Could Lehman Brothers Have Been Saved?

This article was originally published by the Fiscal Times on Thursday, Sept. 2, 2010.

The former CEO of Lehman Brothers testified during one of the final hearings of the commission investigating the U.S. financial crisis that federal regulators prematurely forced the firm into bankruptcy before all other options were exhausted.

By Katherine Reynolds Lewis

Just days before the two-year anniversary of Lehman Brothers' collapse, banking regulators passionately defended their handling of the crisis at a Financial Crisis Inquiry Commission hearing, while the former Lehman CEO insisted the government prematurely forced the firm into bankruptcy before all other options were exhausted.

"Lehman was forced into bankruptcy not because it neglected to act responsibly or seek solutions to the crisis, but because of a decision, based on flawed information, not to provide Lehman with the support given to each of its competitors," said Richard S. Fuld Jr., the former chairman and chief executive officer. "We had the collateral. We had the capital."

In testimony Thursday, Federal Reserve Chairman Ben Bernanke countered that charge, saying it was impossible for the Fed to rescue Lehman Brothers from bankruptcy in 2008 because the Wall Street firm lacked sufficient collateral to secure a loan. Asked how the Lehman case differed from that of American International Group Inc., which received $182 billion in taxpayer aid, Bernanke said there was a fundamental difference.

AIG, as the biggest insurance company in the U.S., had valuable assets which could back up the Fed's emergency loan, he said. "The Federal Reserve will absolutely be paid back by AIG," Bernanke said.

Whether it would have been possible to save Lehman Brothers is one of the most perplexing questions to emerge from the financial meltdown that led to one of the worst recessions in U.S. history. That question clearly divided the 10 members of the commission, whose questions at each were other almost as pointed as the ones they posed to witnesses, who gave sworn testimony.

The hearings underscored a hard truth: that for all the new laws and pending regulations Congress and the Obama administration have put forth in response to the meltdown, future crises will only be averted if industry professionals and the regulators who oversee them use good judgment and pursue hints of trouble even in the face of rosy conventional wisdom.


"It's going to take regulators with strong backbones going forward," testified Scott G. Alvarez, general counsel of the Federal Reserve Board, on Wednesday. "We are not going to be able to stop crises from occurring. On the other hand, we can prepare ourselves better for it and lessen the impact."

Alvarez and John H. Corston, an official at the Federal Deposit Insurance Corp., testified at the hearing Wednesday on Capitol Hill that the sweeping financial regulatory reform that President Obama signed into law in July will make it easier for regulators to supervise financial firms and dismantle those that may threaten the stability of the financial system by virtue of their size and connections with other firms.

Bumpy Road for Commission
The hearing by the independent, bipartisan commission addressed the question of how government officials and regulators determine whether a financial firm is literally “too big to fail,” because of the repercussions it would have throughout the financial system. Bernanke told the commission that regulators must be ready to shut down banks that threaten the system.

The two days of testimony Wednesday and Thursday are the last in Washington scheduled before the commission travels around the country to hear from the public. The commission is scheduled to release its report in mid-December.

The commission reportedly has been hampered by an exodus of senior employees and by internal disagreements that could hinder its ability to produce a report the entire commission could support. Modeled in part on the 9/11 Commission, the panel members hope to produce a detailed report that will influence future policymaking. It has held 12 days of hearings, interviewed more than 500 witnesses and pored over hundreds of thousands of pages of documents.

Much of Wednesday’s hearing focused on the weekend leading up to Lehman's historic bankruptcy filing, in the wee hours of the morning on Monday, Sept. 15, 2008. The firm was set to repay billions of dollars in short-term loans on Monday, and was scrambling to come up with a willing lender in the face of market rumors about Lehman's instability. Commission Chairman Phil Angelides questioned whether the Treasury and Federal Reserve officials managing the crisis were focused solely on the financial impact of the firm's troubles, or if political and public relations motivations colored their actions.

"When I look at this chronology, my first takeaway is that over a period of months, what ends up being made is a conscious policy decision not to rescue the entity," Angelides said. "It looks like there are political considerations at play."

Chronology of a Bankruptcy
For instance, he cited a Sept. 9, 2008, email from then-Treasury chief of staff James Wilkinson saying he "can't stomach us bailing out Lehman,” and that it “will be horrible in the press." The timeline the commission produced, based on interviews by its investigators and internal government and Wall Street documents, also mentioned a Sept. 14, 2008, email from Wilkinson about a White House phone call that concluded the U.S. government "is united behind no money. No way in hell Paulson could blink now," a reference to then-Treasury Secretary Henry M. Paulson.

Government officials were hoping that Bank of America or Barclays would acquire Lehman Brothers to resolve the crisis. When Bank of America decided to purchase Merrill Lynch and the Barclays deal fell through on the weekend in question, officials proceeded to Plan B: bankruptcy.

"Our Plan A was to facilitate a merger between a strong merger partner and Lehman,” testified Thomas C. Baxter, Jr., general counsel of the New York Federal Reserve Bank. “Rest assured, commissioners, we worked night and day to try to make that plan happen. It wasn't about politics, it was about getting to the right result." Fuld maintained that Lehman had $140 billion in collateral to back up the loan it needed on the fateful weekend. But he said his firm wasn't allowed to use that collateral to borrow money through the government's primary dealer credit facility when the Fed opened it to securities firms with looser rules for collateral, on the afternoon of Sunday, Sept. 14.

"When I first heard about the fact that the window was opened for expanded collateral, a number of my finance and Treasury team said, 'We're fine, we have the collateral, we can pledge it,'" Fuld said. "Forty-five minutes later they came back and said, 'That window is not open to Lehman Brothers.'"

That same afternoon, a meeting by the Lehman board of directors was interrupted by a call from Baxter and then-Securities and Exchange Commission Chairman Christopher Cox, encouraging them to consider filing for bankruptcy — but not going so far as to direct them to do it, testified Harvey R. Miller, a partner at Weil, Gotshal & Manges, representing Lehman.

Miller also described a series of meetings over the weekend with government officials, specifically the New York Federal Reserve Bank and SEC, in which Lehman was informed the firm would receive no government capital. "It appeared that the definitive decision not to assist or support Lehman had been made before the meeting with Lehman and the government representatives were not prepared to discuss the rationale underlying their decision or their evaluation of the potential consequences," Miller testified.

He also questioned the government’s tactics in pressing for details on how Lehman would return to healthy financial operations if it received a short-term infusion of capital. "When someone is on the operating room table hemorrhaging out, you don’t ask, 'Can you pay the bill?' You save the patient," he said. "Somebody found a way in the automobile industry; they could've found a way in this industry."

Baxter claimed that Lehman could have used the Fed lending facility on Sunday, Sept. 14, and simply misunderstood the rules. He noted that the firm's bankruptcy filing came days after the government takeover of Fannie Mae and Freddie Mac and just before the AIG crisis.

"Lehman was not our only problem in that month," he said. "This was an extraordinary point in the crisis and I think one of the most historic months in the history of American finance."