Lehman’s Fuld and Fed Clash in FCIC Hearing: Who won?

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Fuld on the Offensive via Getty Images

The Financial Crisis Inquiry Commission on Wednesday took on the question of what led to Lehman’s failure and I’m not sure we came away with any answers. Although we did get a much better window into the lingering bad blood between Fuld and the Federal Reserve.

The FCIC is looking into the question of so-called “Too Big To Fail.” The idea is that one of the causes of the financial crisis is that banks were allowed to get too big. In fact, they got so big that the federal government had no choice but to bail them out even after they did such dump things as buy up worthless real estate properties or lend money to people who couldn’t afford to pay them back, or hold onto billions of dollars of securities that were derived from those silly and ultimately doomed loans. You would expect that a government knowing it would have to bail out big banks if they made even the slightest mistake would have had a very watchful eye. But it didn’t. It not only allowed these banks to finance bad loans, but with the used of derivatives they were allowed to finance each bad loan multiple times.

Lots of juicy stuff to dive into for the FCIC. Of course, as has been the case with the FCIC all along, the commission completely misses the pool. Instead of focusing on these issues, the commission spent a good portion of its time in the Lehman hearing on one issue: Was the Fed in the very last minutes of Lehman’s life willing to save the ultimately doomed institution. Fuld says there were a number of things that the Fed could have done to save Lehman. The Fed officials testifying on Monday say the investment bank was toast no matter what the Fed did.

I’m not sure if this is the issue we really need to get to the bottom of. But, OK, if that’s where the FCIC wants to go, I will play along. It’s Fuld vs. Fed. Here’s how the Curious Capitalist would call the fight:

Typically anger and hatred fades over time. But what is clear is that Dick Fuld still has no plans for a reconciliation beer summit with anyone from the Federal Reserve, or Hank Paulson for that matter, anytime soon. The Gorilla, as Fuld was long nicknamed, is still angry. If anything Fuld’s anger has gotten stronger over the past two years.

Two years ago when Fuld first testified back in October 2008 about what caused Lehman’s failure, here’s what he had to say:

On September 15, 2008, Lehman Brothers Holdings was forced to declare
bankruptcy as a result of an extraordinary run on the bank.  The Honorable James M. Peck, Bankruptcy Judge for the Southern District of New York, after the first several days of intense hearings in the bankruptcy proceedings, observed: “Lehman Brothers became a victim.  In effect, the only true icon to fall in the tsunami that has befallen the credit markets.  And it saddens me.”

Two years later, Fuld still believes he and his firm were victims, but this time around he knows who did Lehman in, and it was the Feds:

Lehman’s demise was caused by uncontrollable market forces . . . . Those same forces threatened the stability of other banks — not just Lehman.  Other firms were hurt by their plummeting stock prices and widening CDS spreads.  But Lehman was the only firm that was mandated by government regulators to file for bankruptcy.

Here’s where you can seen the bad blood boiling over. Fuld chooses not just to say the Fed decided not to bail out Lehman. Instead he says that the Fed “mandated” Lehman’s failure. Fuld uses this “mandated” line twice in his testimony. So did the Federal Reserve purposely force Lehman to fail. The Fed officials also testifying in front of the FCIC on Wednesday say no. Let’s go through their points.

1) The Federal Reserve was legally not allowed to bail Lehman out.

I have always thought this point that either the Treasury, or the Federal Reserve or the Federal Deposit Insurance Corp didn’t have the legal ability to bail out firms was a little week. What was AIG or Citigroup or Bank of America if not bailouts? Why were those legal? Yes, Citigroup and Bank of America came after TARP was passed, but still you get my point. On this point, FCIC Chairman Phil Angelides does a very nice job of swinging the knock out punch. He pulls out a stack of e-mails between Federal Reserve officials discussing Lehman in the months and weeks leading up to the firm’s bankruptcy and what should be done about the apparently troubled firm. The e-mails talk about a number of options. They even discuss the damage a Lehman failure could have on the economy. But not one of the e-mails, Angelides is good to point out, says anything about the Fed not being able to have the legal authority to do the things it is contemplating doing. If that was the case, you would think that would have come up.

POINT: Fuld (with a big assist from Phil)

2) The Federal Reserve’s Lending Window was Open to Lehman. They just chose not to use it.

New York Fed lawyer Thomas Baxter said the Fed’s lending window was open the night of September 14th to any Wall Street firm or big bank for that matter that wanted to use it. Fuld says he needed money the night of September 14, and would have gladly taken it if the Fed was offering. But he said it was made clear to him that Lehman was not welcome to borrow from the Federal Reserve until after the firm filed for bankruptcy. Baxter says this was a misunderstanding, and that Fuld is mistaken.

But this is very hard to believe. First of all, remember how that weekend went down. Fuld was not invited to the Federal Reserve along with all the other heads of the largest banks. Even Merrill Lynch’s CEO John Thain, whose firms was in just as bad shape as Lehman, was allowed to hang out at the Fed that weekend. Fuld was not welcome. It seems that if the Fed wanted to make it clear to Fuld that Lehman was allowed to borrow they could have just told him to come to their downtown office and made it clear. He was only in midtown. Even by the 1 subway train, the trip wouldn’t have taken more than 45 minutes. It seems clear to me that even if the Fed was willing to lend to Lehman, they were not being upfront about it.

Second, Harvey Miller, who was at the Federal Reserve Bank of New York that weekend, has the same recollection of the events as Fuld. Testifying also in front of the FCIC commission on Wednesday, Miller says it was clear to him that the Fed was only willing to lend to Lehman after the firm filed for bankruptcy.


3)Lastly, the Federal Reserve says that even if it was able or willing to lend to Lehman, the investment bank didn’t have enough collateral to back up the amount of money it needed to save the firm. Essentially, Lehman was not a hapless victim of a credit crunch, but in fact insolvent, crisis or not.

Baxter says Lehman had $600 billion in open trading positions on the night of September 14th. In order to get a loan to cover those bets, Lehman would have had to put up hundreds of billions of dollars in collateral. Yes, but many of those bets would have crossed each other out. So it really didn’t need loans for all of them. Many of them could have been simply closed out. How much money did Lehman actually need? In the week following Lehman’s collapse, the firm got a loan for $87 billion from JP Morgan and another loan for $51 billion from the New York Fed. That’s a total of $138 billion. And that’s how much Lehman needed after the bankruptcy, which presumably wiped out some of Lehman’s debt obligations. That is, after all, why you file for bankruptcy. So we can assume Lehman would have needed something north of $140 billion to stick around.

Fuld says he had that much in collateral between his equity and long-term debt. On top of that he could have sold some business like its money management firm Neuberger Berman, which he says could have fetched $9 billion, and other businesses. On this point, Fuld falls short. Lehman’s equity and long-term debt were most likely not worth as much as the firm said it was. Asset values were plummeting. And anyway, no one, and that should include the Fed, should have lent Lehman dollar for dollar at a time when the firm’s future was uncertain. And what about Neuberger Berman. Following the bankruptcy Neuberger was sold for just over $2 billion. So in the end Fuld probably didn’t have enough collateral to cover Lehman’s losses.


So who wins? Even though the count is two to one, I have to give the fight to the Fed. Even if their after the fact, effort to rewrite history is annoying. In the end, whether Lehman would have survived had little to do with what the Fed was or wasn’t willing to do. If the firm was insolvent, eventually it was going to go under.

Of course, the real loser in this fight is the FCIC and us. Are we any closer to stopping the next financial crisis? I’m not sure.