Opinion

Felix Salmon

The cost of Bernanke’s failure-aversion

By Felix Salmon
September 3, 2010

John Cassidy has very little patience for Ben Bernanke’s latest attempt, in front of the FCIC, to explain how Lehman Brothers was allowed to fail so catastrophically. Bernanke is now saying that Lehman was in such bad shape that it would have failed whether or not the Fed had stepped in to guarantee its debts; like Cassidy, I’m very suspicious of that argument, since a Fed guarantee would have stopped any bank run cold in its tracks.

So what does Bernanke mean when he says that “the view was that failure was essentially certain in either case”? My feeling is that Bernanke, along with Hank Paulson, had an unnecessarily binary idea of what exactly “failure” meant. They were faced with a choice between the chaotic collapse that we saw, on the one hand, and a much more orderly failure, on the other; and they utterly failed to grok how much worse the first option was than the second.

Bernanke has long said that the Treasury “did not have the authority to absorb billions of dollars of expected losses to facilitate Lehman’s acquisition by another firm” — but now it seems that he’s also saying something which demonstrates much weaker leadership. If we lose billions of dollars and Lehman still fails, goes the argument as I understand it, then we will have failed too. So we might as well just let Lehman fail on its own. Even if the consequences of that decision are orders of magnitude worse.

A leader will take a hit for the greater good. A profit-driven trader like Hank Paulson, not so much. As Cassidy puts it:

Many people from Lehman and Barclays suspect that the real barrier to the Barclays rescue wasn’t the legal niceties in London but a reluctance on the part of Bernanke and others—Treasury Secretary Hank Paulson in particular—to fill the gaping gap in Lehman’s balance sheet by providing a Bear-style loan from the Fed, which could have topped fifty billion dollars.

With hindsight, $50 billion would have been a very small price to pay for an orderly wind-down of Lehman Brothers. But Bernanke and Paulson, it seems, were too caught up in wanting to avoid “failure” to work that out.

Comments
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Felix,

At a certain point, doesn’t this start to seem a little like pelting General Bernard Montgomery with stones for the relative failure of Operation Market Garden?

It just seems to me that it’s impossible for anyone who was not in Bernanke’s or Hank Paulson’s or Geithner’s shoes at that moment, to understand what it was like, that it was the financial equivalent of a nuclear attack, and decisions were made in the fog of war which were bound to be examined with 20/20 hindsight, rather unfairly, in my admittedly humble opinion.

Bear in mind, I’m in no doubt that the REAL reasons they let Lehman fail, have not been stated in front of any WashDC committee, or admitted to in print by Bernanke or Hank Paulson. Like, bailout exhaustion. Like, whatever happened to “moral hazard”? Or the firewall theory, which they could be excused for believing, that a Lehman bailout would only pull Merrill inside the blast radius, and then where does it stop? Even the Fed runs out of money eventually.

At a certain point it seems worth pointing out that Lehman didn’t fail because Ben Bernanke was incompetent, or a Scrooge, but rather, Lehman failed because Lehman was stuffed to the gills with toxic assets when the bubble popped.

Quick, answer this: How catastrophic (or not) would it have been, if Bernanke and Paulson stepped in to “fill the gaping gap” for Lehman, and what followed was the Barclays deal completely falling through? Would things now be better? Worse? About the same?

Do you or John Cassidy (whose columns in the New Yorker I read religiously) think you’d have been able to even fathom an answer to that question in September 2008?

Posted by EricVincent | Report as abusive
 

@Eric is on the mark.

The Lehman collapse did not cause the world financial crisis. Financial imbalances caused it.

It is not clear at all to me that we would be in a better place if Lehman had not failed. A major financial collapse might have been delayed until the beginning of McCain’s presidency, he would have gotten blamed for it and now Democrats would be poised to make huge gains in Congress.

Posted by DanHess | Report as abusive
 

I’m guessing Lehman was allowed to fail for at least a couple of reasons: 1) ideological – the Republicans in charge didn’t believe in cutting off a finger to prevent dying of frostbite, at least not at that point. 2) Lehman didn’t owe a lot of money to Goldman.

If Lehman had 2-3 more months of capital, they would have been bailed out after Bear Stearns was allowed to fail. By that time, panic had enveloped the financial world and the government had no choice to but to prevent another major collapse. Somebody had to die first, and it was Lehman.

If Lehman had sold swaps to Goldman like AIG had, you can be sure they would have been backed up by the government, just like AIG was.

Posted by OnTheTimes | Report as abusive
 

The failure of Lehman was at least a sign to bankers that they are not immune to over-reaching themselves. The example had global repercussions, not all of them bad. In the UK many said that Northern Rock should also have been allowed to fail. There were a lot of banks that were more prudent and didn’t suffer, so preventing the greedier ones from failing would have harmed them. How can you believe in Capitalism and say that failing companies should be protected by the state, just because they happen to be banks?

Posted by FifthDecade | Report as abusive
 

I suspect Lehman was allowed to fail because they were first.

Not that they didn’t deserve to fail. Plenty of accounting shenanigans going on.

Posted by TFF | Report as abusive
 

@TFF
Lehman wasn’t first. Lehman was second. Bear Stearns was first.

And in the Bear case, the Treasury decided to use an “open bank” style of resolution by guaranteeing $30 billion of its losses. Bernanke and the Fed accommodated the Treasury with alacrity.

So while Lehman surely layered on a near fatal amount of risk, Bernanke and the Secy of the Treasury signaled in March 2008, via the Bear guarantee, that they would toss out 15 years of established government dictum, and allow a financial entity to receive “open bank” assistance without penalizing shareholders. Bear shareholders got $10/share paid for by you and I and the taxpayer’s of the U.S.

Paulson and Bernanke’s “bold” Bear deal gets accolades now, but it was a direct transfer of your tax dollars to Bear Stearns shareholders. And I am not terribly happy that my income tax withholding was sent directly to Jimmy Cayne to support, among other things, his obsessive bridge habit.

And with this “bold” Bear deal, the signal that Paulson and Bernanke sent to the market was the worst of all possible signals: “We, the People, will provide government funds with no risk to the selling shareholders of problem institutions.”

So think about what that means. The US Government signals that it would provide taxpayer assistance but current shareholders of any rogue. failing institution can benefit. Mind boggling!

So what might Lehman think of that March 2008 signal: “Damn the torpedoes! Layer on the leverage!”

So it is not surprising that Lehman management thought that they had several levels of backstop for their risk taking, and it is not surprising that Dick Fuld still thinks that Lehman could have made it with government help.

If you think about it, Paulson and Bernanke’s actions are really the monetary version of “Gaslight.” And you wonder why Fuld acts like he is crazy?

And what is doubly egregious is that Bernanke is now both publicly disingenuous and mendacious when he says that he “did not have the authority to absorb billions of dollars of expected losses to facilitate Lehman’s acquisition by another firm.”

He had the authority in March 2008 apparently. And he misled the market with that authority. The market saw the signal and acted accordingly. He never cried “no more do overs” or “never again.” He simply misled the market with his silence.

But the other point here is that Bernanke allowed Paulson to engage in his doomed but “bold” serial deal-making. (Paulson did it because deal-making was a skill that he had perfected over his 10,000 hours of private sector work.)

So Bernanke allowed Paulson to be very “bold” until they all had to punt. And given the political realities as the election grew closer, Paulson realized that he had to punt on Lehman. No more deal making for the Treasury’s consummate go-between.

Public officials in Paulson and Bernanke’s position need to remember, in the words of Bacon, that “boldness is the child of ignorance.”

Posted by AABender1 | Report as abusive
 

Don’t disagree with you but kudos! Anyone who consistently uses the word “grok” is okay with me. It shows that they understand literature, complex literature, and are willing to help in educating the public.

Posted by TaxLawyer | Report as abusive
 

Thanks for the correction, AABender.

That $10/share price on Bear Stearns was still just 15% of what it was the previous week, however, and just 6% of where it was trading a year earlier. It may have been overly generous to shareholders, but I wouldn’t call it “no risk”.

Has a final score been published on the Bear Stearns rescue? Was the cost the full $30 billion of guarantees?

Posted by TFF | Report as abusive
 

TFF, the Fed publishes a report on the three Maiden lane vehicles. Currently the difference between the expected cash flows of the BSC investments and the loan given to buy the investments is around around -3.5 billion USD so the cost of the bailout assuming projections are correct is 2.5 billion to the tax payer.

Thats to be balanced by the nearly 4billion the taxpayers stands to make on those assets it acquired when it “backdoor bailed out” the investment banks when it closed out the AIGFP swaps.

OnTheTimes, you seriously suggesting that GS had zero exposure to LEH? that LEH going bankrupt had no affect on GS?

AABender1, BSC was different. There was a very defined exposure with BSC given that JP was taking the majority of the risk – the Fed’s risk was capped at 29 billion and that loan was collateralised relatively well as you can see at the relatively smal losses at a cost to you personally of currently 11 USD over two years. I am sure two Big Macs less in that time have not gone a wanting…. Weird no one hears any outrage about the bailouts of the automakers, only one of whom is even vaguely viable.

Posted by Danny_Black | Report as abusive
 

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