“In especially strong language for an academic, Professor Ball (Laurence M. Ball, chairman of the economics department at Johns Hopkins University and author of “Money, Banking and Financial Markets”) takes issue with the established narrative that the Fed was powerless to lend to Lehman in its waning hours: “Fed officials have not been transparent about the Lehman crisis. Their explanations for their actions rest on flawed economic and legal reasoning and dubious factual claims.”…

…As Mr. Bernanke told the Financial Crisis Inquiry Commission in 2010, the “only way we could have saved Lehman would have been by breaking the law, and I’m not sure I’m willing to accept those consequences for the Federal Reserve and for our systems of laws.” That’s because by statute the Fed can make loans only to institutions it believes can pay them back. Again, to quote Mr. Bernanke: “The company’s available collateral fell well short of the amount needed to secure a Federal Reserve loan of sufficient size to meet its funding needs.” But after what seems an exhaustive review of a now voluminous record of transcripts, exhibits and other evidence from multiple official inquiries, Professor Ball concludes there is “no evidence” that the decision-makers “examined the adequacy of Lehman’s collateral, or that legal barriers deterred them from assisting the firm.” Rather, the decision to let Lehman fail reflected a mixture of politics — Mr. Paulson famously said he didn’t want to go down in history as “Mr. Bailout,” and the Bush administration had come under fierce criticism for rescuing Bear Stearns and the mortgage giants Fannie Mae and Freddie Mac — economic policy driven by managing “moral hazard,” and a misguided sense that investors had anticipated a Lehman failure and the consequences would be manageable….And the Fed did lend into continuing runs at both Bear Stearns and A.I.G., although officials argued then that those companies had adequate collateral to guarantee repayment. But Professor Ball shows there was no detailed analysis undertaken to evaluate the value of the collateral at any of the three companies. “This claim is yet another Fed position that does not survive scrutiny,” he concludes. “It’s out of the mainstream of what most academics do,” David Romer, a professor of economics at the University of California, Berkeley, told me this week about Professor Ball’s paper. (Professor Romer read and commented on an early draft.) “It’s likely to offend some people and be controversial. But with respect to the specific questions he asks” — did the Fed have the legal authority to lend and was it forced to shut Lehman down — “I find his answers pretty compelling.” “Larry Ball’s carefully researched work is incredibly important for drawing the proper lessons from the 2008 crisis,” said Athanasios Orphanides, an economics professor and expert on central banking at M.I.T.’s Sloan School of Management….Mr. Paulson said he stood by earlier comments he gave me: “We were united in our determination to do all we can to prevent a systemically important institution from going down.” He added, “Although it was Ben and Tim’s decision to make, I shared their view that Lehman was insolvent and I know the marketplace did.” “I’m not trying to judge them or say I or anyone else would have done any better,” Professor Ball said. “There was extraordinary political pressure not to bail out Lehman, and it would have been very difficult to go against that. But that’s completely different from what they’ve said. The record needs to be set straight.” Professor Ball concludes: “Lehman might have survived indefinitely as an independent firm; it might have been acquired by another institution; or eventually it might have been forced to wind down its business. Any of these outcomes, however, would likely have been less disruptive to the financial system than the bankruptcy that actually occurred.””, James B. Stewart, “Pointing Fingers at the Fed in the Lehman Disaster”, The New York Times, July 22, 2016

“Another major financial crisis narrative from the government (and its officials at the time) is challenged as false and I believe it is false! I believe the same thing happened to IndyMac Bank. No collateral analysis was done by the Federal Reserve and/or FDIC. Clearly, when markets are severely disrupted, if those distressed prices are used to mark assets to market, then every bank and financial firm in the U.S. and world (because of their leverage) would have been insolvent in the 2nd half of 2008 and 1st half or so of 2009. It would be like buying a brand new $100,000 BMW on credit ($90,000 loan) in Dubai, India and driving out into the rural countryside and getting a call from the bank saying we are calling your loan immediately, pay us back what you can….and you stop and stand on the side of the road, with a for sale sign on your new luxury car…what are you going to get for it out there? Not much, with no real buyers. That’s roughly how the FDIC fire-sold IndyMac Bank in late 2008 (sold)/early 2009 (closed) at a time when FDIC Chair Sheila Bair was quoted in The New York Times saying “asset prices were irrational.” So, if asset prices were irrational Ms. Bair, wasn’t the FDIC’s fire-sale of IndyMac Bank into that irrationality, irrational and irresponsible and isn’t that why IndyMac Bank cost the FDIC insurance fund billions, not anything management did? You didn’t know, your were just following FDIC protocols? Then why did every other trustee or conservator of crisis era assets and institutions wait years to sell (some other countries like the U.K. still own stakes in their major banks today), until markets recovered rationality and liquidity and confidence?”, Mike Perry, former Chairman and CEO, IndyMac Bank

Economy

Pointing a Finger at the Fed in the Lehman Disaster

Common Sense

By JAMES B. STEWART

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The former Lehman Brothers headquarters. There has been much debate over whether the government should have done more to rescue the now-failed investment bank. Credit Mario Tama/Getty Images

As the last eight years have unfolded, the enormous economic and political consequences of the Lehman Brothers failure have emerged with stark clarity, never more evident than in this week’s Republican convention.

The widespread anger, frustration and disillusionment that has fueled the rise of Donald J. Trump can be traced to Lehman’s collapse, the bailout of Wall Street and the ensuing Great Recession.

No wonder the debate over Lehman’s fate, and whether it could have been avoided by Treasury and Federal Reserve officials, hasn’t subsided.

Now a widely respected academic — Laurence M. Ball, chairman of the economics department at Johns Hopkins University and author of “Money, Banking and Financial Markets” — has produced the most comprehensive and persuasive argument yet that the Federal Reserve could have saved Lehman from the precipitous and chaotic bankruptcy that occurred that fateful weekend in September 2008.

He recently presented the result of four years of research, “The Fed and Lehman Brothers,” to a group of economists gathered in Cambridge, Mass.

In especially strong language for an academic, Professor Ball takes issue with the established narrative that the Fed was powerless to lend to Lehman in its waning hours: “Fed officials have not been transparent about the Lehman crisis. Their explanations for their actions rest on flawed economic and legal reasoning and dubious factual claims.”

By focusing narrowly on a claim by the Fed that it had no choice but to let Lehman fail, Professor Ball, in his 214-page paper, has brought much needed clarity and rigor to the historical record. His conclusions directly contradict accounts in testimony, memoirs and myriad media interviews by the principal decision makers — Henry M. Paulson Jr., the former Treasury secretary; Ben S. Bernanke, then the Fed chairman; and Timothy F. Geithner, who was president of the New York Fed.

As Mr. Bernanke told the Financial Crisis Inquiry Commission in 2010, the “only way we could have saved Lehman would have been by breaking the law, and I’m not sure I’m willing to accept those consequences for the Federal Reserve and for our systems of laws.”

That’s because by statute the Fed can make loans only to institutions it believes can pay them back. Again, to quote Mr. Bernanke: “The company’s available collateral fell well short of the amount needed to secure a Federal Reserve loan of sufficient size to meet its funding needs.”

But after what seems an exhaustive review of a now voluminous record of transcripts, exhibits and other evidence from multiple official inquiries, Professor Ball concludes there is “no evidence” that the decision-makers “examined the adequacy of Lehman’s collateral, or that legal barriers deterred them from assisting the firm.”

Rather, the decision to let Lehman fail reflected a mixture of politics — Mr. Paulson famously said he didn’t want to go down in history as “Mr. Bailout,” and the Bush administration had come under fierce criticism for rescuing Bear Stearns and the mortgage giants Fannie Mae and Freddie Mac — economic policy driven by managing “moral hazard,” and a misguided sense that investors had anticipated a Lehman failure and the consequences would be manageable.

“It’s out of the mainstream of what most academics do,” David Romer, a professor of economics at the University of California, Berkeley, told me this week about Professor Ball’s paper. (Professor Romer read and commented on an early draft.) “It’s likely to offend some people and be controversial. But with respect to the specific questions he asks” — did the Fed have the legal authority to lend and was it forced to shut Lehman down — “I find his answers pretty compelling.”

Professor Ball has an impressive roster of mainstream economics credentials: He has a Ph.D. in economics from the Massachusetts Institute of Technology, taught at Harvard and Princeton, is a visiting scholar at the International Monetary Fund and is a research associate at the National Bureau of Economic Research.

“Larry Ball’s carefully researched work is incredibly important for drawing the proper lessons from the 2008 crisis,” said Athanasios Orphanides, an economics professor and expert on central banking at M.I.T.’s Sloan School of Management.

I did speak to several people who remain unpersuaded (none willing to be identified), and it’s fair to say no one paper will ever fully resolve this debate. Several said that, however impressive in the abstract, Professor Ball’s analysis was missing a real-world perspective, which was that almost no one believed at the time that Lehman was solvent and virtually nothing short of a politically untenable federal takeover of Lehman would have staved off a run. Defenders of the theory that Lehman was deeply insolvent also point to the fact that Lehman’s creditors ended up suffering tens of billions of dollars of losses in the bankruptcy.

None of the principals themselves have budged from their oft-stated positions that the Fed’s hands were tied. Mr. Paulson said he stood by earlier comments he gave me: “We were united in our determination to do all we can to prevent a systemically important institution from going down.” He added, “Although it was Ben and Tim’s decision to make, I shared their view that Lehman was insolvent and I know the marketplace did.”

Mr. Geithner said he had not read the paper and thus could not comment. Mr. Bernanke didn’t respond to a request for comment.

Having written extensively about these same issues, and interviewed the major decision makers on multiple occasions, I think that much of Professor Ball’s account rings true.

That isn’t to say that, during the maelstrom of events that precipitated the financial crisis, the Fed’s legal authority wasn’t the subject of continuing concern to Treasury and Fed officials. But it also was not the be-all and end-all that it was eventually characterized as in subsequent accounts of the crisis, which also had the self-serving effect of absolving the officials of any blame for what, with benefit of hindsight, seems a deeply flawed judgment call.

My colleague Peter Eavis and I reported in 2014 that an internal Fed team assigned to value Lehman’s collateral reached a preliminary finding that the firm was narrowly solvent and the Fed could have justified a loan. But everyone was too busy to listen, and the report was never delivered to Mr. Geithner, Mr. Bernanke or Mr. Paulson. This is consistent with Professor Ball’s findings.

“I’d always had these nagging questions about why the Fed stepped in with Bear Stearns and A.I.G. but not Lehman,” he told me this week. “The explanations never really made sense.”

As one example, he noted the oft-cited rationale that Fed officials “shouldn’t lend into a run” and that a loan to Lehman would have been “a bridge to nowhere.”

“That’s nonsensical,” Professor Ball said. “It’s Economics 101. That’s exactly when the lender of last resort needs to lend.”

And the Fed did lend into continuing runs at both Bear Stearns and A.I.G., although officials argued then that those companies had adequate collateral to guarantee repayment. But Professor Ball shows there was no detailed analysis undertaken to evaluate the value of the collateral at any of the three companies. “This claim is yet another Fed position that does not survive scrutiny,” he concludes.

One of the more intriguing questions Professor Ball tackles is why Mr. Paulson, rather than Mr. Bernanke, appears to have been the primary decision maker, when sole authority to lend to an institution in distress rests with the Fed. The answer, he suggests, is to be found more in psychology than data.

“By many accounts, Paulson was a highly assertive person who often told others what to do, and Bernanke was not,” Professor Ball writes. “Based on these traits, we would expect Paulson to take charge in a crisis.”

There’s no way to know whether lending to Lehman that weekend would have staved off a financial crisis, or significantly reduced its magnitude.

“I’m not trying to judge them or say I or anyone else would have done any better,” Professor Ball said. “There was extraordinary political pressure not to bail out Lehman, and it would have been very difficult to go against that. But that’s completely different from what they’ve said. The record needs to be set straight.”

Professor Ball concludes: “Lehman might have survived indefinitely as an independent firm; it might have been acquired by another institution; or eventually it might have been forced to wind down its business. Any of these outcomes, however, would likely have been less disruptive to the financial system than the bankruptcy that actually occurred.”

Correction: July 21, 2016
An earlier version of this article misstated the given name of an economics professor at the Massachusetts Institute of Technology. He is Athanasios Orphanides, not Athansios.

A version of this article appears in print on July 22, 2016, on page B1 of the New York edition with the headline: Faulting the Fed in Lehman’s Fall

Posted on September 30, 2016, in Postings. Bookmark the permalink. Leave a comment.

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