|By JAMES B. STEWART and PETER EAVIS|
Inside the Federal Reserve Bank of
At issue that September, six years ago, was whether the Fed could save a major investment bank whose failure might threaten the entire economy.
The firm was
But as the world now knows, no one rescued Lehman. Instead, the firm was allowed to collapse overnight, a decision that, in cool hindsight, let problems at one bank snowball into a full-blown panic. By the time it was over, nearly every other major bank had to be saved.
Why, given all that happened, was Lehman the only bank that was not too big to fail? For the first time, Fed officials have offered an account that differs significantly from the versions that, for many, have hardened into history.
But now, interviews with current and former Fed officials show that a group inside New York Fed was leaning toward the opposite conclusion — that Lehman was narrowly solvent and therefore might qualify for a bailout. In the frenetic events of what has become known as the Lehman weekend, that preliminary analysis never reached senior officials before they decided to let Lehman fail.
Understanding why Lehman was allowed to die goes beyond apportioning responsibility for the financial crisis and the recession that cost millions of ordinary Americans jobs and savings. Today, long after the bailouts, the debate rages over the Fed’s authority to bail out failing firms. Some Fed officials worry that when the next financial crisis comes, the Fed will have less power to shield the financial system from the failure of a single large bank. After the Lehman debacle,
Whether to save Lehman came down to a crucial question: Did Lehman have enough solid assets to back a loan from the Fed? Finding the answer fell to two teams of financial experts at the New York Fed. Those teams had provisionally concluded that Lehman might, in fact, be a candidate for rescue, but members of those teams said they never briefed
“My colleagues at the New York Fed were careful and creative, and as demonstrated through the crisis that fall, we were willing to go to extraordinary lengths to try to protect the economy from the unfolding financial disaster,”
Interviews with half a dozen Fed officials, who spoke on the condition they not be named, so as not to breach the Fed’s unofficial vow of silence, suggest some Fed insiders believed that the government had the authority to throw
“We had lawyers joined at our hips,” said one participant. “And they were very helpful at framing the issues. But they never said we couldn’t do it.”
As another participant put it, “It was a policy and political decision, not a legal decision.”
A Wall Street Watershed
The account from the New York Fed officials provides new insight into a dangerous moment in
“There is close to universal agreement that the demise of
“The Fed has explained the decision as a legal issue,”
Whether the Fed should have tried to save Lehman is still a subject of heated debate. And it is unclear whether the firm could have been rescued at all.
What happened that September was the culmination of circumstances reaching back years — of ordinary people too eager to borrow, of banks too eager to lend and of
Back in 2008, the Fed possessed broad authority to lend to banks in trouble. Section 13-3 of the Federal Reserve Act provided that “in unusual and exigent circumstances” the Fed could lend to any institution, as long as the loan was “secured to the satisfaction of the
Whether and how much the Fed could lend Lehman depended on those teams’ findings, although the final decision rested with
A Question of Valuation
In recent interviews, members of the teams said that Lehman had considerable assets that were liquid and easy to value, like United States Treasury securities. The question was Lehman’s illiquid assets — primarily a real estate portfolio that Lehman had recently valued at
Others had already taken a stab at valuing Lehman’s troubled assets.
A group of bankers summoned to the Fed by
“There can’t be any reasonable doubt that had the Fed rescued Lehman, that very act would have pushed up the value of its assets,”
While the Fed team did not come up with a precise value for Lehman’s illiquid assets, it provided a range that was far more generous in its valuations than the private sector had been.
“It was close,” a member of the Fed team that evaluated the collateral said. “Folks were aware of how ambiguous these values are, especially at a time of crisis. So it becomes a policy question: Do you want to take a chance or not?”
Argument continues today over the value of Lehman’s assets. A report compiled by
Ultimately, the appraisals of the New York Fed teams did not matter. Their preliminary finding was that Lehman was solvent and that what it faced was essentially a bank run, according to members of the group. Researchers working on the value of Lehman’s collateral said they thought they would be delivering those findings to
The Fed would be lending into a run,
Those at the Fed who have contended that Lehman was insolvent have never provided any basis for that conclusion, other than references to the estimates of
‘A Lack of Legal Authority’
So why, then, was Lehman allowed to die?
In written testimony before
It was only on
“Of course the Fed can stop a run,” said
Scholars are still struggling with the claim that the Fed could not rescue Lehman but was nonetheless able to save Bear Stearns and A.I.G.
What is clear to
“The inconsistency was the biggest problem,”
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