Lehman Weekend

In America [Lehman Brothers Chair and CEO] Dick Fuld is not going to be too concerned ... that there's a chance that the government would ever let him go?

The moral hazard was so deep that I think there was a widespread perception that somehow all the banks will be saved. ...

Bear Stearns in a sense was saved; it was folded in to JPMorgan. But the shareholders, the officers lost a great deal, and they're very angry because if the Fed had extended the lending rights to Bear Stearns that had extended the next day to the other investment banks, they believe they would have survived.

Whether that's the case or not, I don't know. But certainly there was a very strange timing there of extending privileges on one date to some and not to another.

Rumors were going around about what was the reason, going back to one of the earlier Fed-engineered bailouts, Long-Term Capital Management at the end of the '90s. The story was Bear Stearns didn't play game, and they were going to be punished.

So a lot of people on Wall Street didn't really care that much when they went down because they thought they got their comeuppance.

That's right, but that also sent a warning: Maybe if you're not playing the game, the Fed picks and chooses, picks winners and picks losers. ...

There were rumors after Bear Stearns went down that Lehman was going to be next, and that's where you have the next moment of incredulity. The Fed seems to have been taken by surprise when Lehman Brothers went down. It seems to have been taken by surprise at the consequences of Lehman Brothers going down.

To many of us, this was a mystery. The bubble broke in 2007. That's when you should have started getting worried. You should have known what their portfolio was.

When Bear Stearns went down, the common wisdom was Lehman Brothers was going to be next. Shouldn't you have been looking at the full consequences if Lehman Brothers went down? Talking to people on the staff, it seems not to have fully appreciated the risks of what went on.

When it happened, the first line of defense they said was: We thought the market had time to adjust. Again this blind faith in the markets, just like markets manage risk -- they should have learned about that.

Then they said: Well, the markets were seeing what was going on. … Data on the freezing of the financial markets, interbank market in the period before this should have sent a clear signal that markets were not really well prepared.

So then they came to their second defense: We didn't have the legal authority to do anything. That also had seemed very funny, because two days later they bailed out AIG.

Now all of us thought the Federal Reserve was supposed to be dealing with commercial banks, and then they extended their purview to investment banks. But then AIG, an insurance company?

If they had authority to do what they did with AIG, clearly they had the authority to deal with Lehman Brothers. And if they didn't have that authority, wasn't their responsibility back in 2007, when the problems arose, to go to Congress and say, "We don't think we're going to need this, but just as a matter of precaution, please change this line in our authorization." They didn't do that.

In the end, you have to say they really didn't do what they should have done.

Not so many months after Bear Stearns had been bought at a bargain price, why was Lehman Brothers allowed to fail?

I don't understand that. ... I think they thought they were going to do a sale to Barclays, and there really wasn't a plan B. … I think they felt there were legal constraints, and why they didn't have those with Bear Stearns but did have them with Lehman, I don't know. …

That's remarkable to me. As chairwoman of the FDIC at the time, you still don't know why they allowed that to happen?

Again, we were consulted when there was a major insured bank involved. We really were out of the loop when you dealt with all these big non-banks. …

Describe for me the moment in September 2008 when ... you get the news about the government is not going to bail [Lehman] out.

... I had the president with me. That was a devastating moment because what really happened was not that the U.S. government was unprepared to play a role, but that the British government was not going to permit Barclays to acquire Lehman. And that was the last chance.

Bank of America, which had been the other bidder, was clearly going another way at that point in acquiring Merrill Lynch. So with Barclays out of the running, there was no hope. That was probably the most devastating moment during the financial crisis.

Did you carry the news to Fuld?

The president and I went back to a conference room and immediately got on the phone. We weren't going to do it in front of everybody else.

We first tried, probably foolishly on my part, to talk to the British government. Since the secretary had not been successful, I should have probably figured out that I wouldn't be either. And I did make a phone call, and I was told the ship had sailed. ...

What we had been told was that the British government's response had been: We, the British government, are not going to permit the cancer in the United States financial system spreading to the United Kingdom.

I said that if Lehman fails, the cancer is going throughout the world. And I was told it was just too late. ... Then we got on the phone to Dick Fuld. ...

... There's lots of talk out there that Paulson was trying to convince [Lehman Brothers Chairman and CEO Dick] Fuld to sell, but he didn't seem to be motivated enough. What was going on? ...

There almost seems to be a Rashomon-like quality to what was going on from the day Bear collapsed until September at Lehman.

From my perspective -- and this is when we first started to do substantial work with Lehman -- Dick Fuld and senior management were very concerned about being ... next on the chopping block. So there were numerous attempts to try and sell the company. Not just with the Koreans, which is the one that receives all the publicity, but there were feelers put out to any number of institutions, most of which were rejected automatically.

There was also the initiative to see if Lehman could become a bank holding company subject to Federal Reserve supervision, which ultimately is what happens for Goldman [Sachs] and Morgan Stanley. That didn't succeed.

So it was not as if Lehman was unaware, from my perspective. It was not as if they didn't try and take action to sell the company.

Then why did it happen? There were quite a few months in between the March events with Bear and the September events with Lehman Brothers.

... The source of the problem was in that environment, no major financial institution had a serious interest in acquiring Lehman. Again, there were conversations, and it usually was from the other side: We've thought about it. We're just not interested in pursuing it. It never got to a question of price, at least in the phone calls I had. ...

Describe Dick Fuld. ...

... He certainly had some of what I would call Wall Street characteristics, but I think the better ones.

He worked very hard. He was there first thing in the morning; he was there late at night. He was totally committed to trying to salvage Lehman. There's always a reference to Type A personalities in Wall Street. Dick Fuld was a Type A personality.

But some of the other portrayals I never saw. Some of these discussions could get heated all around. I never saw him really lose his temper. I never saw any of the screaming that you read about or hear about. He listened to advice. ...

When you heard [Lehman Brothers] going down Sunday night, did you figure big trouble in the future, in the immediate future?

I knew about it before that Sunday night.

And you knew how bad it was going to be?

I can't say again, as a member of a body of 18 people that I personally knew how bad it would be, but I did know, because you could see it in the numbers, and also you could hear it in our discussions. And we talked about these things, that there were others who were significantly exposed. And if you had been watching the marketplace, you could see the spreads and the cost of insuring against failure for these various institutions. And so Lehman wasn't alone. The complexity of Lehman was only found out after you pulled back all of those layers.

I do want to give the New York Fed enormous credit. In a very short period of just several days of peeling back all of the layers of that onion, the SEC [Securities and Exchange Commission] should have, because they were the supervisor, have understood all of the underlying risk. But the New York Fed staff, assisted by others from around the system, did an incredible job of actually wrapping their arms around the risk of what was actually Lehman Brothers.

So why'd we let it go? How did it go?

Well, that's something for the history books to document, but it is what happened.

The decision to let Lehman fail -- what was your view, and what were the complications?

... Lehman's failure had unknown consequences, and you see this occur within 24 hours. I think if anyone had said ... that if Lehman failed, the largest money market mutual fund would fail within 24 hours, and that in turn would likely take down the entire money market mutual fund industry, there may have been second thoughts.

But I do want to come back to the question of was there a decision to let Lehman fail. I think the decision was that Lehman could be rescued without the government having to put in much, if anything, in terms of support. And the judgment that Lehman could be rescued was flawed -- not totally flawed, because in fact Paulson pushed the other banks to provide substantial support for Lehman, and they had committed to something in the neighborhood of $45 billion among them to support Lehman and to provide a foundation for Barclays to acquire Lehman.

But then the whole issue came up as to whether the British government would permit Barclays to proceed. … The specter of the Asian markets opening at 8:00 on Sunday night was the deadline. When it became clear about noon on Sunday that Barclays was not going to participate, there was no option left.

Why did it come down to this one weekend? Why hadn't they planned for this? ...

The failure to work out something in advance probably has several contributing factors. One, ... if you start talking about a rescue, you precipitate the need for a rescue. So I think there was a reluctance to be too aggressive in bringing the banks together, saying we need to save Lehman.

There's also a view that decisive action can only be prompted by a crisis, so you almost let a crisis go. I think maybe people had been given a false sense of optimism by the ability to save Bear. But there was no JPMorgan at this point.

One clear failure was of communication between the U.S. government and the British government, and perhaps the blame is equal on both sides. It's probably also to the private sector, because the private sector should have been encouraging the two governments to talk. I think there was probably a presumption in the private sector that the two governments were talking, which was clearly not the case until the very end.

So mistakes get made, and when you have to make decisions and take action within an extraordinarily confined period of time, the potential for those mistakes is multiplied.

When all of it starts to cascade, what were you thinking when you were watching it go? Did you have a sense of how vulnerable everything was over Labor Day weekend in 2008? Were you personally concerned?

Extremely, yes. It was a very, very scary time. I think up until that Labor Day weekend, we were in just another financial crisis. Those aren't pleasant occurrences, but they repeat, and they have patterns that one can recognize, and over the course of a 20-year career, you learn to recognize them. Up until that point, I think we were in one of those situations.

At that point, we were in totally new territory. The notion that a Lehman Brothers could be filing for bankruptcy and AIG could be at risk of the same fate -- and it was very uncertain what would happen to the rest of the broker/dealer community that week -- was absolutely unprecedented. And thinking through the implications of that for the health of not just the U.S. economy but the world, it wasn't really conceivable to do that. I couldn't get my mind around it. I know others couldn't.

The extraordinary actions that were subsequently taken by governments to intervene were absolutely necessary, because the consequences of an interconnected failure by all of those institutions simultaneously would have been unimaginably terrible in terms of impact not on the shareholders of those corporations who suffered terribly anyway, but on the man on the street.

We know that credit conditions are tight today; they would be nonexistent had those events unfolded. Absolutely nonexistent. The Great Depression would have looked like a small event by comparison to what I think would have happened had that process continued unrestricted.

And one of the great tragedies of understanding, or misunderstanding, it through all of this is the notion that somehow banks and/or Wall Street were bailed out at the expense of the taxpayer. What has been lost in translation is that it is for the sake of the man on the street that the financial system needed to be stabilized, and it was unambiguously in the interests of the taxpayer that that system be stabilized.

And let us not forget that the shareholders and many, many employees of these financial institutions that did make major mistakes have paid dearly in terms of their own personal net worth and the value of their companies. The bailing out aspect was keeping them afloat through the presence of government backstops and capital so that credit markets could go through a process of un-seizing themselves without abject panic. And that was what we were looking at then.

This wasn't about credit derivatives, this was a much more complex situation. It had at its core credit conditions that were easy and had been that way for many years; it had the low savings rate in the United States, the high savings rates in the emerging economies, particularly China and India, the growth in the emerging markets.

All of these things had conspired to create an environment that essentially became a bubble. The consuming habits of United States citizens driven, in part, by the housing bubble led to a lot of this buoyancy and lack of fear of risk in financial markets. And there was a significant deployment of leverage, leverage in the form of balance sheets that were running with very little capital against large volumes of assets which all looked fine, except when the music stopped in a correlated fashion, they deteriorated.

That, at its essence, was the root cause of this financial crisis. The derivatives, in a sense, are a manifestation of people's risk appetite. How they used derivatives reflected their lack of fear of the consequences of market behavior, lending in particular in mortgage markets. …