As many of our readers know, my colleagues and I have written and spoken about the Lehman failure and the lack of forensics on the Fed’s Bear Stearns decision and the Fed’s Lehman non-decision. We have articulated the risks to policy transparency that originate with the US Senate Banking Committee under Senator Christopher Dodd’s chairmanship; he has kept the Fed’s Board with only 5 governors and therefore forced a unanimity rule instead of a super majority rule which was intended for Section 13 emergency power intervention. Note that there are no records and no memorialized discussions other than when 5 votes were affirmatively cast.
We have asked what happened during the 6 months between March when BSC was merged through the use of Maiden Lane, LLC and September when Lehman failed. Those 6 months were the months when Lehman was using the Fed’s own treasuries to secure overnight repos and when primary dealers like Lehman were borrowing directly from the Fed and pledging collateral. What was the Fed seeing in Lehman? What was Lehman asked to produce besides collateral? Was there any clue about Lehman’s growing insolvency? Other questions still unanswered include if there were suitors among the primary dealers or elsewhere who would have taken Lehman? Were they among the firms that have to answer to a foreign central bank or regulator; therefore they may have required the Fed to take a larger amount of Lehman’s toxicity onto the Fed’s balance sheet in the form of a Maiden Lane 2?
These and related questions remain unanswered. Today some of them are being asked by the NYTIMES. One might wonder where the Times was for the last 6 months as these events unfolded. Where were the editorials calling for transparency between March and September? Whatever the case, now the Times has awakened to the important role played by media. We forward this editorial in case any of our readers missed it.
New York Times
December 15, 2008
Questions for Mr. Geithner
Timothy Geithner, President-elect Barack Obama’s choice for Treasury secretary, has some explaining to do.
As president of the Federal Reserve Bank of New York, Mr. Geithner was a key decision maker last September when the government let Lehman Brothers fail and then, two days later, bailed out the insurer American International Group for $85 billion.
Those decisions proved cataclysmic. The markets and the economy have yet to recover from Lehman’s failure. The bailout of A.I.G. dealt a further blow to the Fed’s credibility — and, by extension, Mr. Geithner’s — because it was an abrupt reversal from the no-new-bailouts stance that had applied to Lehman and, initially, to A.I.G. Together, the decisions showed that several months into the financial crisis, officials lacked the information and the insight to correctly call the shots.
Making matters worse, the Fed and the Treasury have now changed their story about how the calamity unfolded. No one expects a perfect performance in the thick of a crisis. But an after-the-fact revision of what happened at best raises questions and worse, looks like an attempt to dodge accountability.
In testimony before Congress on Sept. 24, about a week after Lehman’s collapse, Federal Reserve Chairman Ben Bernanke gave an accounting consistent with comments and news coverage at the time. “The Federal Reserve and the Treasury declined to commit public funds to support the institution,” he said. He said that the failure of Lehman posed risks but that the firm’s troubles had been well known for some time and investors recognized that bankruptcy was a significant possibility. “Thus,” he said, “we judged that investors and counterparties had had time to take precautionary measures.”
Mr. Bernanke said Lehman’s default, “while perhaps manageable in itself,” combined with the “unexpectedly rapid collapse of A.I.G.” to create a global financial tempest. In other words, Mr. Bernanke, Mr. Geithner and Treasury Secretary Henry Paulson believed the system was stable enough to withstand Lehman’s downfall.
The story changed as they were proved wrong and as the government’s obligations to prop up the financial system rose precipitously. In a speech on Dec. 1, Mr. Bernanke said “legal constraints” had prevented the Fed from rescuing Lehman, making a bankruptcy “unavoidable.” Translation: Not our fault!
The law allows the Fed to make emergency loans when the financial system is in danger, provided that the lending is “indorsed or otherwise secured” to its satisfaction. The Fed has accepted all manner of dubious assets in exchange for its various loans as the crisis has deepened. In a speech on Oct. 15 and in his Dec. 1 speech, however, Mr. Bernanke said Lehman’s collateral was insufficient. Secretary Paulson also invoked a lack-of-legal-authority argument in a speech last month to explain Lehman’s demise. Why didn’t they say so at the time?
Mr. Geithner has made few public comments during the serial crises, but a spokesman for the New York Fed recently disputed this page’s characterization that the Fed “allowed” Lehman to fail, saying — you guessed it — that the Fed had no legal authority to intervene.
The lack-of-legal-authority line also surfaced in video interviews by Fortune magazine of executives at its recent Fortune 500 conference. Peter Peterson, the co-founder of the private equity firm Blackstone Group and a former chairman of Lehman Brothers, was asked about the prevailing view that Lehman’s collapse was “the straw that broke the camel’s back.”
Mr. Peterson said he had talked to Mr. Geithner about that and was told that the Fed did not have the authority to intervene. Mr. Peterson suggested that the media might want to explore the issue in more depth, “before there is too much criticism of what Mr. Geithner’s role was.” He added: “You can probably see I’m a little defensive about Geithner. I was involved in picking him” to lead the New York Fed.
The burden is on Mr. Geithner to clear up the matter. If legal constraints precluded a Fed intervention in Lehman, why weren’t they mentioned at the time? Did Fed officials consider asking Congress for the necessary authority? There was plenty of time to do so because, as Mr. Bernanke noted last September, the collapse of Lehman was a long time coming.
In the absence of an explanation, the changing Lehman story seems like an attempt to deflect public attention from what could go down in history as an epic blunder. It also reinforces the impression of bias created by the disparate treatment of Lehman and A.I.G. Lehman was left to die, while A.I.G.’s counterparties were saved.
The revised version of the story (in which there is no disparate treatment, only officials following the letter of the law in each case) sidesteps questions about whether the bailout of A.I.G. — arranged by Mr. Geithner — was influenced by the specific needs of some of the insurer’s counterparties, like Goldman Sachs.
The Times’s Gretchen Morgenson reported that Lloyd Blankfein, the chief executive of Goldman, was the only Wall Street executive at a meeting at the New York Federal Reserve on Sept. 15 to discuss the A.I.G. bailout. A Goldman spokesman said Mr. Blankfein was not there to represent his firm’s interests, but rather that Goldman “engaged” the issue because of the implications to the entire system.
Adding to the opacity, the Fed recently decided to keep confidential one of two reports that it made to Congress on the A.I.G. bailout. If the Fed had not insisted on confidentiality, that report would have been made public.
Mr. Geithner should be asked at his confirmation hearing to explain which firms were threatened by an A.I.G. collapse, in what amounts and how those entanglements justify an ongoing bailout. Mr. Geithner must also explain how such entanglements came to be the norm on his watch. His answers will help shed light on whether he is sufficiently distant from Wall Street to reform a system that has proved catastrophically unstable.