Lehman Bankruptcy: Crisis Management Via Crisis Export?

Although the Lehman bankruptcy is long past us (feels like an era for many of us if only for the fact that so very much has happened since, doesn't it?), I think it's nevertheless valuable on many levels to understand it in the correct context. For those of you who'd like to retrospect, CNN Money has an excellent in-depth review of the Three Days That Shook The World.

There's one unmistakable take-away from the analysis: US government definitely, specifically wanted Lehman to go down. They couldn't prevent the BoA (BAC) and Barclays (BCS) talks of a buy-out, of course. But whenever parties involved in the rescue effort went to them for help, you could almost see the glee in their collective eyes when they said "no". Why is that?

In retrospect, FSA's refusal to approve the Barclays deal was a devastating, decisive event. Why did they? The official explanation is that Barclays was not strong enough to take over all of Lehman. But they surely could've asked the US government for some assistance and, between US and UK government backing, there surely must've been a way to make the deal happen. We don't know whether the UK government did ask the US for some cooperative effort. Nor do we know whether FSA acted on request from the US government. But we do know for a fact that the US didn't do anything.

But even then, all hope was not lost:

But Lehman's ordeal that Sunday night was far from over. First came a tantalizing ray of hope with the word that the Federal Reserve Board agreed to expand the collateral that investment banks could pledge to the Fed as part of both the Primary Dealer Credit Facility - the name given to the historic measure that allowed investment banks to borrow directly from the Fed window after the demise of Bear Stearns on March 16 - and the Term Securities Lending Facility, a $70 billion "collateralized borrowing facility" created on Sunday by banks to enhance liquidity in the marketplace.

When the Lehman executives started to hear on Sunday afternoon that these windows of emergency financing were opening up, they called the New York Fed to see if it were true. If the Fed allowed Lehman to pledge its shaky collateral to the discount window "we might get a reprieve," one Lehman banker said. But the Fed told Lehman, according to this Lehman banker, "'Yeah, we're doing that for everybody else but you. We're going to let you guys go.'"

Now let's take a look at what the Lehman bankruptcy has changed.

Since the subprime crisis first broke out in August 07, it had been a US crisis. Everybody else was still looking pretty, especially Old Europe. But after the Lehman bankruptcy, it became a global crisis within a week. All of a sudden, we learned that European banks were in even deeper trouble than their US counterparts. The invincible Euro and GBP started tumbling, along with Ruble and Won and whatnot. Iceland went bankrupt. Basel II became the Biggest Joke in Financial Regulation...well, you know the rest.

The Lehman bankruptcy marked the globalization of the crisis.

But, as I said before, the beauty of this crisis is that it's global. If it had been a US crisis, any single one of the subsequent bailouts -- the AIG bailout, the $700B bailout and the Citi (C) baliout -- would've been devastating to the USD and treasuries. Another beauty is that everybody has fiat money. The two combined means that everybody can print as much money as he or she needs without worrying about currency exchange or inflation -- not until the economy revives.

I'm usually not the one who starts conspiracy theories. But the links here are too strong to deny.

Here's another passage from the CNN Money article to finish this off:

McDade and Lowitt, on Lehman's behalf, made one last-ditch effort to convince Paulson that taxpayers should bail out Lehman. They went back down to the Fed and walked the Treasury secretary through a doomsday presentation that Lehman had put together foretelling the likely global consequences in various markets - foreign exchange, swaps and derivatives, among others - if Lehman were allowed to fail. After McDade finished, Paulson told him, "You're talking your own book. We've thought this over.

"That's exactly the point you idiots", Paulson silently laughed to himself.

Stock position: None.

Comments

[Steven Hansen:]

Bo, this is the best theory yet why Lehman was allowed to fail. we may never know the truth.

2008 Dec 29 05:07 AM

[Tom Armistead:]

The decisions was so clueless, I have long thought it was made in the Oval Office.

2008 Dec 29 09:13 AM

[Shaggieman:]

Might have something to do with George Soros being a major shareholder in Lehman. Did Bush let Lehman die to get to an old enemy? It would be just like going to Iraq because Sadam tried to kill his daddy. Are these too simple explanations or is this the real GB?

2008 Dec 29 09:34 AM

[Bill M:]

Someday someone from the inside will make a lot of money writing a book on what went down.

2008 Dec 29 11:11 AM

[Bo Peng:]

I should add one more point:

For a full year before Lehman bankruptcy, US had been struggling while "Old Europe" had been standing on the sideline enjoying the pathetic show. I believe Europe made a strategic mistake in not helping US more proactively and earlier. They took this as an opportunity to establish Europe as one pole in the new multi-polar world, but failed to see how fragile their own footing was -- perhaps the most vivid evidence of this attitude is ECB's decision to raise rate as late as July 08.

Without active European corporation, Lehman bailout would probably have been very damaging to USD and treasuries. Why should we (US) bear all the brunt saving their ass while they enjoy the benefits as the best opportunity in a lifetime?

IMO, it was a strategic decision in the framework of international politics to let Lehman fail. US had little choice in face of Europe's persistent, misguided judgment of the situation.

2008 Dec 29 12:49 PM

[User 327550:]

So now what happens to us poor smucks that had bonds with Lehman?

2008 Dec 29 02:06 PM

[Tom Armistead:]

No bailout for you.


On Dec 29 02:06 PM User 327550 wrote:

> So now what happens to us poor smucks that had bonds with Lehman?

2008 Dec 29 03:15 PM

[a. palmer jr.:]

I guess that the fact that these big banks are hoarding the money now pretty well proves they didn't need the bailout to start with! The small businesses, retailers, etc. that went and are going out of business are the ones that needed help, and the government wouldn't even consider bailing them out. And I never heard of any $400,000 vacations for retailers this year!!

2008 Dec 29 11:57 PM

[johnbee:]

Some good lessons for Europe to learn then for the future, and pretty much everyone else in the world. Not to trust Americans with their money and not to trust the $US dollar. Even Jim Rogers says get out while you can and he's as died in the wool American as you can get.

2008 Dec 30 10:31 AM

[mr freddo:]

Hmmm... another great insight Bo. Traditional thinking is that the US blew it by letting Lehman go, creating a world-wide crisis and sending shock waves through the CDS market which helped to send AIG over the cliff.

But then the dollar strengthened dramatically because in a world-wide crisis, treasuries are still perceived as the safest haven. So interest rates have fallen and mortgage rates are at their lowest levels in many years, thereby helping the housing market recover (hopefully). Peter Schiff's predictions of doom for the dollar have not occurred (yet) because by letting Lehman go, the US assured that there would be no decoupling of the the US economy from the rest of the world. Wow!

Jan 03 03:39 AM

[Bo Peng:]

Yes, mrfreddo, Lehman bankruptcy "paid out" for the US in many ways. But it'd give too much credit to our elected and politically appointed officials if we say they saw all these and then did it. Heavens no! Otherwise we would've had the housing bubble starting at least moderating in 04. I think they were just reacting like headless chickens, as they've always done.

From the global perspective and the European perspective in particular, however, it's a sad mistake that nobody was willing to chip in a joint effort until the pain undeniably spread everywhere. Everybody was enjoying the slowly unfolding US demise. So "screw'em" is ironic, sad, yet poetic justice for all.

Work, reward, pain -- all must be shared.

Jan 05 10:38 AM

[Ricard:]

I've noticed most European governments and their central bank seem to single out the handling of the Lehman affair as their sole reason to condemn the US efforts. Most interesting...I suppose it could have been any firm, but Lehman's timing was just right.

Jan 07 07:18 PM