Paulson was right not to save Lehman
SO Dick Fuld, Lehman Brothers’ former boss, has finally said sorry. The banker they nicknamed “the gorilla”, who himself lost much of his fortune in the collapse of his firm, should have apologised a long time ago to his shareholders, bondholders, staff and counterparties. But he hasn’t changed his mind on one thing: in common with many of his former colleagues, he still believes the government should have bailed out his firm.
I disagree. Hank Paulson, then Treasury Secretary, was right to let the firm go bust. The view that his decision turned a crisis into a catastrophe, while superficially appealing, has little merit. In fact, by jolting investors, governments and central banks out of their stupor, it probably helped us get out of the crisis faster than we would otherwise have done.
The financial system was already rotten to the core before Lehman’s implosion. Bank write-downs had reached $500bn by August 2008 and it was obvious that there was much more to come. Trillions of dollars in debt were secured on collapsing property prices; banks, households, firms and governments had all planned for a never-ending boom. By September 2008, a deep crisis was inevitable, with or without Lehman.
The firm’s spectacular demise merely precipitated the day of reckoning. Because it came as such a shock to complacent markets, it triggered an immediate 500-point drop in the stock markets and was followed promptly by total meltdown in the derivative markets, a freezing over of the credit markets and fears that every other big bank was about to fail. The repercussions were catastrophic – but all of this would eventually have happened anyway, whether or not Lehman had been saved. The chain of events would have been slightly different; the ride might have been smoother; but the end result would have been identical.
It is often forgotten that Lehman, Merrill Lynch and AIG were all on the ropes and there was no way the American public would have countenanced a bailout of all three (it had already underwritten Bear Stearns’ sale to JP Morgan and the rescue of Fannie Mae and Freddie Mac). Had a sound bank been found to rescue Lehman, it too would have been destroyed, just as Bank of America (a potential Lehman suitor) was crippled by its takeover of Merrill. The impact of AIG going bust would have been much more severe than Lehman, which was the smallest, least systemically important of all the big Wall Street firms at the time.
There was undoubtedly plenty of silliness, not least from Timothy Geithner, then the New York Fed’s boss. He blocked Fuld’s attempts at turning Lehman into a bank holding company. Yet Goldman Sachs and Morgan Stanley were subsequently allowed to take on the status, a move which helped reassure their counterparties at the height of the panic.
Some have compared Lehman’s demise to that of Creditanstalt, an Austrian bank which went bust in 1931, exacerbating the Great Depression. This is to exaggerate Lehman’s importance. Its demise was tragic, destroying the savings of many of its employees, the vast majority of whom have been unfairly maligned. But had it not gone bust, another big firm would have done so; the destructive forces unleashed last Autumn had already become unstoppable long before Lehman’s demise.