It’s the Economy: Lehman Brothers, We Heard You Were Dead

Lehman Brothers is having a great year. The bank, which almost destroyed the global economy four years ago this week, recently emerged from bankruptcy, resolved a third of its debts and executed the largest U.S. real estate deal of the year. Today, the company appears an awful lot like a normal investment bank. Its trading floor — on one of the two floors Lehman occupies in the Time & Life Building in Midtown Manhattan — is filled with dozens of young people who stare at financial graphs on Bloomberg terminals and talk in the hallways about the deals they’re working on.

Except that Lehman’s sole objective is to sell everything it owns so it can repay its lenders and disappear. The reason it has taken so long (and will take many more years) is that selling off the pieces of a big investment bank is almost ineffably complicated. Banks have few physical assets, and they go fast. (Lehman sold its headquarters the day after its bankruptcy.) A bank’s main value is really just a huge pile of promises. Banks borrow money (often from other banks) and promise to pay it back; then they lend that money (again, often to other banks) on the promise that they’ll return it, too. Every bank could collapse if more than a small percentage of people ask for their money at once.

The system works because lenders have confidence that if there’s ever a run on a bank, governments and central banks will step in and limit the damage. Of all the financial calamity that Lehman inflicted on international markets, perhaps the most significant was that it came close to destroying that confidence. And one reason this sluggish economy persists is that investors still haven’t got it back.

Much of our continued distress, as measured in bond rates and fewer loans issued, comes down to a lingering fear that another bank (or for that matter, a country) could collapse. Lehman’s long unwinding has only worsened these fears. Like all big banks, Lehman was more like a loose agglomeration of hundreds of individual companies. Its bankruptcy affected thousands of subsidiary entities and triggered filings in 80 jurisdictions around the world. This led, immediately, to several conflicts. The now-separate divisions in the United States and Switzerland, for instance, are still negotiating exactly how much they owe each other.

The Lehman Brothers office in Midtown makes up around a third of the original company, in terms of assets, and is responsible for paying back $360 billion in more than 60,000 claims. It has already distributed around $22 billion and estimated that it will pay back another $40 billion — giving investors an average of 18 percent of that $360 billion — by the time it closes its doors completely, some time after 2017. The company’s entire business objective is to fulfill the terms of a 791-page legal document listing all of its unfulfilled financial promises. The task is even more overwhelming than it first appears. Each creditor is owed a different percentage based on the type of loan it gave and which division the creditor gave it to. Investors who lent money to Lehman’s commercial-paper subsidiary get a return of 56 cents on the dollar; those who bought a bond from the parent company are getting a little more than 20 cents. And each of those creditors can pursue a challenge and demand more money. One of the new Lehman’s busiest departments, not surprisingly, is legal.

Why would anyone lend money to any institution if there was a chance, once trouble hit, that they would have to wait years to get 20 cents on the dollar? U.S. officials have tried to stanch the loss of confidence by claiming that they have now solved the problems of Lehman. The core solution — as stated in Title II of the Dodd-Frank reforms — is predicated on the notion that the problem wasn’t Lehman’s overinvestment in sketchy real estate deals but rather that the U.S. government did not have the powers it needed to wind it down. The law, at the time, only allowed for the Federal Deposit Insurance Corporation to step in and take over a troubled U.S.-chartered bank. Lehman, though, was about 2,000 companies, many outside the country and most of which weren’t chartered as banks. The government could either bail the whole thing out or let everything fail.

The F.D.I.C. now has the power to take over a huge holding company, sell off the healthy parts, and — in theory, at least — manage a careful wind down. Last year, the F.D.I.C. released a remarkable paper, “The Orderly Liquidation of Lehman Brothers Holdings Under the Dodd-Frank Act,” which lays out how the agency would have saved Lehman if it possessed those new powers at the time of the collapse. The F.D.I.C. would instantly dismiss existing management and force total losses on all the shareholders, but work hard to keep all other promises. It would create a “bridge bank,” a carbon copy of Lehman, run by regulators, that would maintain the company’s role in the global financial system while helping the company gradually disappear. By their own reckoning, the new powers would have meant far more money for creditors — 97 cents on every dollar, not 18 — in far less time.

Most people in finance are glad that officials will have more options for taking on the next crisis, but the stingy lending environment suggests that they are not persuaded that the problem has been solved. While the law now requires the largest financial institutions to disclose all their important subsidiaries, it is up to each bank to decide which ones are important. The major banks have each disclosed a dozen or so firms, but still keep thousands of others — some of which might be carrying massive risk — hidden. The F.D.I.C. strategy also assumes that global regulators will happily cooperate as the U.S. government takes over a huge bank and eliminates the value of all its shares, including those owned by foreigners. The F.D.I.C.’s Lehman report deals with the massive challenge in one sentence: “The F.D.I.C. would have contacted the relevant foreign and domestic regulatory authorities and governments to coordinate the resolution.”

The main lesson of Lehman’s collapse is that the response to a troubled financial system is, ultimately, determined not by technical regulation, but by politics. The F.D.I.C. can use its new powers only after receiving the consent of the Treasury secretary. And its new powers pertain only to those banks deemed systematically important, a designation determined by political appointees. So while the F.D.I.C. is working to formalize the rules governing its new powers, investment-bank lobbying has grown by nearly 60 percent since the crisis began. Bankers learned that they need to be closer than ever to politicians.

Kenneth Rogoff, who co-wrote the pre-eminent history of financial crises, “This Time Is Different,” told me that crises don’t end because new laws are enacted and politicians can be trusted again. In 1945, “the financial markets were devastated,” he said. “State and local governments had defaulted on everything. Lending had shrunk.” Somehow, though, the economy recovered and experienced nearly 30 years of robust growth. Confidence comes, he said, when “enough time passes so everyone forgets there was ever a problem.” I was thinking about this as I walked through the new Lehman headquarters and overheard one employee brag about a real estate deal he had just made. (After all, the advisory firm Alvarez & Marsal could earn more than $600 million from winding down Lehman.) But the larger fact is that Lehman, which once seemed essential to the economy, is slowly disappearing. That few even know that this is happening in the Time & Life Building suggests that our confidence may not be far away.

Deep thoughts this week:

1. Lehman is still alive.

1.5. Sort of.

2. And few people have noticed.

3. Which is the best news possible.

Adam Davidson is co-founder of NPR’s “Planet Money,” a podcast, blog and radio series heard on “Morning Edition,” “All Things Considered” and “This American Life.”