As most people now know, Lehman declared bankruptcy on September 15, 2008. Lehman was a primary dealer, with the ability to bid directly at Treasury auctions. The firm’s failure ushered in immense turmoil in the markets, destroyed trust, and ignited an explosion in perceived default risk which eventually brought down AIG and called into question the business models of both Goldman Sachs and Morgan Stanley, and forced the merger of Wachovia with Citi and then Wells Fargo. And that’s before we tally up the effect on the real economy as credit tightened, spending evaporated and global trade suffered.
Amongst all this, the turmoil doomed John McCain’s presidential campaign, and likely affected numerous Republican races in 2008.
So, the question is whether there was a political reason behind the decision to let Lehman fail. After all, what morning’s complete without a conspiracy theory?
Here’s one bit of speculation that has not been aired. President George Bush’s second cousin George Walker was a senior managing director at Lehman Brothers. His unit (Asset Management) emerge relatively unscathed, but. Imagine the outcry and political fallout if the Fed had bailed out a firm with taxpayer support where the president’s close relative was a senior executive. And of course George Walker wasn’t really hurt too much in the implosion since the Asset Management unit is a relatively steady business that could be (and was) spun-off. He’s now the chief executive of Neuberger Investment Management.
There are a number of other reasonable explanations:
- Lehman had become a target right after the failure of Bear Stearns and as the smallest of the surviving investment banks, it was the easiest target.
- Lehman was negotiating a merger with both Bank of America and Barclays prior to the weekend of Sep 15. BoA backed way because a more interesting merger opportunity (with Merrill Lynch) appeared. But Barclays specifically backed away because there was no government support (unlike the deal struck between JP Morgan and Bear Stearns backed by the Fed and the creation of Maiden Lane LLC. It was clear that there was no political support for any sort of government support.
- The Fed and Treasury had repeatedly stated they were concerned about moral hazard and the impact on future behavior if they kept rescuing failing firms.
- The Fed and Treasury may have felt Lehman had enjoyed a 6 month period where it could have cut a deal, but hadn’t because various senior executives did not wish to lose control.
But still, the question remains, why was Lehman allowed to fail?
In retrospect, the decision to allow a primary dealer to declare bankruptcy was very damaging and may have forced the government to put far more taxpayer dollars at risk than would have been required to rescue Lehman. It has almost certainly made the current recession far worse.
That said, it’s clear that the system survived, or rather was resuscitated, after Lehman’s failure. All CDS contracts on Lehman cleared, and we now know that an orderly unwinding of a large financial institution can happen without destroying our financial system, but that it comes at an extreme cost. Lehman’s bankruptcy may also have been a blessing in a very good disguise, it made everyone wake up and take notice (if they’d managed to ignore Fannie/Freddie being pushed into the bear-hug of conservatorship). And maybe, just maybe, we’ll learn something from this, like leverage weakens you during stressful times.
So, the question remains, are we bearing that cost partly because Lehman had the misfortune of employing the president’s cousin? And if so, is the administration now kicking itself?