Laurence Ball writes,
The people in charge in 2008, from Ben Bernanke on down, have said repeatedly that they wanted to save Lehman, but could not do so because they lacked the legal authority. . .
I conclude that the explanation offered by Fed officials is incorrect, in two senses: a perceived lack of legal authority was not the reason for the Fed’s inaction; and the Fed did in fact have the authority to rescue Lehman. I base these broad conclusions on the following findings:
- There is a substantial record of policymakers’ deliberations before the bankruptcy, and it contains no evidence that they examined the adequacy of Lehman’s collateral, or that legal barriers deterred them from assisting the firm.
- Arguments about legal authority made by policymakers since the bankruptcy are unpersuasive. These arguments involve flawed interpretations of economic and legal concepts, and factual claims that do not appear to be accurate.
- From a de novo examination of Lehman’s finances, it is clear that the firm had ample collateral for a loan to meet its liquidity needs. Such a loan could have prevented a disorderly bankruptcy, with negligible risk to the Fed.
- More specifically, Lehman probably could have survived by borrowing from the Fed’s Primary Dealer Credit Facility on the terms offered to other investment banks.
In short: Bernanke lied, Lehman died.
1. Whenever you look at government policy in financial markets, assume that the primary goal is to allocate credit to preferred borrowers, particularly toward governments themselves. This goes for regulatory policy and so-called monetary policy.
2. I am inclined to interpret the decisions made in 2008 as credit allocation decisions based on Hank Paulson’s personal whims. Note that Ball says
The record also shows that the decision to let Lehman fail was made primarily by Treasury Secretary Henry Paulson. Fed officials deferred to Paulson even though they had sole authority to make the decision under the Federal Reserve Act.
The decisions helped some investment banks, including Goldman Sachs (the “AIG bailout” was mainly a funneling of short-term Treasury securities to Goldman and other investment banks). The decisions hurt Freddie Mac, Fannie Mae, and Lehman. I think that is what Paulson wanted to see happen.
3. Whereas Ball seems to suggest that the Fed should have bailed out Lehman, I am more inclined to believe that the government should have allowed institutions to go through bankruptcy or to make concessions among themselves. By the latter, I mean that if nobody bails out AIG, then maybe Goldman and the others decide that “collateral calls” are only going to hurt themselves in the long run, so they allow AIG to keep some near-term liquidity, and it ultimately survives.
4. The consensus story from the establishment is that Bernanke and Paulson saved the country from another Great Depression. Maybe that story is right, but with my heterodox views I do not believe it. I think that many ordinary citizens do not believe it, either. The widespread suspicion of the establishment gave rise to such phenomena as the Tea Party and, arguably, Donald Trump. It would be easier to defend the establishment if you could say that Bernanke was telling the truth.