Sunday, March 14, 2010

Maybe Not Bailing Out Lehman Was the Right Decision

Former Secretary of the Treasury Henry Paulson and the current Chairman of the Federal Reserve, Ben Bernanke, have been well-excoriated for their 2008 decision to let Lehman Brothers fail, rather than bailing it out like Fannie Mae, Freddie Mac and, subsequently, AIG. The charges leveled against them are to the effect that the financial markets expected a bailout, and Lehman's failure led to a massive credit lockup that turned a mild recession into the worst economic crisis since the times of Charlie Chaplin. Paulson and Bernanke are, at least implicitly, held responsible for the layoffs of millions of Americans, the near collapse of the financial services industry and the 50% drop in the stock market.

Now we have a bankruptcy examiner's report on Lehman's demise, which depicts a recklessly managed (or mismanaged, to be precise) firm on a hedge fund-like leverage rampage that artfully (in the Dickensian sense of the term) presented itself as an investment bank. Prominent among Lehman's shenanigans was the sly use of British repo transactions to sweep some of its leverage under the carpet at the ends of quarterly financial reporting periods in order reduce the firm's apparent leverage. Now that this stink bomb has exploded, a lot of former high ranking Lehman executives are denying knowledge of these British repos (called "Repo 105s") or not commenting. The auditors insist they did an acceptable job, although it appears they knew of the allegations of a whistleblower. And one can only wonder if, at its meetings, the board was focused on what would be served for lunch instead of the financial condition of the firm.

The press and blogosphere are now swarming the potential culprits like packs of ravenous wolves with litters to feed. Blame is being avidly and abundantly cast. Very possibly, it is well-deserved.

Perhaps, though, along with the zestful mud-slingarama, we should consider whether anyone comes out looking a little better. Maybe Hank Paulson and Ben Bernanke weren't so far off the mark. With what we now know about Lehman's true financial condition, we can see that a bailout would have been much more expensive than it seemed at the time Lehman collapsed. Outrage over bailing out undeserving Wall Street executives would have been all the more magnified if the shameless gamblers at Lehman had received the munificence of taxpayers. The chattering classes would have fulminated about immoral levels of moral hazard and the witlessness of the government allowing potential wrongdoers (top executives, board members and auditors) to live to fail another day.

It doesn't necessarily follow that a Lehman bailout would have precluded the need to bail out AIG. Perhaps, a bailout would have encouraged AIG to extend its leverage even more in the hope of trading its way out of trouble, like the losing gambler who goes in for a dollar after losing a dime. That strategy could have easily led to mega-disaster in the volatile markets of 2008. Then the taxpayers would have been taken to the cleaners even more than they were.

Did Hank Paulson have an inkling of what Lehman was up to? After all, he would have had access to the top levels of Wall Street, and it's quite possible that others on the Street sensed, if not knew, what was going on at Lehman. Did Chairman Bernanke field enough phone calls from Wall Street execs to get the picture? We may never know for sure everything that Paulson and Bernanke knew, heard, sniffed out or suspected. But, in the interest of Monday morning quarterbacking government officials fairly, let us consider that their decision not to extend the generosity of taxpayers to a bunch of rascals really wasn't all that bad. Indeed, had Lehman not gone into bankruptcy, we wouldn't have the comprehensive examiner's report to provide a better picture of how inept risk management in the financial system has been, and why financial regulatory reform, still stalled in Congress, remains desperately needed.

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