Should they have or shouldn’t they? What would have happened if they hadn’t? Did their actions make things worse? Or did they merely bring about events that would have inevitably occurred? I am referring to the failure by the U.S. authorities to save Lehman Brothers, one year ago this week. The decision not to rescue Lehman led to its bankruptcy and subsequent collapse.
When Lehman went under the commercial paper money markets literally seized up. Risk premiums went sky high. LIBOR — the base rate at which banks lend to each other — more than doubled from 3.1 percent to 6.4 percent. Anyone holding Lehman debt realised they were holding toilet paper. Too many bankers found themselves in the wrong place at the wrong time. Commercial banking just about ground to a halt. It would be many weeks before inter-bank rates would start to look like anything “normal.”
Of course after that weekend, nothing would ever look “normal” again. In the space of seven days, Merrill Lynch, Goldman Sachs and Morgan Stanley had all ceased to be traditional investment banks and had either been sold or become differently regulated animals. Where there had been five Wall Street titan investment banks, now there were none.
At the time financiers believed some deal would be cobbled together to rescue Lehman either by selling it off, or by offering U.S. government guarantees. In the interest of completeness, it is worth pointing out that Tim Geithner, then president of the N.Y. Federal Reserve, now Treasury Secretary, maintains neither the Treasury nor Fed had the legal power to save Lehman. That power would not arrive until the TARP bailout bill later that year. This detail of fact seems lost in the shouting. The prevailing view remains that the decision to let Lehman go brought about financial Armageddon.
There are two views: One is that the regulators had to draw a line in the sand and Lehman was that line. The other is that by allowing Lehman to fail they opened a spigot of petroleum onto smouldering embers and ignited a bonfire. In short, they made a bad situation much worse because of the counter-party risks Lehman’s had in the market.
Both views are, of course, right but really don’t answer the question. Lehman’s collapse was the financial equivalent of shouting fire in a crowded cinema. It had everyone rushing for the door at once but remember, there were already many real fires burning deep down in the basements of the financial world. Smoke was seeping out for all to smell and indeed see. It was time to get out before it consumed us all.
Subprime’s flames were taking their toll; Bear Stearns and Countrywide had already gone, Northern Rock was nationalised in the UK and interest rates had begun falling, although not fast enough. Years of over leverage coupled with complex financial instruments few understood had built financial bonfires which were now alight. What has taken place over the past 12 months had to happen.
We had all believed that the debt party would last forever and that the credit card bill would not arrive. In a way prescient in Tom Wolfe’s 1987 book “Bonfire of the Vanities,” bankers in the early years of this century did believe they were MOTU – Masters of the Universe. They had rewritten fundamental laws of economics and human behaviour. They were wrong.
By September 2008, there were simply too many improvised financial explosives waiting to go off. It was always going to be impossible to neatly deal with this crisis in a gentle way. Those who believe otherwise, frankly, helped light many of the bonfires to begin with. Whether it was Lehman or some other combustible catalyst, forget niceties of whether it was right to “let Lehman go.” This fire was going to burn someway, somehow, somewhere.
– End –
Richard Quest is a CNN correspondent based in London,
host of the weekday one-hour program “Quest Means Business”.
For program highlights and more, go to www.cnn.com/qmb