The Odds of Economic Meltdown: Hoisted from the Archives from Ten Years Ago

Must-Read: Barry Ritholtz: Let's Put the Lehman Bailout Debate to Rest:

Could the Fed have rescued Lehman? Was Lehman solvent? Was it capable of raising capital?...

The issue I'm skipping for now (assuming the Fed could have rescued Lehman) is whether it should have done so. That's a separate question. Let’s dispose of the first issue.... As subsequent events have shown, most especially with the Fed-led bailout of insurance giant American International Group, if there was a will, there most certainly was a way.... The second issue is two-fold: Was Lehman technically solvent and could this be determined in the weekend before the collapse with any degree of confidence? The answer to the former is probably not; the answer to the latter is definitely not. As researchers William R. Cline and Joseph E. Gagnon at the Peterson Institute  wrote, Lehman Brothers was "deeply insolvent... true net worth at the time it filed for bankruptcy is somewhere between –$100 billion and –$200 billion".... Questions of Lehman’s true liquidity were evident even in early 2008....

But the proof of Lehman’s insolvency is found in its notorious accounting deception, Repo 105. Each quarter, Chief Executive Officer Dick Fuld and his team of accountants at Lehman managed to move about $50 billion in liabilities off of Lehman’s books just in time for the quarterly earnings report. As the Wall Street Journal reported, “Because no U.S. law firm would bless the transaction, Lehman got an opinion letter from London-based law firm Linklaters.” Hiding $50 billion dollars or more of liabilities each quarter is prima facie evidence of insolvency.... Lehman’s accounting was especially opaque, even relative to other investment banks (and that’s saying something!), making it difficult for any suitor to throw Lehman a lifeline, especially on such short notice.

There was one white knight who could have saved Lehman: Warren Buffett.... Berkshire Hathaway offered to buy preferred shares that would pay a dividend of 9 percent and could be converted to common at the then-market price of $40.30. Buffett’s money was costlier than other potential investors, but it came with the imprimatur of the world’s best-loved investor. That alone probably would have guaranteed Lehman’s survival. Part of Buffett’s offer was that Lehman Brothers senior managers invest on the same terms alongside him with their own cash. Fuld spurned that proposal. When Buffett offers you a few billion dollars--and you foolishly reject it--you can no longer make the claim that attempts to raise capital were unsuccessful....

Lehman was the first trailer in the park to be destroyed by the tornado. Whether it lived or died was not going to stop the financial forces that had been decades in the making and unleashed when the credit bubble popped. I agree with Ann Rutledge, a principal with New York-based R&R Consulting, and co-author of two books on structured finance. She noted “It wasn’t a mistake to let Lehman fail, it was a mistake to let it live so long.

Comments