Who Let Lehman Fail? We All Did

It's a wonder that we're still asking the question, "Who let Lehman fail?" two years after the investment bank's bankruptcy. Yet the curious refrain came up again earlier this week when Andrew Ross Sorkin -- the leading authority on who did what when and why during those live-wire days in late Summer of 2008 -- combed through emails released by the Financial Crisis Inquiry Commission. As the anniversary approaches next week, we're sure to hear the familiar tune again.

In media terms, it's not a surprise that Sorkin is trying to gin up a reversal story. He's got a column to write and he wants to frame the admirable effort of going through the emails as breaking news. The snippets Sorkin adduces mostly suggest there was a bias within the government not to guarantee Lehman's liabilities as it had with Bear Stearns. Is that really a surprise? By August of 2008 weren't we all wondering when and where the guarantees would end?

Sorkin is trying to expose Hank Paulson, Ben Bernanke and Tim Geithner for hypocrisy because they claimed to have lacked the legal means to save Lehman. Of course, this is such a complicated and sensitive issue, the Times columnist ends up writing this blunted indictment:

While there is no question that our leaders at the time worked around the clock to find a private market solution for Lehman -- and I have praised them in this column for staving off another depression in the wake of the panic that followed Lehman's collapse -- its failure should go down in history as a gigantic misstep. (In truth, though, no one has yet to offer up another option for the government.)

Of course, there's an overwhelming case to be made that Lehman's failure was a sideshow to the main cause of the crisis. (And saying that Lehman should have been saved is a little like claiming that had Archduke Franz Ferdinand had better bodyguards the First World War might never have happened.) But even more striking is that the best evidence and explanation for why Lehman wasn't saved--and it was a combination of unwillingness to be seen bailing out every investment bank after the government's guarantee of Bear Stearns and its takeover of Fannie and Freddie, a move it had promised would prove unnecessary--comes from Sorkin's own monumental book on the subject, Too Big to Fail.

There Sorkin lays out in fascinating the detail the way Paulson and Geithner arranged a similar deal for Lehman and Barclays to the one constructed for Bear Stearns and JP Morgan. In the Barclays deal, Paulson had strong-armed the New York banks into providing financing for the deal if the UK government would play the same backstop role as the US had in the Bear Stearns deal.

In the end, Britain's FSA scuttled the deal -- not Paulson or Geithner or Bernanke. Having gone that far, should the US have stepped in for the UK? Probably not. The parallel story line that runs through Sorkin's own book explains why.

Though failed investment bank CEOs like Jimmy Cayne and Dick Fuld are inherently more fun to read about, the real story of the financial crisis was the collapse of AIG. The massive government bailout of AIG dwarfs what was necessary to save Lehman. Perhaps if the UK Ministers had known where things stood with AIG on the same weekend, they might have stepped in to help with a more orderly unwinding of the credit bubble.

But they didn't know because, as Sorkin shows us throughout Too Big to Fail, AIG's own CEO, Robert Willumstad, barely understood how bad things were for his own company. We'll never be able to run the counterfactual scenario to see if Lehman could have been put into bankruptcy without causing the credit markets to seize because the AIG bailout took place in near synchronicity. The idea that AIG had been destroyed by its own bad bets suggested no institution was safe, no rock-solid entity could remain a redoubt. And, in the weeks that followed, the great names from GE to Buffett to Goldman Sachs were all called into question.

Reading Sorkin's book, the real villain isn't the arrogant, brooding Fuld but the hapless Willumstad, who keeps trying to fob his problems (and responsibilities) off on Jamie Dimon. As Geithner and Paulson bully the New York banks to provide Lehman a soft landing, Willumstad keeps appearing from the wings like a comic figure in a comedy of manners. He might as well be carrying a racket and and calling out: "Tennis, anyone?" No seems willing to take him seriously or want to pay attention to his worsening problems.

The reasons for that are not ideological, political or driven by public opinion. No one paid much attention to Willumstad and AIG because Willumstad himself never understood the time bomb he was sitting atop. He never rang the bell; he never rushed in with his hair on fire.

Of course, once everyone woke up to the disaster that was AIG, Lehman seemed like small beer. The US government did save AIG because there was no other option. For the trouble, making AIG's counterparties whole and raising an entirely different set of complaints about the government's decision making.

The same day that Sorkin's column came out, there was another echo from the days of the maelstrom two years ago. Robert Diamond, the head of investment banking at Barclays who wanted to buy Lehman before it failed and eventually got an even better deal after the bankruptcy, was named the next CEO of all of Barclays.
One very good reason not to save Lehman was the need to bring the consequences of risk back into the global banking system. With Diamond's ascendancy announced, many observers have wondered at the same thing. Even though credit markets seized in the wake of Lehman, all of the major European banks are now run by investment bankers. If nothing else, this signals a level of comfort with the kinds of risk embedded in Lehman's failure.