Labor Day 2008. What were we thinking before le Lehman deluge? What was going through the minds of principals as the storm gathered? As they left their beds on Sept. 2, did they sense the forces already primed to explode? Did they sense inevitability? Lehman Brothers shares had been falling all summer. Lehman trader Lawrence McDonald, the co-author of "A Colossal Failure of Common Sense," sat on Cape Cod gloomily hanging onto fading hopes of a deal with Korea Development Bank. Joseph Tibman (a pseudonym), in his soon-to-be-published memoir, "The Murder of Lehman Brothers," emphasizes the hope that drove rank and file: the belief that the business was sound, bad assets would recover and someone would save the firm. David Wessel in "In Fed We Trust" reports Henry Paulson and Tim Geithner took calls from Lehman chief Dick Fuld "for months," rejecting a good bank, bad bank scheme (on the federal dime) and a plan to become a bank holding company. On Labor Day, regulators fixated on Fannie Mae and Freddie Mac, which were failing; the government seized them on Sept. 7. Soon after, Wessel writes, Paulson and Ben Bernanke met at breakfast, then over a midmorning conference call, to discuss Lehman, which had preannounced another huge loss. "With Lehman clearly struggling for survival, Paulson and Bernanke assured each other -- and others on the call -- that all the companies and traders that did business with Lehman had been given time to protect themselves from a possible Lehman bankruptcy."
Like a bubble, inevitability only exists after the fact. There are many roads into the forest and only one road out. And that road -- Lehman's failure -- shapes both the future and the remembered past. Throughout this period at Lehman there were two murky, dynamic, determinative realities. First, was the hole in its balance sheet. How big were subprime and commercial real estate losses? Fuld obviously had some sense, but he may have been delusional (he's not talking or writing). But Bart McDade, who replaced Joe Gregory as COO in June, and his senior team were not. Did they see a way out, or were they praying for a deus ex machina too? And what of regulators, who, at least since the Bear Stearns Cos. implosion in March, were presumably all over Lehman? Everyone else had to peer through a foggy window. Given the evidence of the bankruptcy filing, well over $100 billion in losses, short sellers, led by David Einhorn, came closest to the mark, which is something to ponder. (Shorts can create their own reality, but even Einhorn couldn't concoct that big a reality.) Staffers, many of whom didn't (or couldn't) sell their shares, continued to believe, as Tibman notes. Still, given what we know about losses, wasn't the game effectively over before Labor Day? Was a near-term market that would have refloated those assets remotely realistic? Ah, hindsight.
Second, there was Lehman's systemic situation. Wessel's offhand comment, which he never elaborates, implies that Bernanke and Paulson were wrong about Lehman, and that no one corrected them. They seem to have had only sketchy notions of the scale of impaired assets (or worse: they knew and did nothing) and no idea how deeply Lehman continued to be still entangled with everyone else. Granted, this is tricky: Warn counterparties to back off and you trigger the very run you wish to avoid. The result: paralysis, which seemed to seep into less overt steps, like a comprehensive examination, without the Lehman spin. If you can't act, at least you can get the full monty, internally and externally, and game out a response. There's no evidence of that (and Wessel is a sympathetic chronicler), although other testimony, like Paulson's own book, may alter that view.
Much has been made of the unprecedented circumstances that faced executives and regulators last fall. And there's some truth to that. But what's growing clearer as these books emerge is the inertia that prevailed. It appears that by Labor Day, Lehman was all but dead, though the persistence of hope, nurtured by partial knowledge, is astounding. There had been time to act. Fuld would have had to move to deal with the problem at least a year or more earlier; instead he gunned the engines and bought back shares. The board was fatally passive. Regulators had months to decide what to do if Lehman failed. But as summer ended, Washington still lacked a clear view of the situation. Fuld looked to Paulson and Geithner; Paulson, Geithner and Bernanke looked to counterparties, potential acquirers, the market, and that gang looked at one another -- and bailed. And when Sept. 15 arrived, the decision had to be made quickly and in the dark. Maybe it was dark because it was always someone else's job to turn on the light. Maybe it was just fate.
