There is a lot of finger pointing going on one year after Lehman declared bankruptcy. Most of those fingers are pointing to Lehman and the way the bankruptcy was handled. However, that is a very simplistic view of what happened a year ago. The crisis was transformed into a panic — not because of the Lehman filing, but largely because of the bungling policy known as TARP.
Setting the Record Straight on Lehman
Lehman deserved to fail.
Here is the real story.
Then Treasury Secretary Paulson was getting a lot of pressure to help Lehman. Paulson wisely asks for the following information. He wants to know how they are valuing a list of illiquid assets. He requests the same valuations from Goldman and J.P. Morgan. The data come back quickly. The values that Goldman and J.P. Morgan are carrying on their balance sheet are deeply discounted and quite close to each other. The values that Lehman has on their balance sheet aren’t even close. Angry, Paulson is determined that the firm will go down. Why bail them out? It would be a colossal waste of taxpayer money.
This was the correct thing to do. Any bailout would have probably taken many rounds of taxpayer help.
Of course, the execution of the bankruptcy was a problem. Surely, arrangements could have been made for a more orderly transition. This would have given counterparties more time to unwind Lehman linked positions.
It is ironic that the disorderly bankruptcy of Lehman poisoned the possibility of the government letting other large firms file. As a result, the government adopted the terrible policy of “too big to fail.”
Let’s summarize the events:
- Paulson comes to Congress with a three-page term sheet asking for close to $800 billion
- The American people (rightfully) assume that the Treasury Secretary and Fed Chairman have inside information on the gravity of the financial crisis.
- They stoke uncertainty by their vague reasons for needing the $800B the apparent lack of strategy.
- They cause outrage on Main Street when it is revealed that toxic assets will be purchased at premium prices — essentially bailing out bad trades with tax payer money.
- TARP fails on first vote.
- TARP eventually passes.
- TARP is never TARP. That is, the money was not used for Trouble Assets. Instead, money was used to inject equity into big banks.
- Essentially, no questions were asked before the banks got the TARP money — remember the famous “Stress Test” came after the money was given to the banks.
- Government guarantees the big 19 banks.
- Good TARP money went to many firms that were essentially in Lehman’s situation. The TARP money was used to reduce risk rather than create new loans to pull us out of recession.
- Banks realize that they can’t pay bonuses at the same rate with TARP. As a result, they begin to give money bank. This results in even less money for lending – completely defeating the purpose of the original equity injection.
Now let’s speculate about some future events in 2010:
- Toxic assets still remain on the balance sheets.
- TARPless banks return to paying big bonuses.
- Defaults peak some time in 2010.
- Banks and policy makers are not surprised by the large number of defaults in Commercial Real Estate.
- Banks and policy makers are surprised by the large number of prime mortgage defaults.
- 1,000 banks are in trouble in 2010.
- Banks go back to the trough, err, TARP.
Already the FDIC is out of money — and they will need a lot more. 92 banks have failed this year and there are hundreds more to go. I made the 1,000 forecast last year. I noticed today that John Mauldin (who I high recommend reading) quoted some unpublished analysis from Institutional Risk Analytics that grades 2,256 banks in the “F” range. If less than half go under, you are at the 1,000 number.
There is more pain to come. Again, the decrease in new claims for unemployment insurance was spun as “good” news. Claims dropped by 12,000 to 545,000. However, to get the unemployment rate to meaningfully decrease, we need to reduce claims by about 300,000 — not 12,000. We are not even close to that. As I have written, the continued high umemployment will be the prime driver of prime defaults.