Lehman Died as Regulators Lied (?)

Is it fair to say "regulators lied?"  We find that soundbite to be too harsh.  True, maybe, but too harsh. Two recent news/opinion articles (New Light on Regulators and Fed Fretted ... Demise of Lehman) push the ideas that:

(1) Paulson, Bernanke, Geithner, and other regulators didn't know what they were doing in 2008;

(2) Some or all of these celebrity regulators were less than candid, shall we say, in their public remarks; and

(3) The U.S. gov't should have bailed out Lehman.


We say "YES" to (1), "YES" to (2) - but understandable given (1), and "NO" to (3).


Instead of a deep-dive analysis, we'll content ourselves here with a few pithy observations:

*    As Treasury Secretary, Paulson had no right - in our opinion - to dictate an initial equity bid of $2 per share to Bear Stearns in March 2008.  Where did he get the idea that was legal?!

*    JP Morgan messed up the "Bear Stearns debt guarantee" in March-April 2008.  This same issue arguably killed the Barclays rescue of Lehman in September of that year.  Nobody seems to understand this point - and it still matters!

*    The New York Fed bent (broke?) the law in its participation in the Bear Stearns bail-out.  To make this dubious deal work, the Fed encouraged and condoned the mis-marking of "Maiden Lane" collateral.

*    In the bail-out of AIG, Bernanke didn't understand AIG insurance entities were not at risk from the failure of AIG Financial Products (the part of AIG with all the losses).

As references for the observations, see:

   House of Cards by William Cohan - the excellent book (not the movie!)

   In Fed We Trust by David Wessel

   Too Big to Fail by Andrew Ross-Sorkin

   Lehman Chapter 11 Proceedings Examiner Report

Rather than dwell on what is fast becoming ancient history, our goal is to make a simpler point.  The financial markets are complicated!!  Regulators don't know how it all works.  Neither do the people who run the banks.  Let's not be surprised when we learn 5 years after the fact that the Fed and the government didn't see failures at Lehman, Fannie, Freddie, AIG FP, and WaMu until the very end.  The executives of all these firms were just as surprised!

More Answers than Questions - the Hank Paulson Story

If ever there was a man who had "more answers than questions" - as the cliche on a cliche goes - it's Hank Paulson.  But let's give him his due.  He's a hard-working guy.  He rose to high prominence and stayed there.  He's as honest as the day is long (not meant to be a joke that we're writing in winter).  His signature is on the currency we all use.  You can't beat the career credentials.

In today's news, though, he's making a comeback to tell us all that there are still big financial problems.  We know that!  While it's not offensive to state the obvious, we need more content than that.  We need a bigger message with REASONS and proposed ACTIONS.

Well, Paulson does have talking points.  He focuses on Fannie and Freddie and the government's dominance and ownership of residential mortgage lending since the Crisis.  Paulson:

    "It perplexes me that nothing has been done [by Washington politicians to unwind his own takeover of Fannie and Freddie as Treasury Secretary in 2008]."

He's perplexed that Washington wants to retain government control?!  Then Paulson says:

    "Every financial crisis has its roots in flawed government policies that lead to excesses in the markets that build up and build up, and then you get a bubble and it bursts."

In his very next breath, Paulson chides a group that is TRYING to reform Fannie and Freddie with an accusation of "OVERSIMPLIFICATION."  And his explanation above of the bubble burst was ..... WHAT?  Brilliantly deep analysis?!  A problem with these Paulson statements is that he's not saying anything.  There's no content.  It's surface-level thinking and reacting.

We read On the Brink, Paulson's book about the Crisis published in 2010.  The book is valuable as historical record.  (We recommend it.)  What is most striking is the absence of any Paulson thoughts.  The man just does not think deeply about the ways of the financial world.  A recurring theme of Paulson's in the book is (paraphrase) "I didn't have time to explain to House and Senate members why it was necessary to spend $700 billion and bail out the banks.  They just wouldn't have understood.  The financial world is too complicated to explain quickly to non-experts."

OUR QUESTION:  Well, why not tell us in your book, Mr. Paulson?  (In his book, he doesn't like strangers calling him "Hank.")  Every book begins with many blank pages.  Fill them with that long, complicated explanation that Congress couldn't understand.  But there's nothing there.  There's no discussion of whether banks are over-leveraged - for example, why is 20:1 leverage okay?  If it's not okay, what should it be?  Why?  (Leverage is just the first and easiest question!)