The Fed and Lehman Brothers: Setting the Record Straight on a Financial Disaster

Studies in Macroeconomic History

by Laurence M. Ball

The bankruptcy of the investment bank Lehman Brothers was the pivotal event of the 2008 financial crisis and the Great Recession that followed. Ever since the bankruptcy, there has been heated debate about why the Federal Reserve did not rescue Lehman in the same way it rescued other financial institutions, such as Bear Stearns and AIG. The Fed's leaders from that time, especially former Chairman Ben Bernanke, have strongly asserted that they lacked the legal authority to save Lehman because it did not have adequate collateral for the loan it needed to survive. Based on a meticulous four-year study of the Lehman case, The Fed and Lehman Brothers debunks the official narrative of the crisis. It shows that in reality, the Fed could have rescued Lehman but officials chose not to because of political pressures and because they underestimated the damage that the bankruptcy would do to the economy. The compelling story of the Lehman collapse will interest anyone who cares about what caused the financial crisis, whether the leaders of the Federal Reserve have given accurate accounts of their actions, and how the Fed can prevent future financial disasters.

Genres: Economics, Finance, Business, Nonfiction, History

280 pages, Kindle Edition

First published May 8, 2018

Reviews

[Frank Stein · Rating 4 out of 5]

This book should more or less settle the case about why Lehman Brothers failed. Ball proves that Lehman Brothers's fundamentals and assets were strong, that it was probably solvent or close to it, that it just suffered a short-run liquidity run, and that the Federal Reserve could have saved it. Yet he also shows that Secretary of the Treasury Hank Paulson, tired of being called "Mr. Bailout," insisted that the Fed close its window to them, perhaps precipitating the greatest financial crisis since the Great Depression.

Since the collapse, Ben Bernanke, Paulson, and others have claimed that Lehman Brothers simply did not have enough assets for the Fed to lend on. This is clearly false. Just the day before the company declared bankruptcy, the Federal Reserve opened up its Primary Dealer Credit Facility to almost every type of collateral, from almost every company, except Lehman Brothers itself. The next day they explicitly told Lehman Brothers to file for Chapter 11 and not to borrow from the Fed like every other bank. The day after the company failed, however, the Fed began making $30 billion in loans to its broker-dealer subsidiary, LBI, on the very collateral they said was not good enough the day before. Overall, Lehman had hundreds of billions of collateralizable assets, and over $100 billion in liabilities not due for a year or more, out of a $600 billion balance sheet. There were plenty of assets for the Fed to lend on, with little danger that they would run out of funds in the interim. The government, for a combination of political reasons, and perhaps personal distaste for the outsiders like CEO Dick Fuld at Lehman, forced the company into bankruptcy.

Maybe the failure of Lehman was not as big a deal as Ball makes it out to be, but he has done the legwork to show it was a going concern right up to the last minute. Even if one thinks the Federal Reserve shouldn't have leant to Lehman, the government's later obfuscations needed just such an answer as Ball gives here.

[Ksensei K · Rating 4 out of 5]

The recent financial crisis is a hobbyhorse of mine, I seem to be unable to stop reading about it. Luckily, some seem to be unable to stop writing about it, this book being released a decade (holy shit, has it been that long?) after the events in question took place.

“The Fed and Lehman Brothers” present a thorough examination of Lehman’s failure, the events and thought process behind letting it happen and the firm’s actual condition at the time. The author’s argument strikes me as cohesive, sound and generally well-articulated. There are several crumbs of information I wish got more attention (such as Lehman’s SIVs), but regardless, Ball’s conclusions are well supported and exceptionally researched. He does an outstanding job at avoiding lazy conclusions and emotional appeals.
The book started as a monograph for professional audiences, which shows, most revealingly so in the structure: Ball describes his sources meticulously and repeatedly, and qualifies every chapter and argument with short summaries and introductions. Repetition in general is ever-present and somewhat tiring, while the reader may need periodic refreshers on numbers being discussed, every mention of “administration” does not need to have “British version of bankruptcy” amended. One can remember that. Hopefully, such lingering traces of academic writing are further remedied in the published version. Thankfully, the style itself is quite engaging, though rather uneven, and makes for a fast-paced read, despite the complex subject matter.

In general, the book is informative and valuable, one I would recommend to those with a deep, rather than cursory, interest in the 2008 finial crisis.

Thanks to netgalley for a copy of this book.

[Michael · Rating 5 out of 5]

Economist Laurence M. Ball re-examines the evidence of the choices facing the managers of the 2008 financial crisis. In particular he looks at a crucial choice – to let the storied Wall Street firm Lehman Brothers fail in bankruptcy rather than offer taxpayer support for a bailout.

His conclusion: the Federal Reserve, US Treasury, and New York Fed made a grave unforced error in allowing Lehman Brothers to declare a messy bankruptcy – still the largest US corporate bankruptcy of all time – in the process adding destructive force to the financial tsunami already enveloping the economy and financial markets in September 2008. And they disingenuously described the reasons for their decision.

The main managers of the 2008 financial crisis, Treasury Secretary Hank Paulson, New York Federal Reserve Bank President Tim Geithner, and Federal Reserve Chairman Ben Bernanke all claimed in official testimony and their subsequent memoirs that Lehman Brothers was “insolvent” at the time of the bankruptcy. One of the conditions of Fed lending is that it cannot lend money to insolvent institutions, or banks with insufficient collateral to pledge for a new loan.

It is undeniable that Lehman faced a liquidity crisis in September 2008 – the inability to pay back everyone it owed money to, if everyone wanted their money back right away. That’s a classic problem facing any bank in which depositors demand immediate return of their deposits. The dispute Ball addresses is whether Lehman had enough assets in the medium-to-long run that would have covered what it owed so that a fresh loan from the Fed could have averted bankruptcy.

In household terms, we can imagine a well-off person with a valuable house and car worth a million dollars, $25,000 cash in the bank, and who owes $750,000 in a combination of a personal loan, mortgage and car loan. If a lender suddenly demands a $100,000 personal loan be paid back immediately, we would say that person has a liquidity problem but is not insolvent. Given enough time, the person could likely solve the problem, through a sale of the car and house. Even easier than a fire sale of the car and house, a fresh loan against the home equity would ease the situation. Bankruptcy is far from inevitable.

In the case of Lehman, Ball argues, the Federal Reserve had created a program earlier in 2008 that could have provided that fresh loan.

The rest of my review:
http://www.bankers-anonymous.com/book...

[Jagordo · Rating 4 out of 5]

This book reads more like a doctoral thesis than it does a pop-finance piece (read: dry but content dense), but it does well in its mission. Be prepared for repeated bits of dialog as Ball emphasizes his case on what happened in this absolute clusterfuck of months in '08.

[Jim Milway · Rating 4 out of 5]

Prof. Ball investigates why the Fed let Lehman Bros fail in Sept. 2008. At the time of the failure, the protagonists (Paulson, Bernanke, and Geithner) seemed to conclude that as a matter of policy they wouldn't rescue Lehman. Paulson had earned a reputation as Mr Bailout because of Bear Sterns, Freddie Mac, and Fannie Mae earlier in 2008. Even though it wasn't his decision (as Treasury Secretary) to make, Paulson cowed the Fed into letting Lehman fall into bankruptcy. He simply had a force of personality that the academic Bernanke didn't.

But then when the decision caused so much turmoil in the markets, the same protagonists changed their rationale to explain their blunder. Now they said that they couldn't legally support Lehman with liquidity. Ball meticulously goes through the evidence to show that they had the legal authority and that Lehman's main problem was liquidity, not insolvency.

Should the Fed have bailed out Lehman? I am certainly no fan of bail outs. But going back to Walter Bagehot, there is a defensible rational for the central bank to help solvent firms get through liquidity crises. And Lehman seems like a textbook case for such action.

The book doesn't have the inside feel of Sorkin's book Too Big to Fail, but Ball seems to have checked every assertion as much as possible. And while it doesn't have the drama, the book is very easy to comprehend.

[KS · Rating 1 out of 5]

An interesting book but I think he fails to "prove" that Lehman had adequate collateral. He bases this on a variety if sources but in reality no one knows what anything at these companies were worth at the time. His assumptions on the collateral are very weak and does not seem to understand the fluidity of the situation during those days- lots of that collateral could have been worthless and hidden off shore.

He certainly could have made the case that the decision to let Lehman fail was a political/personal one. Fuld is unlikable and arrogant, the issue of moral hazard was paramount, Bush/Paulson did not want the political heat etc. All these are solid arguments but he bases the whole book on the evaluation that Lehman had enough collateral which is very suspect. In retrospect, it is clear that somehow the Fed or Treasury should have done something at the time to ease the dissolution of Lehman.

It would not surprise me that Fuld paid him to write the book so it looked like Paulson/Bernanke were to blame for the fiasco. The book would have been more effective/credible if he delved into Fuld and his hiding of an offer from KDB and well as the horrible decision to issue a stock buyback as the crisis was starting to unfold.

This is an incomplete book with some questionable math.

[Alessio Montella · Rating 4 out of 5]

This book’s main argument is that the Fed chose not save Lehman. Ball’s evidence suggests that the Fed’s decision was probably a political one, where officials decided not to help Lehman because of political pressures and because they underestimated the consequences. It contrasts with the view that it was illegal for the Fed to lend money to Lehman Brothers. Indeed, it shows not only that it was completely legal, but also that legal constraints were never mentioned by Fed policy-makers in discussions prior to the bankruptcy.

This book sheds some light on the truth of the Lehman Brothers bankruptcy, it demonstrates that LB was: “unlucky enough to find itself short of cash at a moment when previous rescues had produced overwhelming opposition to another one, and when policy-makers had not yet learned how destructive the failure of a leading financial institution would be.”

[MJ Tian · Rating 4 out of 5]

Great recount of the 2008 Financial Crisis.

It's always easier to summarize a complex event into a simple catchphrase ("mortgage crisis", "housing bubble") as per news sources and movies like "the big short".

Yet, the crash in September was so much more complicated, with its stage set years before Lehman's eventual bankruptcy.

It is easy to point fingers at the fed (why didn't it bail out Lehman? why was Bear Sterns given preferential treatment?) but it is hard to avoid the elephant in the room - it was the banks that got themselves into that position in the first place by creating the myriad of questionable / dubious financial instruments.

[Beachpig · Rating 4 out of 5]

This book was well researched and put together. There was great emphasis placed on identifying the statements and actions/inactions of the Fed and Treasury Secretary and then explaining where other actions and statements contradicted these. The book reads well, at times it reiterates its premise or theory about the poor action taken by Paulson et al a few too many times, but in whole I found it interesting and worth reading.

[Hetal Barai · Rating 5 out of 5]

Something about the financial crisis really tickles my pickle - very enjoyable read

[Golan Mor · Rating 4 out of 5]

Really interesting abstract view into the Great Recession. Author makes a really strong and fairly convincing case that the decision to let Lehman fail was political, not legal as suggested subsequently by the Fed. There are a three assumptions you have to award to the author for his premise to be true.

First, the quality of assets available by Lehman in the form of non-rolled Repo's and assets not secured by long-term debt were indeed sufficient enough to be put up as collateral to the Fed.

Second, short term borrowing by the Fed in light of the run on Lehman's Repo's would have been sufficient enough to bridge time for LB to execute its spinoff plan.

Third, accounting rules that lead to the depletion of Lehman's equity under GAAP, the author contends that conventional valuation of cash flows allowed by REIT's would have lead to a successful spin-off of the Real Estate assets away from LBHI.

Giving the author these assumptions, there are many reasons why his contention is convincing. I enjoyed this book quite a bit, learned a bit more about IB'ing, and the Fed's role in the recession with Bear and AIG and most importantly how that contrasted with its treatment of LB. Does not speak well of the independence of the Fed from the Dept of Treasury which could have dire consequences in future recessions.

[Keshav · Rating 3 out of 5]

A dry and academic account of the technicalities of the Lehman crisis. Ball illustrates how Lehman was solvent (and, indeed, liquid if you consider the enhanced set of securities acceptable as collatarel under the new PDCF) at the time of its 'forced' bankruptcy in the event of the derailment of its merger talk with Barclays due to technicalities in UK banking law. Lehman was caught in the crosshairs with the treasury secretary Paulson trying to protect his own political standing of not being wanted to see as 'Bailout man' and a 'deferential' Bernanke not forcing a Great Depression era law, sec 13(3) that protects Fed independence in such matters (The amended law requires treasury agreemeent and sets a dangerous precedent for future such events), while neither understanding the wider repurcussions of the bankruptcy- which once they becameapparent led to the AIG bailout 2 days later (while the AIG lies outside of Fed purview and was then accepted as a more dangerous borrower). Thoroughly engaging with technicalities clearly laid out and clearly repeated, it can nonetheless be a drab read if you're interested in the minutaie of central bank laws and 'repo' agreements.

[Isaac Chan · Rating 4 out of 5]

Quite an interesting an amusing account of the Lehman crisis. It uncovered a reveal that were kept under wraps by Fed officials and the Treasury, and for that I learnt quite a great deal. One major flaw that I am unable to dismiss is that the author draws his conclusions on resources that seem quite shallow and frivolous, for example material that are available to the public, such as testimonies and various statements from policymakers. The author even goes as far as referencing heavily on the memoirs of Paulson, Bernanke and Geithner! I feel that the author should have delved deeper into the crisis and sought out more confidential data, by which readers would feel far more enlightened. But overall, this book is indeed engaging, and I consider it a top recommendation for anyone who is interested in the crisis.

[Gabriel Stein · Rating 5 out of 5]

Excellent and lucid overview

Whether it was right or wrong to let Lehman Brothers fail, can be discussed. But what is clear is that the way it was done owed less to the fundamentals of the business and more to political pressure. Ball shows that the Fed could have saved Lehman, but, under pressure from the Treasury Secretary Hank Paulson, it decided not to. Moreover, he does so in a lucid and exemplary fashion. Strongly recommended.

[Robert Deaton · Rating 4 out of 5]

This book makes some strong points at the very end about the dangers presented by Dodd-Frank should we get into another credit crisis. It is too bad more people won't read it to understand what these dangers are.

[Joshua Slive · Rating 4 out of 5]

“The Fed and Lehman Brothers” by Laurence Ball has a straightforward and convincing argument that LB could have and should have been saved. But it does feel to me that hindsight can’t fully appreciate the perspective of the crucial weekend.

[Tate Bregman · Rating 3 out of 5]

Solid context on the Fed’s role during the Lehman collapse, but very technical and dense with economic jargon.

[Phil Mackie · Rating 5 out of 5]

Does exactly what it sets out to do. Examines the evidence for the Fed allowing Lehman to fail.

[Cristie Underwood]

Laurence M. Ball has written a phenomenal summary of the most important moment of modern financial history: the failure of Lehman Brothers in September 2008. The author provides evidence that important decisions were made due to politics and the fallout from that.