In Ben Bernanke’s Memoir, a Candid Look at Lehman Brothers’ Collapse

The stated reason is often that AIG was so huge that it had to be saved to avoid disaster. Yet, this article seems to argue that the exact reason Lehman wasn't saved 2 days earlier was because it was just too large for the government to handle and that it didn't have the authority to do so until a month later when TARP was passed.

You have to wonder how candid memoirs by former officials are vs attempts to influence the historical record. Wikipedia says that Bernanke now advises Citadel which benefited to the tune of $200 million from the bailout of AIG.

>Every morning at nine o'clock, [acting treasury secretary] Morgenthau; Jesse Jones, the head of the RFC; and George Warren would meet with the president over his breakfast of soft-boiled eggs, to determine the price of gold for that day. They began at $31.36 an ounce. The next morning this increased to $31.54, then $31.76 and $31.82. No one had a clue how they went about setting the price, although everyone presumed that some subtle analyses of the world bullion and foreign exchange markets went into the calculations. In fact, the choice of price was completely random. All they were trying to do was to push the price a little higher than the day before. The exercise brought out the juvenile in Roosevelt. One day he picked an increase of 21 cents, and when asked why, replied that it was a lucky number, three times seven.

Source: "Lords of Finance"

One of them was a man who sat down at the table next to me. We talked for a bit, and he explained that he worked at the Bank of Tokyo. I think he was trying to practice his English. He asked me 'What is the most famous bank in Canada?'

After thinking about the most famous Canadian bank for a bit, I told him it was probably Toronto Dominion (TD). Or maybe the Royal Bank of Canada (RBC). Then I thought for a moment and said 'Though, the bank most famous in Canada is probably Lehman Brothers.'

He had such a look of sadness on his face when I said that.

The problem with Lehman was that it was a large prime broker for many hegde and pension funds. That essentially means its a bank that holds the holding(cash, stock and bonds) of these funds.

When it went bankrupt in the US, what was expected was that each of the funds would pull out their holdings and move them to healthier prime brokers.

This would have the double bonus of removing one unhealthy company(Lehman) and at the same time propping up other healthier companies by having them handle the assest of the funds pulling their holdings out of Lehman( sort of like letting a bank fail and having deposits put into other banks.

Unfortunately the British financial regulators, who built London on a program of pretty much anything goes style regulation, woke up that day and decided that for the first time ever they needed to actually regulate and they declared Lehman's assets frozen, meaning that otherwise healthy funds (including pension, mutual, and hedge) now had no access to their own assets.

So now hedge funds can't trade, pension funds can't pay people and mutual funds can't allow redemption's and the other banks can't take in these assets to prop themselves up. The equity markets started to seize up as funds had no assets to trade.

The capital markets nearly seized up. Repo desks are the portion of banks that lend money to each other to ensure everyone has the money they need to operate, suddenly couldn't get money and weren't allowed to lend out money for fear of lending to a company who might go bankrupt.

Almost all large companies these days operator on this over night borrowing, using this to smooth out cash flows, similar to using a line of credit.

General Electric had 2 days of cash before they couldn't continue operations. We came really, really close to having the entire world stop working!

Andrew Ross Sorkin has a great book called Too Big to Fail that goes into this. House of Cards is also a great book on the 2008 crash.

The other big firm to go under in 2008 was Bear Sterns. If you like finance read "When Genius Failed" its the history of the rise and fall of Long Term Capital Management. In the book they detail how everyone except for Bear Sterns pitches in to bail out the fund. In 2008 Bear Sterns was the one who needed the bail out and the same people who pleaded with Bear to help with the LTCM bailout just turned their bask of Bear and let them go bankrupt and then get bought for $172 a share at the end of 2006 to being bought for $2 a share in 2008.

Yet it's incredibly difficult to believe the Fed and Treasury were completely against any bailouts, considering that 6 months before, a rescue package was offered to Bear Stearns, and the eventual purchase of Bear by JP Mogran was effectively guaranteed via the NY Fed's backing.

I want to believe it was for reasons other than influence by GS and their alumni, but that is a hard sell.

The reluctance of the Federal Reserve to lend to Lehman contrasts with its actions regarding Bear Stearns and A.I.G. The difference is that in the other two cases, the Fed saw itself as lending against reasonable collateral.

In the case of the Fed’s loans that facilitated the acquisition of Bear Stearns by JPMorgan Chase, $29 billion of Fed money was at risk against a collection of Bear Stearns assets thought to be worth $30 billion. JPMorgan would absorb the first $1 billion if the value of those assets declined, providing a cushion ahead of the Fed (that is, ahead of taxpayers). Those assets were good in the end, with the Fed fully repaid with interest.

In the case of A.I.G., the Fed’s loans were collateralized by the entire assets of the firm, based on the observation that A.I.G. had potentially huge losses at its unit that sold credit default swaps but the rest of the firm was a successful insurer. The latter parts — the rest of the company — provided the collateral for the Fed’s initial loans, and eventually TARP funds were substituted for the Fed resources to provide the company with a better capital base rather than Fed loans. To be sure, it was hard to know in September 2008 that the value of the company would offset the potential losses in A.I.G.’s financial products division, but this turned out to be the case, with both the Treasury and the Fed turning considerable profits on their investments in A.I.G.

Such a successful outcome was simply less imaginable with Lehman than with either Bear Stearns or A.I.G. To all eyes, the problem at Lehman was one of solvency while the issue in the other two cases was liquidity. The Fed’s actions on Bear and A.I.G. were thus appropriate in its role as a lender of last resort and the same with its caution at Lehman. Indeed, after Lehman had filed for bankruptcy, the Fed did extend loans to allow the firm’s broker-deal subsidiary to function, but in bankruptcy these loans could be fully collateralized by assets within the brokerage subsidiary and not encumbered by obligations in other parts of the larger firm. [1]

Basically, Bernanke knew that Lehman owned a bunch of worthless paper whereas firms like AIG, GM, Fannie Mae + Freddie Mac, Goldman, etc. owned actual valuable assets that they could use as collateral against taxpayer loans, and operated in profitable segments outside of risky IB and junk-debt securitization. He was tight-lipped about saving Lehman Bro's because he wanted the private sector to step up and do it themselves, and also so that they wouldn't know whether or not to expect handouts from the Fed down the road.

Although I disagree with Bernanke's decision to adhere to Keynesian economics during the economic crisis, valuing short-term stability over properly setting precedents for long-term prosperity and growth, I have to respect the man for his intelligence and thoughtfulness. Looking forward to reading his account of the crisis and why he made the decisions that created the economic environment as it currently stands.

[1] http://economix.blogs.nytimes.com/2013/09/13/why-lehman-wasn...

Inside Job - Charles Ferguson

I'm not saying that what they did was wrong. But the guy here is just making up this pretend honesty to solidify all the choices he made afterwards.

Anyone who swallows this self serving nonsense is naive.