But three things are striking about the Sorkin-provided details:
First, Fuld (and presumably the underlying business) was desperate as of early July. Sorkin has Fuld arranging for contacts to be made to possible buyers like Bank of America on a Saturday. Huh? He was clearly flailing about, yet not offering a price or deal terms commensurate with his obviously panicked state.
Second, Paulson and Geithner were aware of Fuld's desperation. The Wall Street Journal reported earlier that Fuld was calling Paulson almost daily (and suggested Paulson was somewhat puzzled). The Sorkin excerpt shows Fuld petitioning the Fed via Geithner to become a bank holding company:
Mr. Fuld's outside lawyer, Rodgin Cohen, chairman of Sullivan & Cromwell, had recently suggested an idea to help stabilize the firm: to voluntarily turn itself into a bank holding company. The move, Mr. Cohen had explained, would make it easier for Lehman to borrow money from the Fed "just like Citigroup or JPMorgan."
Mr. Cohen, a 64-year-old, mild-mannered mandarin from West Virginia, was one of the most influential and yet least well-known people on Wall Street. Pacing in his hotel room in Philadelphia before the wedding of his niece that night, he joined the call between Lehman and the New York Fed.
"We're giving serious consideration to becoming a bank holding company," Mr. Fuld started out by saying. "We think it would put us in a much better place." He suggested that Lehman could use a small industrial bank it owned in Utah to take deposits to comply with the regulations.
Mr. Geithner, who was joined on the call by his general counsel, Tom Baxter, was apprehensive. "Have you considered all the implications?" he asked.
Mr. Baxter, who had cut short a trip to Martha's Vineyard to participate, walked through some of the requirements, which would transform Lehman's aggressive culture, minimizing risk and making it a more staid institution, in league with traditional banks.
Regardless of the technical issues, Mr. Geithner said, "I'm a little worried you could be seen as acting in desperation," and the signal that Lehman would send to the markets with such a move.
Mr. Fuld ended his call deflated. Later that evening, Mr. Fuld called Mr. Cohen, finding his lawyer in the waiting room of a hospital, attending to a cousin who had become ill at the wedding.
Yves here. If Geithner and his colleagues didn't get that Fuld was at the end of his rope, they were choosing to ignore an elephant in the room. Now they may have been completely unwilling to consider the petition and this was the easiest way to signal their opposition (taking Fuld through a long list of requirements, some of which presumably would have been pretty painful, was another message).
But this speaks to a question we have raised again and again: why was there no serious assessment of what a Lehman bankruptcy would mean? After Bear went down, everyone knew Lehman was next on the list, with Merrill and UBS also known to be wobbly. Why didn't the Fed, Treasury, and SEC together demand certain types of information from all big US regulated capital markets players (including JP Morgan and Goldman, perceived to be the healthiest, so as not to be singling out the weaker members of the herd?). This is a massive oversight. Relying on luck, which is what assuming all would be well after the Bear debacle, is no substitute for having a strategy. There was clear urgency in July. Even a month of assessment and evaluation of options (it probably would have taken two weeks to orchestrate the information requests among the agencies) would have been better than nothing. But the Freddie/Fannie unwind was moving to front burner, that probably consumed a lot of available bandwidth.
And we have the third, and peculiarly most obvious point to anyone who has had some exposure to deals, but one that Sorkin does not bring forward: what the hell was Fuld doing trying to negotiate his own deals? This is a mistake CEOs make all the time, and it never ceases to amaze me.
Reading between the lines of conversations I've had with Fed and Treasury officials--though they never quite actually say it--both were well aware that Lehman (and Merrill) were on the rocks. They had also decided that they were not going to take any extraordinary measures to bail them out, because they believed that the banks were in the grip of a serious case of moral hazard. Indeed, this is possibly the most plausible explanation of Dick Fuld's unwillingness to make the kinds of deals that could have kept his firm from a catastrophic collapse--he thought his BATNA* was a bailout-backed fire sale, not the implosion of the company and his own probable personal bankruptcy as his shareholders filed suit.
So Treasury and the Fed spent the time between Bear and Lehman building contingency plans for the bankruptcy, rather than working as hard as hard could be to ensure that one didn't happen. Then Lehman's collapse had an effect no one had anticipated: the Reserve Primary Fund, a money market fund that held a lot of Lehman's commercial paper, broke the buck, triggering a general run on the money markets that only stopped when the government stepped in to backstop the losses. Most of their contingency plans worked as intended, which is why the Lehman bankruptcy wasn't an even bigger disaster. But the run in the money markets made it clear (or at least, made them fear) that they just weren't capable of planning their way around the failure of a systemic institution; the markets were too complicated, and trouble forestalled in one sector would just pop up somewhere else. After Lehman, they stopped trying to orchestrate an orderly transition, and started pumping as much money into the system as they could without much worrying about the effect that this might (did) eventually have on banker psychology.
You can argue about whether this was the right decision, and certainly the current banker attitude towards the resulting profits is pretty galling. But ultimately, I think they made the right decision in both cases. In September, moral hazard seemed like a huge problem that was actually making the crisis worse, and would certainly make the likelihood of another one much higher. After September, we knew better, but there was no way to find that out ahead of time. Once we did, though, it made sense to try to shepherd the system through the crisis, and reform it later. You can always slap down bankers at some later date (though whether we will, of course, remains an open question). But the families that lose their homes when unemployment spikes to 15% and the banks collapse take a long time to get back on their feet.
* Best Alternative To Negotiated Agreement
there was no way to find that out ahead of time.
As we say in the programming field: "Nothing like live testing on the Alpha Server!"
Indeed, this is possibly the most plausible explanation of Dick Fuld's unwillingness to make the kinds of deals that could have kept his firm from a catastrophic collapse--he thought his BATNA* was a bailout-backed fire sale, not the implosion of the company and his own probable personal bankruptcy as his shareholders filed suit.
This is why moral hazard is so dangerous. Even the perception can lead to devastatingly wrong assumptions.
I worry that TARP is just creating more.
The scary thing is that we are seeing the moral hazard effect so soon. You would have thought that with the gigantic collapse not even behind us yet that the risky high-flying behavior would have been tempered, with the moral hazard showing up as memories receeded. But instead we see it already, when we are still in the middle of the Second Depression. That doesn't bode well.
What is the number thrown at the banks? $12.4 trillion?
One could look at it differently. Moral Hazard? Its OURS! We bought it. Paid in full with the expectation of full service.
This is why I think we are far from the end of this mess.
Derek
So we'll end up with >10% unemployment, $12 trillion or so on the taxpayer's books and still no end to bankruptcies, AND a still out of control banking sector doing the same thing they were doing that led up to the crash.
And a depreciating dollar.
Derek
Looking Back at Lehman; In Anger ?
How bad can it get ? :)
On the one hand, nobody revolts
to preserve their standard of living.
On the other hand, no government is ever
more than three missed meals away from
a revolution.
On the Gripping Hand, are TPTB capable
of giving up some of their power in order
to avoid losing it all ?
Most every battle has a turning point, at which
the loser could win by a change in tactics.
Are TPTB willing to relax their restrictions
on innovation, and let the private sector
manufacture enough new, Hi-Tech wealth to pay off
our creditors before they stop buying our bonds ?
Hi-Tech wealth to pay off our creditors before they stop buying our bonds
Why would the Chinese ever want to be paid back?
The only way to "pay them back" would be for the US to run a current account surplus with China. I certainly don't see Chinese policy makers being in favor of that... basically... ever...
I don't know about that. They'll learn eventually that buying American products is more beneficial than owning our debt. Especially if that debt is depreciating in value.
They'll learn eventually that buying American products is more beneficial than owning our debt.
Anything they buy from us could just as easily be made by the millions of peasants that arrive in Chinese cities every year. Why would they want to give jobs to Americans at the expense of their restless and potentially volitile peasant population?
Nelson,
If you are right when do you expect Chinese policy makers to allow China to run a substantial current account deficit with the US? I could see them moving toward a balance of trade flows but expecting them to allow the flow of trade to reverse, I just can't see that happening.
Can you really see China allowing the flow of goods to substanially reverse itself?
How much is Hawaii worth?
I don't see it as "at the expense" of their jobs. They can improve their standard of living and increase the value of their jobs by improving their infrastructure. The fastest way to do this is with American technology (especially if they can get it cheaply).
Everything should equalize over time but the balance of trade is so unbalanced now that it almost has no choice but to swing temporarily the other way, especially if we get to the point where the only politically viable way we can cover our debts is to devalue our currency.
They can improve their standard of living and increase the value of their jobs by improving their infrastructure. The fastest way to do this is with American technology (especially if they can get it cheaply).
I'd assume they are improving their infrastructure as fast as is practicable. Even with massive infrastructure spending the only way to provide enough jobs is through the export of low end manufactured goods.
The goods don't have to be low end. Or, at least, they can redefine low-end by increasing quality (using our technology and processes) while keeping costs low. That seems to be the path they're choosing to take anyway. As their standard of living improves, their biggest and best market will be internal. Captain obvious says they have more consumers than any other nation on Earth.
Nelson,
As their standard of living improves, their biggest and best market will be internal.
Again, that will happen. The question becomes even when that happens will they prefer a balance of trade or will they prefer a massive flow of goods imported from the US as we "pay them back"?
As you know, currently the petro states like Kuwait and Saudi Arabia are accumulating treasuries. The stated goal is to eventually cash those in and exchange them for our grain and other exports when the oil runs out. They do expect to be paid back - China? I just can't see it ever making sense for them.
I don't see it as "at the expense" of their jobs. They can improve their standard of living and increase the value of their jobs by improving their infrastructure. The fastest way to do this is with American technology (especially if they can get it cheaply).
But what technology would that be? What does the US have that the Chinese don't have or cannot get by copyright theft or obtain from better-qualified suppliers?
To remove just one example from that claim, China is fully capable of building up their own electrical power system. In fact, a nontrivial portion of accessory gear for North American power infrastructure is being imported from China these days. The critical design, testing, and reliability standards used here are contained in publicly-published documents from the NFPA and IEEE, available for a few thousand bucks per publication at the very most. For anything high-tech or specialized beyond their capabilities, they can get better-suited equipment from Europe and Australia, which use similar voltage and frequency standards. China also has a large amount of hydro experience and builds large-scale generation equipment locally, and exports some of that to North America, as well.
What killer application does the US have that the Chinese must come here with cash to obtain?
I have to agree with jmo. If it happens, it won't be for a long, long time. The Chinese economy is heavily export-dependent, and the ChiComs' hold on the country is somewhat fragile.
Mouse, theoretically speaking, even if we can both do the same things, it's still easier to trade for some things rather than build everything themselves. But as for specifics where they're behind, one example is green technology. Not just windmills and solar panels, but more along the lines of everything we do has to be within EPA standards. We can help them reduce pollution, which their people are going to start demanding if their incomes go up.
A better question is to ask why would they want to keep exporting us stuff forever, with no intention of ever getting anything in return?
Even if they didn't want anything in return, they might at least consider consuming the stuff domestically instead of shipping it over to the US in exchange for meaningless pieces of paper.
A better question is to ask why would they want to keep exporting us stuff forever, with no intention of ever getting anything in return?
To keep all those peasants busy.
Even if they didn't want anything in return, they might at least consider consuming the stuff domestically instead of shipping it over to the US in exchange for meaningless pieces of paper.
They would love to. But, as long as Chinese consumers continue to save between 30% and 50% of their income there isn't enough domestic consumption to soak up all those goods.
The conversations between Paulson and Fuld are an important background missing from this excerpt. Paulson repeatedly told Fuld the administration and Fed would do nothing for him, and that Fuld needed to broker a sale of the company without them or face certain failure. Fuld was delusional and arrogant enough about the importance of his firm to think this was a bluff.
Fuld was the perfect poster child, but there should have been at least a few more to get the point across..
Surely the position in summer 2008 was that the US Treasury knew that unless the endangered banks raised more capital, a crunch was very, very likely. The Treasury could not act to force recapitalisation because they faced a pòlitical logjam. The only plausible way to break it (as it ws broken in October)was to get the Brits to act first recapitalising the London banks.
So the US Treasury people crossed their fingers and hoped. Specifically. they knew that Dick Fuld had a number of possible deals to save Lehman's, and probably felt sure he would pay the price asked for one of those deals rather than go under. 'Plan B' was probably that a Lehman's failure would force the others to take their half-negotiated recapitalisation deals. However Plan B seems to have been no more than that sentence. There seems to have been no contingency planning (e.g. to suspend markets) so as to be sure that the possible recapitalisation deals (some of which involved finance from abroad) had time to complete. There were no plans to bring home immediately to the other Wall St. CEOs that they had to sign their deals now, or else. And I suspact that there was no top level effort to get the Brits to take the lead when it could really have helped.
It was a bit like the Officer of the Watch knowing that the ship was steering for the rocks; despairing of waking the Captain up; not preparing the lifeboats, and hoping that some accident of wind and tide would save the ship if and when they scraped against the reef.
I suspect that the Officer of the Watch in London tried to wake his Captain up in early summer, but failed to persuade him to confirm any useful orders before October.
So both ships hit the rocks; and were severely damaged.
But ultimately, I think they made the right decision in both cases. In September, moral hazard seemed like a huge problem that was actually making the crisis worse, and would certainly make the likelihood of another one much higher. After September, we knew better, but there was no way to find that out ahead of time. Once we did, though, it made sense to try to shepherd the system through the crisis, and reform it later.
I think they made the right decision in the first case and the wrong decision in the second. I believe there were better methods available to keep the system from collapsing.
Most of the banking crisis pretty much boils down to moral hazard arising from government backing. It began with the assumed backing of the GSEs/FMs and propagated through the system from there. It was also present deeper in the systemic institutions, and Fuld pretty well exemplifies the danger of moral hazard of intrusion here.
Now we have really entrenched the threat, although we won't feel the effects until the next crisis. Right now it doesn't matter much because we are deep in a recession. When (if!) times return to normal, the moral hazard that got us into this mess will be an order of magnitude worse.
I believe the correct response would have been to temporarily extend FDIC protection to the money market funds and to be ready to provide liquidity. I would consider letting a few of the weakest MM funds die first. The best thing would be be like a FDIC closing - sell the assets to the highest bidder and guarantee the depositors. Only if the collapse continued only then would I consider liquidity injections, in the form of loans from the US to provide temporary cash flow stabilization.
But that's just my opinion... I could be wrong!
I think you are putting far too much emphasis on moral hazard.
The dot com crash had no moral hazard involved and was in many ways worse than the current crisis in terms of the harshness of the crash. It simply involved a much less important sector of the economy. (It's been how many years and the NASDAQ is at what percentage of its height?)
Gamblers will gamble, and non-gamblers will, for the most part, get fired for not getting the returns that the gamblers are getting. That's the way of the stock market.
Honestly, without any promise (implicit or explicit) or reality of a government guarantee, I suspect that the crash would have played out in much the same fashion expect there'd be very little left of the American economy by this point. (When the panic finally came, the carnage would be many times worse...)
I suppose the "it's all (mostly) moral hazard" folks have a lot higher opinion of the how careful most investors are. The DotCom boom/bust cured me of that forever.
[Of course, I may just be bitter because the last financial adviser I truly respected got fired for not jumping on the dotcom bandwagon just before the crash happened :-(. (The last financial journalist I respected (at that time period) had been booted a few months before - after all, after 3 years of being wrong, it's obviously not that your cautious, it's that your a stupid dinosaur...)]
The dot com crash had no moral hazard involved
Well, there was some. Widespread seller financing meant eq providers were basically underwriting the operations of their customers, who were thus incentivized to take more risks.
I appreciate your response, thank you Tom. I respectfully disagree, with emphasis on the word respect.
Gamblers will gamble, and non-gamblers will, for the most part, get fired for not getting the returns that the gamblers are getting. That's the way of the stock market.
This culture of reckless gambling is a direct result of moral hazard. In a system without moral hazard, the investors with healthy investment concepts that include not just return but capital preservation would be the ones making the big returns, and it would be the the gamblers that would be getting fired.
Honestly, without any promise (implicit or explicit) or reality of a government guarantee, I suspect that the crash would have played out in much the same fashion expect there'd be very little left of the American economy by this point. (When the panic finally came, the carnage would be many times worse...)
There is no real reason to think it would be worse. The losses were not created by the crisis, they were there all the time. The "crisis" is simply moment in time we became of the illusion. The panic is like the moment in time you realize just how deep you are in this mess.
The only real effect the government guarantee has is to distribute the losses differently. One would hope in a calm and orderly fashion. But what we got instead was a distribution where the bankers are now getting very large bonuses. This was to be expected.
In a system without moral hazard, they would be unemployed and unemployable by the banking sector. The small minority of banks with a culture of responsible lending would now be rising to dominance.
And now the cycle will continue. The people who got us into this mess will continue to be in power, and their culture and ideas will continue to be the dominant ones.
A couple of questions come to mind here:
1) When did Geithner quickly approve Goldman's petition to become a bank holding company and not Lehman's?
2) What the hell kind of name is "Rodgin", and why does a man whose last name is "Cohen" have that as his first name?
Meh. Should have been "Why", not "When" in question 1).
Excellent question! Couldn't possibly have anything to do with the fact that Goldman would have one less competitor coming out the other side of the crisis. Nah, no way!
All three remaining "consolidated supervised entities" (i.e., the investment banks) became bank holding companies at about the same time after Lehman failed and Lehman's systemic risk problems became obvious. And, if I recall, they weren't given much choice about the matter.
Fuld negotiating his own deals was a signal of the importance of the matter. If he'd sent a VP and counsel, it wouldn't have been as obvious that Lehman was desperate.
Geithner's insistence on spelling out the difficulties and suggesting that becoming a BHC wouldn't solve anything (for Lehman or systemically) was a polite bureaucratic "no."
So, Fuld made mistakes, but involving himself in negotiations wasn't one of them. And Geithner screwed up, pretty badly.
Great post and interesting comments. There is not much to be optimistic about these days, but I hope that banking CEOs will remember the story about how Dick Fuld played chicken and lost big. I hope they do not conclude that based on the fallout from the Lehman collapse, the Treasury/Fed will never let another bank fold. I also hope the Treasury/Fed does not conclude that it can never let another bank fold, but instead sends whatever signals it can that in the future bailouts will be loaded with painful consequences to management and shareholders.
If Treasury was preparing for a bankruptcy between Bear and Lehman, why weren't Lehman's counterparties doing the same?
Some probably were. I recall a buddy of mine who dabbles in markets noticing Lehman-based stuff starting to collapse months out. Thing is, somebody has to be left holding the bag. The market is always net long.
@ aMouseforallSeasons: US must-have Killer App for China ?
One would say none, but after further consideration...:)
Is there any other contemporary business success story
to match the exponential growth of WinTel ?
Dr. Nebel's Polywell Fusion group will know by April 2011,
if they have the beginnings of one such, and will begin
an iterative design improvement program, with each model
providing experimental data to guide the design of the
next. They plan to sell developer modules, but I doubt
anyone else can keep up with the exceptional pace
of creative development in the US; Simpler to buy
from us, now, rather than bring their reinvented wheel
on line two years later.
Creativity is the unique intangible that the US has for sale,
if our government will allow it to work, rather than tying
it down in a web of regulations.
P.S. Did I mention that the final iterations include both
a model which converts fusion energy _directly_ to electricity,
and another which will make a dandy deep-space drive :)
Dr. Nebel's Polywell Fusion group will know by April 2011,
if they have the beginnings of one such,
Hey, all right! Another Polyweller!
We haven't heard from Nebel in a while, but his explanations on the electron thermalization and bremsstrahlung problems a year ago were intriguing. They had thought things through more than some of us expected.
The tidbit about funnelling alphas through the cusps he shared caught me totally by surprise. Never thought to do a calculation on the gyroradius at 5-10 Teslas (just assumed an alpha would fly right on out; I mean, come on: it's an alpha). A few thousand passes means the first wall problem is mitigated to a nonissue.
Can't wait to see what they get with .8T magnets!
Oh -- and did you see the last contract? They appear to expect to have some results by early 2010.
The thing that really boggles my mind,
is that Dr. Bussard was ready to quit,
I mean the storage crates for the gear
were sitting on the floor of the lab,
when he had his Epiphany.
He had his team shield the apparatus
to prevent electron loss, which let
"Compound Interest" work as expected,
and pegged all the meters on the next,
and last, shot left in the power
storage capacitor; It was that close.
Now Dr. Nebel is having trouble maintaining
his air of scientific detachment, whilst
reporting test results that have him
grinning like a burro eating cactus
(I surmise - I sure would be).
It is an encouraging development in the
more general attempt to lower the cost
of electrical power, from which all
manufacturing productivity blessings flow.
Just come comments on China being able to out-produce us in every field.
1. This is not true. Let me know when you prefer to fly on a Chinese made plane vs. Boeing.
2. If the currency was floating, and it was 1:4 instead 1:6.85, you might see some of our products priced below theirs.
3. China can make handbags very cheaply. And yet some people buy them made in Italy. Its essentially the same bag.
4. Movies, software, education are also considered as "exports"
5. China slapped punitive tarrifs on American car parts that Chinese car makers wanted to import. Note that the Chinese manufacturers wanted to import these parts.
6. Its funny what is sometimes better when made in the USA. In Taiwan, you can buy USA made toothpaste. Not much labor in that. Our cable TV guy also installed us using made in USA cable co-ax. I asked why not use made in Taiwan (it should be easy to make, right?) He said the quality was poor.
So don't knock American products so easily.
DA: USSR never managed to make ball point pen;
Little ball at end has to be both spherical and
textured, with greater precision than workers of
the Proletariat could provide.
P.S. USSR _could_ produce military Hi-Tech:
Mig-25 was amazing aircraft; Rough, brute force,
but got the job done; Shoot down B-70.
Chinese are a different story; No reason to expect
less from them than the Japanese have achieved;
If they take Taiwan that will be a true
Great Leap Forward for them, and a comparable
economic disadvantage for us, nyet ?
Does it matter, in a macroeconomic sense? Is there a possible narrative in which a rescue of Lehman would have prevented, or softened, what happened later?