. So why not, in the famously ill-timed words of Citigroup’s Chuck Prince, “keep dancing until the music stops?”

The eagerness of the Street and the media to pin this meltdown, which has ruined millions of lives and cost trillions of dollars, on a couple of old guys (however greedy, vain and stupid they were), rather than on an out-of-control financial system desperately in need of reform, speaks volumes about who creates the narrative in this country, and how much those narrators feel they have to gain by retaining the status quo.

Mr. McDonald has a bit more self-awareness than the average Wall Street trader, but there is a delicious moment of unintended irony when he stops talking, for a moment, about Lehman’s excessive leverage and risk taking, and instead focuses on his own complaint that his bonus for 2007 is inadequate. Mr. McDonald’s trading book generated over $30 million in profits for the year, and, he says, that there was an unwritten rule that every $20 million in profit should generate a bonus of $1 million for the trader. At the same time, he whines, Mr. Fuld and Mr. Gregory took home bonuses of $35 million and $29 million, despite the fact that Lehman’s problems were, by then, becoming apparent (in spite of the excellent reported results for the year ending November 2007).

There is almost too much material in this thought to tease it all out properly. For one thing, where does Mr. McDonald think that all the money came from for him, a junior trader at a relatively poorly capitalized firm (compared with its peers), to generate profits of $30 million? Could it be possible that without the 30-1 or 40-1 leverage that Mr. McDonald decries, there would not have been capital available for him to put on his trades? Or that, without the leverage, the firm would have had to have been much larger for him to have made the same bets, meaning that there would be more mouths to feed besides his own?

For another thing, which is it? Was Lehman doing really well at the end of 2007, in which case Fuld and Gregory (and McDonald) should be entitled to big bonuses, or was it teetering on the brink? By McDonald’s outraged reaction to Fuld and Gregory’s payouts (which were roughly flat with their 2006 bonuses), clearly he thinks that the firm’s published financials did NOT really reflect the firm’s fiscal health, so large bonuses to EVERYONE (Mr. McDonald included) were not appropriate.

The most important questions of all are not even asked in “A Colossal Failure of Common Sense,” or in any other account I have so far seen of the Lehman failure. Simply put, how did Lehman’s published financial statements, as recently as its final 10-Q published in July of 2008, show a positive net worth of $26 billion, when the bankruptcy liquidators are saying that they are looking at a negative net worth of $130 billion?

Put another way, “Why is it that Lehman’s $660 billion balance sheet, heavily weighted in real estate and residential mortgages, experienced no writedowns whatsoever before February 2008, and writdowns of less than 1% of total assets thereafter, in the midst of the largest collapse in value of such assets in recorded history?” And why did Lehman management assert, repeatedly, through the crisis that it had no problem with liquidity or solvency, when clearly it had problems with both? How is it that the sale of preferred equity securities by the firm in April of 2008 was accomplished without revealing that the firm’s assets would soon be revealed to be worth over $100 billion less than its liabilities? Doesn’t any or all this constitute securities fraud? And shouldn’t there be criminal liability for the executives who signed the firm’s 10-K and 10-Q’s, who under Sarbanes-Oxley are responsible for material misstatements made in those documents?

All of these questions may or may not be answered in the fullness of time, once the bankruptcy is concluded. And it will be satisfying, in some sense, if those who knowingly committed securities fraud, if that is what occurred, are brought to justice.

But in a larger sense, books like Mr. McDonald’s, focusing as they do on heroes and villains, rather than on real flaws in how we conduct our financial capitalism, and how we regulate our systemically important institutions, are doing greater damage than what may have been specifically wrought by Mr. Fuld and Mr. Gregory. They promote the myth that, in the end, Lehman is a tale about a few bad apples who screwed up a great bank, rather than about a system run amok, where insiders reaped enormous rewards for creating risks borne by the society at large.



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