Ten years ago, on September 15, 2008, Lehman Brothers Holdings Inc. failed in spectacular fashion.
The implosion of the $600 billion in assets investment bank immediately triggered the financial crisis, which led directly to the Great Recession.
But none of that had to happen.
Lehman could have been saved or, at least, slowly and systematically unwound. The financial crisis could have been averted, and the Great Recession should never have happened.
Those events happened for good reasons in hindsight. Not good for you, me, the economy, or America, but good for the re-shaping of political and banking powers who benefited from what they let happen.
Picking Up Nickels in Front of Buses
On June 2, 1987, President Ronald Reagan nominated Alan Greenspan successor to Paul Volcker as chairman of the Board of Governors of the Federal Reserve System.
In case you don’t know, the Federal Reserve is America’s privately owned central bank that lets Congress appoint its head to fool the public into believing it’s a government institution. It’s not.
Two months after his confirmation, Chairman Greenspan faced the 1987 stock market crash.
His response was to publicly affirm the Fed’s “readiness to serve as a source of liquidity to support the economic and financial system.”
In other words, use of the Fed’s powers to soak banks and markets, and – by trickle-down distillates – the economy, with cheap money to stimulate bank and market profitability and economic growth.
The reclusive Fed Chairman – who spoke, when he had to, in some odd, obfuscator central bank code that awed Congress and the public – came off as an economic wizard whose academic-bent and self-important research work elevated him above other petty policy pushers.
Greenspan thought easy money was the answer to all of America’s excesses, especially when banking and market excesses plus failures necessitated his rescue.
His rescue efforts became known as the “Greenspan put.” In other words, like a put option contract, if the market was headed down, Greenspan’s Fed would always be there to stem losses and turn them into profits for risk-on speculators.
That’s why Greenspan served under Presidents Reagan, George H.W. Bush, Bill Clinton, and George W. Bush.
When Genius Failed
The only time the Greenspan put wasn’t immediately underwritten was in the summer of 1998.
That’s “When Genius Failed,” which is the title of Roger Lowenstein’s extraordinary inside story of how Long Term Capital Management (LTCM), a giant hedge fund run by some of the smartest Wall Street veterans ever, including two Nobel laureates in economics, failed when its massively overleveraged bets went haywire.
LTCM was big, secretive, and super successful. It was also the envy of Wall Street, especially the banks and investment banks who wanted to know how they were making so much money.
To get closer to the heat generated by all that genius, banks threw themselves at LTCM, lending them billions, margining them to the hilt, taking the other side of their trades to try and figure out what strategies they were employing, and clearing their trades.
Genius failed – temporarily, as it turned out – when Russia partially defaulted and credit markets went crazy, handing LTCM billions in paper losses in a matter of days in the summer of 1998.
The New York Federal Reserve Bank president, William McDonough, assembled all the big firms who had lent money to LTCM. He told them the Fed would not bail out a hedge fund, and they’d all have to put up billions more to keep LTCM open long enough to unwind it systematically. Otherwise, they’d suffer the consequences of their own losses.
Only Lehman Brothers, run by Dick Fuld, who wasn’t ever in the Wall Street boys’ club, refused to pony up.
Fuld walked, leaving the others to pick up Lehman’s share of new money going to LTCM.
That hubris set the stage for Lehman’s demise ten years later.
Karma’s a You-Know-What
Meanwhile, Greenspan kept interest rates low for years, forcing yield-hungry investors to stretch further and further out on the risk spectrum, eventually chasing subprime mortgage loans. And, as the principal regulator of Wall Street’s biggest banks, let insane leverage build up in mortgage securities and associated derivatives markets.
As an aside, LTCM, if it hadn’t been so greedy, and had its partners not exited outside capital investors and replaced them with internal partners’ borrowed money to fatten their own capital accounts, would eventually see their trades return to profitability and would have managed through their crisis.
One of the banks who had to pony up more money when Lehman walked out on LTCM’s rescue package was The Goldman Sachs Group Inc. (NYSE:GS).
Goldman’s new CEO in the summer of 1998 happened to be Henry Merritt “Hank” Paulson, Jr.
Ten years later, in 2008, Hank Paulson was Treasury Secretary as Lehman Brothers faltered.
Paulson apparently never forgot Dick Fuld’s failure to step up and that Goldman had to saddle themselves with additional risk because of Lehman, and close associates say never forgave him.
According to Bryan Marsal of Alvarez & Marsal, the firm that led Lehman for three years after its bankruptcy, Paulson had “no standing in the Lehman bailout decision but seemed to dominate the entire process.”
Mr. Marsal echoes what sources close to Goldman and Lehman think of the former CEO’s dislike of Dick Fuld, saying, “Paulson simply didn’t like Dick Fuld, and he had run out of patience.”
Hank Paulson didn’t cause Lehman to fail; he just let it go into the night, a very dark and stormy night.
On Friday, I’ll tell you exactly what crooked games Lehman and Bear and all the other too-big-to-fail banks were doing that drove all of them to insolvency, and why and how the Fed rescued some directly, like Goldman Sachs (surprise surprise), some were merged, and all of them are bigger now.
And, I’ll tell you how and why the financial crisis was allowed to spawn the Great Recession and who benefited by it.
But until then, I have an opportunity for you.
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