Lehman, Five Years Later

On July 16, 2008, I returned home from a year abroad with my family.  I planned a gentle re-entry, getting gradually back up to speed at work over two or three weeks.  Instead, I got a high-speed descent into chaos, as the financial sector melted down, plunging the entire globe into a brutal recession, whose after-effects we still struggle with years later.

Perhaps the single most identifiable event in the crisis that ran from mid-2008 into early 2009 was the failure of Lehman Brothers, which declared Chapter 11 bankruptcy exactly five years ago yesterday.  The week before Lehman’s filing, the Treasury and the Federal Reserve had declined to provide emergency financing, concerned that bailing out troubled financial institutions would create moral hazard — it would encourage in future the same type of imprudent behavior that put Lehman at risk in September of 2008.  Despite these concerns, the Fed and the Treasury tried to broker a deal in which another money-center bank or brokerage would buy Lehman.  That deal fell through at the 11th hour.  Lehman failed on Monday, September 15, 2008.

Within hours of Lehman’s collapse, regulators began to understand the scope of the linkage problem in the global financial sector.  Lehman’s short-term paper was owned by many individuals and institutions, and timely payments on that paper had been guaranteed, to the tune of $100 billion, by huge insurer AIG through the now-infamous credit-default swaps.  If Lehman failed to pay on its paper, AIG would fail, and then the various counter-parties to AIG’s guarantees would fail in turn.

Within days, even hours, the entire world financial system might seize up.

It was during this chaos that the Treasury put forward plans to create a “bad bank” to buy up the toxic assets of troubled financial institutions.  Congress turned Treasury down and the U. S. stock market suffered the worst one-day point drop in history.  This brought legislators back to the table.  Congress did an about-face and approved $800 billion to fund TARP (the Toxic Assets Relief Program).

TARP was used for a broad variety of financial purposes not originally contemplated, from providing emergency liquidity to money-market funds to keep them from “breaking the buck,” to keeping automakers GM and Chrysler in business until Obama took office.  All of this happened while Bush was still President, a fact often forgotten.  TARP was ultimately profitable to the Treasury, as debt markets gradually returned to normal.  Despite the ultimate full recovery of funds advanced by the taxpayers, TARP was an important issue in the GOP Presidential primaries.  In the end, most of the candidates made a retrospective pledge to not support TARP.  (Sort of like a dislike on Facebook, and in any case deeply misinformed.)

Or maybe not.  I firmly believe, with Warren Buffett and most economists, that in the absence of the desperate measures undertaken during the crisis, the entire global financial system might have failed.  In that case, instead of 7.5% unemployment, we might today have 30% unemployment.

But if those desperate acts were necessary, they have also had deeply troubling unintended consequences. Five years later, the “too big to fail” institutions have only grown larger. We have a new, complex and burdensome financial regulatory apparatus, which on balance benefits the same banks and brokers that put the world economy at risk in the first place, at the expense of smaller, regional players who were by comparison blameless. Lending to Main Street is dead in the water, while speculation reaches pre-crisis levels.  Is the global financial system safer?  Depends who you ask.  

As investors, we can largely put the financial crisis in the rear-view mirror, with markets making new highs monthly. As money managers, we celebrate the gains while continuing to look for advantages for our advisory clients.

Yet as a citizen of the world’s greatest democracy, I can’t escape the feeling that we have gone astray. In a real sense, the bad guys won.

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