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Reporting the Crisis

worried on the stock market floor; via Flickr

Paul Solman: This week marks the anniversary of the collapse of Lehman Brothers and one of the most extraordinarily tumultuous weeks Wall Street has ever had. So, in reflecting on those events and the subsequent year, I thought I’d offer a few thoughts on what it has been like having a ringside seat to the biggest story of the past 12 months.

First, what’s made this crisis different?

What stands out? That for the past year, people have really cared about what I’m reporting. Really REALLY cared. Not that economics was considered irrelevant. Over my 32-year career as a business and economics journalist, interest has grown pretty steadily. But never before, save for the day after the stock market lost 20 percent in 1987, were so many people so urgently attentive. It was kind of nice, in an On-the-Beach/Mad-Max/Battlestar Galactica way.

Not to say that I’m longing for a return to urgency, mind you. But you have to admit: It will up the traffic here on the Business Desk. And once again make us among the most sought-after guests at the cocktail party. Historically, “I’m the Economics Correspondent for the NewsHour” hasn’t exactly drawn a crowd.

Is there anything to be said yet about how the history of this crisis is being written? Are folks — at least in the media — making too big a deal of the anniversary of the fall of Lehman rather than really acknowledging the slow-moving train wreck that was most of last year?

We media folks are always looking for a peg, a hook, a point of common interest with you, the audience. Anniversaries are utterly random events and yet, we have collectively come to note them. The further the event recedes in time, the less frequent the notice. But 10 years, 25 years, 50, 100…they’re socially arrived-at markers for things we seem to want to remember as a group.

The anniversary of Lehman is, in that sense, not much different than the old chestnut about where you’d meet someone in New York if you knew the day but not the time or place: You try to imagine what the other person is trying to imagine YOU imagining, and vice versa. Or watching the Oscars because you figure everyone else will too, and you want to join in the conversation.

That said, many comments I’ve seen about Lehman have used the anniversary as a pretext to look at both the slow-moving train wreck BEFORE Lehman/AIG, and the explosion of that fateful week as well. Most useful, perhaps, would be to share thoughts WE recorded for OUR anniversary piece, slated to run tonight (Monday). These didn’t make it in, but arguably should have.

Here’s Bob Glauber, Harvard professor and former Undersecretary of the Treasury under George Bush I. He was there for the non-bailout of the investment bank disaster of the ’80s, Drexel Burnham.

Paul Solman: Did Lehman cause the crisis?

Bob Glauber: Well, clearly markets anticipated that Lehman was going to be allowed to collapse and as soon as that happened the cost of short-term money went up dramatically and markets froze. So it has to be that Lehman was unanticipated and a major ingredient into the freezing of the markets.

PS: So how much of a role do you accord Lehman? I mean without Lehman we would have been okay?

BG: No. Without Lehman it would have been something else. With Freddie and Fannie the week before, it was AIG the day after, these were all rolling forward so it would have been one or another. Lehman was the proximate cause and it was really after Lehman that the markets seriously collapsed but they were on their way long before Lehman to seizing up.

PS: But if Lehman had been rescued would we have had the crisis?

BG: I think we would have had the crisis. The rescue of Lehman wouldn’t have stopped it. Markets were scared, they didn’t know what was going to fail next, you had other much larger firms Goldman Sachs, Morgan Stanley, that almost were caught up in the collapses and so no, we would have had a serious crisis whether or not Lehman was saved or allowed to go down.

PS: So if you’d been in the administration at that point in time would you have saved Lehman?

BG: It’s an extraordinarily difficult choice to make. On the one hand, after Bear Stearns was saved there was outrage that a bunch of managers were allowed to stay if not whole at least come out with some money. There was the whole issue of moral hazard. If you continue to save these large institutions everybody will act as if they’re going to be saved and take more risk, so there was a strong argument to try to set the record straight to get the balance back, to draw the line somewhere and so a great inclination to save Lehman.

What’s clear is the Secretary of the Treasury understood that if they didn’t save Lehman it was a dangerous situation. He tried to telegraph it the whole week before. He said: We’re not going to do it. Hope that the markets would take note of that and prepare themselves. In the event when he didn’t save them as he said he wouldn’t, the markets seized up.

You asked earlier whether or not we would have had a serious problem. We’d have still had a serious problem but we ended up with a market where short term money basically became frozen and so it really got very close to the edge. I think it would have been less severe if they had intervened although there still would have been a very serious crisis.

PS: Now in ’87 you faced this with regard to Drexel, right?

BG: Yeah.

PS: And there you said: Let them go!

BG: There we said let’s not extend the safety net where it has never been extended before. Let’s not put a safety net under Drexel which would have been the first investment bank where a safety net had been employed. We decided that we could afford to do it. Remember that these were much simpler times. Drexel was smaller, Drexel was less interconnected, you didn’t have a derivatives market of the sort we did. And it turned out to be the right decision. But as I say, those were easier times and to get it right then doesn’t mean you get it right the next time.

PS: What was the pressure like then? I mean were there people arguing the other side?

BG: Sure. I mean there were people making much the same arguments: The markets are deeply interconnected, you have to worry about systemic problems, if you let this go it’s going to start the dominoes falling. We believed that Drexel actually could be wound down without catastrophic results and we turned out to be right. We could have turned out to be wrong!

PS: So what kind of opposition was there to letting Drexel fail.

BG: There were people closely connected it the market including regulators as well as market participants who were very worried about the consequences of allowing a bank as large, an investment bank as large as Drexel to actually fail. They were worried that this would cause ripples throughout the market, it would cause systemic failure.

PS: Just like now?

BG: Just like now. And just like now it’s a job of trying to weigh the consequences and you sometimes get it right, sometimes get it wrong. Again we had in the back of our mind that this would be the first time of extending the safety net beyond insured commercial banks and therefore wanted to try and avoid it. On the other hand nobody wants to cause a systemic collapse and I’m sure that’s exactly what Secretary Paulson was facing except that for him they had already put the safety net under Bear Stearns and there was a lot of pressure on him to draw the line somewhere.

PS: Did you guys say, ‘Phew!’ when Drexel did not take down the markets?

BG: We were very relived because there were some people who thought that it might and indeed it might have.

PS: Are you glad you weren’t there during all of this?

BG: Boy am I glad I wasn’t there during all of this! This was a time of unparalleled crisis. I mean just think of what the Secretary of Treasury and the Head of the New York Federal Reserve system had to do in short periods of time! Everybody spent vast amounts of time second-guessing what they did but these are decisions one after another that had to be made in short periods of time, a couple of hours in a situation of evolving chaos. One weekend heads of the major banks, the New York Fed… You’ve got to deal with Lehman, Merrill Lynch and AIG. I’m very glad I wasn’t there!

Finally, here’s former Fed vice-chairman Alan Blinder. Unlike Glauber, he’s a Democrat.

ALAN BLINDER: I think Lehman not being bailed out was a huge big deal. I mean of epic, historical importance. I think this is going to be written about in history books like the stock market crash of 1929 — it was a seminal event. Everything just fell apart after that.

PAUL SOLMAN: Why? And in that case, was Lehman’s failure the Fed’s failure?

AB: Everything fell apart after Lehman. Why is that? You had this old doctrine of “too big to fail” – what did that mean? It meant — and some people denied it, by the way — but it meant that there were some financial institutions so large that their failure would cause a cascade of other failures. That doctrine morphed into what I like to call “too interconnected to fail” which is the first cousin to it.

And the idea there being it’s not so much bigness — although it’s very much related to bigness — is that some institutions had so many paying and receiving counterparty relationships with so many other institutions that if one of these “too interconnected to fail” institutions did in fact fail, it’s like the node of an electrical grid going dead. Things can’t pass through it anymore and pretty soon there’s chaos everywhere. To my mind, before Lehman there might have been some controversy of whether that was exaggerated or not. After Lehman there wasn’t, shouldn’t have been, any controversy because things just started cascading downward everywhere in the financial system, in the whole world!

PS: And you attribute it to the Lehman collapse?

AB: I do. Now that doesn’t answer the question that some people have asked which is, ‘Suppose we had saved Lehman, wouldn’t the dam have broken somewhere else?’ and it might have, that’s hard to say. For example, while the failure of Lehman led immediately to the failure of AIG maybe if we had saved Lehman, AIG would have limped on for another two weeks and then failed. Hard to know the answer to that. But you’ll note that seeing what happened in the immediate aftermath of Lehman, the Federal Reserve jumped in instantly and did not let AIG fail. I guess I should always be saying, ‘Not let them fail messily!’ I mean, AIG is no longer the company that it was, neither are Fannie Mae or Freddie Mac but they weren’t allowed to just go into Chapter 11.

PS: And just dissolve!

AB: And just dissolve.

PS: Would you have been strenuously for saving Lehman if you had still been a vice-chairman [of the Fed]?

AB: Yes. And I think I said so at the time.

PS: You would have argued vociferously?

AB: I think I would have. It’s hard to know because you’re hearing and seeing a lot of different things if you’re sitting in that seat but I think I would have…and I know that from my private perch I was very distressed that Lehman was allowed to evaporate, as you say.

PS: Would you have prevailed do you think, had you been there?

AB: I don’t know. I don’t know.

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