Too Big to Fail [290]
That, of course, raises a more pointed question: Once the crisis was unavoidable, did the government’s response mitigate it or make it worse?
To be sure, if the government had stood aside and done nothing as a parade of financial giants filed for bankruptcy, the result would have been a market cataclysm far worse than the one that actually took place. On the other hand, it cannot be denied that federal officials—including Paulson, Bernanke, and Geithner—contributed to the market turmoil through a series of inconsistent decisions. They offered a safety net to Bear Stearns and backstopped Fannie Mae and Freddie Mac but allowed Lehman to fall into Chapter 11, only to rescue AIG soon after. What was the pattern? What were the rules? There didn’t appear to be any, and when investors grew confused—wondering whether a given firm might be saved, allowed to fail, or even nationalized—they not surprisingly began to panic.
Tim Geithner admitted as much in February 2009, acknowledging that “emergency actions meant to provide confidence and reassurance too often added to public anxiety and to investor uncertainty.”
Of course, there are many people on Wall Street and elsewhere who argue to this day that it was the government’s decision to let Lehman fail that was its fundamental error. “On the day that Lehman went into Chapter 11,” Alan Blinder, an economist and former vice chairman of the Federal Reserve, said, “everything just fell apart.”
It is, by any account, a tragedy that Lehman was not saved—not because the firm deserved saving but because of the damage its failure ultimately wreaked on the market and the world economy. Perhaps the economy would have crumbled anyway, but Lehman’s failure clearly hastened its collapse.
CEO Richard Fuld did make errors, to be sure—some out of loyalty, some out of hubris, and even some, possibly, out of naiveté. But unlike many of the characters in this drama, whose primary motive was clearly to save themselves, Fuld seems to have been driven less by greed than by an overpowering desire to preserve the firm he loved. As a former trader whose career was filled with any number of near-death experiences and comebacks, he remained confident until the end that he could face down this crisis, too.
Despite claims to the contrary by Paulson, it seems undeniable that the fear of a public outcry over another Wall Street rescue was at least a factor in how he approached Lehman’s dilemma. One person involved in the government’s deliberations that weekend, in a remarkably candid moment, told me that the fact that the UK government indicated that it would face a major struggle to approve a deal with Barclays was “actually a strange coincidence,” because “we would have been impeached if we bailed out Lehman.”
While hindsight suggests that the federal government should have taken some action to prop up Lehman—given the assistance it was prepared to offer the rest of the industry once it began to face calamity—it is also true that the federal government did lack an established system for winding down an investment bank that was threatened with failure. Paulson, Geithner, and Bernanke were forced to resort to what MIT professor Simon Johnson has called “policy by deal.”
But deals, unlike rules, have to be improvised—and the hastier ones tend by their very nature to be imperfect. The deals hatched in sleepless sessions at the Federal Reserve Bank of New York or at Treasury were no different. They were products of their moment.
In truth, while unnoticed, it wasn’t the fate of the U.S. operations of Lehman Brothers that caused the white-knuckled panic that quickly spread throughout the world. To its credit, the Fed wisely decided to permit Lehman’s broker-dealer to remain open after the parent company filed for bankruptcy, which allowed for a fairly orderly unwinding of trades in the United States. Outside the country, however, there was pandemonium. Rules in the United Kingdom and Japan forced Lehman’s brokerage