September 15 and Revisionist History

trefoil · Sep 15, 2009

Tomorrow and for the next few days after I'll be on the road, so apologies in advance if there's any sort of reaction to the below and I don't answer. But I felt like I had to write this.

I knew the details would get lost, so last year, when Lehman went down, I saved all of the current news I had seen on it in one place, for reference on the inevitable day that forgetfulness would set in and someone, somewhere, would write something like what Niall Ferguson did in today's Financial Times:

Why a Lehman deal would not have saved us

By Niall Ferguson

Published: September 14 2009 20:15 | Last updated: September 14 2009 20:15

If only. Lawrence McDonald begins his insiderâs account of the fall of Lehman Brothers with seven âwhat ifâ scenarios, speculating on how different decisions might have saved his former employer. If only Dick Fuld, Lehmanâs chief executive, had listened to those who warned of impending losses on the bankâs property portfolio. If only Mr Fuld had not antagonised Hank Paulson, the then Treasury secretary. And so on...If only. If only Lehman had been saved, there would have been no credit crunch. No near-Depression. The S&P 500 would not have sunk to 682 (its nadir last March). We would probably be back to 1,500 by now.
But there was a reason why no buyer could be found in this universe. Lehman was a firm in its death throes. It had lost $6.7bn in the space of six months. It had debts in excess of $600bn. Its assets were collapsing in value. Even when a deal with Barclays seemed within reach, the British Financial Services Authority vetoed it. Alistair Darling, the chancellor of the exchequer, made it clear: âWe are not going to import your cancer.â
So, in a third and final parallel universe, an alternate Mr Paulson and an alternate Ben Bernanke could have nationalised Lehman outright â as they had already nationalised Fannie Mae and Freddie Mac on September 7, and would nationalise AIG the day after Lehman filed for bankruptcy. These surely were the kind of âunusual and exigentâ circumstances that permit the Fed to take emergency action.
In this universe, however, Mr Paulson had resolved to stop being âMr Bail-outâ. More than once, he stated bluntly that there would be âno taxpayer money on the lineâ for Lehman. When Mr Fuldâs lieutenants warned that their bankâs failure would unleash a financial tsunami, Mr Paulson accused them of âtalking their own bookâ. It is clear that he underestimated the consequences of letting Lehman fail. Maybe, as a former Goldman Sachs chief executive, he did let his prejudice against Mr Fuld get the better of him. In one respect, however, Mr Paulson did the right thing â albeit unwittingly. By showing Americans â and particularly their legislators in Congress â just what could happen if even the fourth-largest investment bank failed, he created what had hitherto been lacking: the political will for a wholesale bail-out of the US financial system.
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The bolded statement is a flat-out lie.
The true circumstances of what happened to Lehman were recorded in real time last year. Almost all of the info is, fortunately, still out there, and the sum total of it shows just how much of a lie that statement is.
To begin at the beginning: we all know that in March Bear Stearns was sold to JP Morgan for, at first, 2 bucks. This shocking development made clear that the value of any financial company out there was in question.
Then, the GSE's, Fannie and Freddie, began to go down because of their narrow investment base: all mortgages all the time. The response of Treasury? To push out preferred shares and encourage banks to buy these preferreds.
John Dizard on Aug 31 said the following (bear in mind this was before the infamous TARP):

In the past couple of weeks it seemed that the entire US economy had a pivot security, or set of securities: the preferred stock issued by the government-sponsored entities, or GSEs. Fannie and Freddie, the Sodom and Gomorrah of âpublic/private partnershipsâ, sold about $36bn (Â£20bn, â¬24bn) of non-cumulative preferreds to the banks and the public, with the aggressive support and encouragement of the US Treasury and the GSEs regulator.
I thought that saving Fannie and Freddieâs preferreds would support the entire asset class of preferred stock. The banking system needs to raise several hundred billion dollars of equity, and preferred stock is the lowest-cost way to do that in the public markets. While some sophisticated investors could distinguish between preferreds issued by a sound bank holding company, and preferreds issued by the overleveraged F&F, international investors and domestic retail investors would not have the data or analytics to draw the distinction.
The alternative, as I see it, to recapping the US banking system with preferreds is some form of direct government investing in the equity of banks or bank holding companies. That would be even more expensive to the taxpayers â as in at least 10 times more expensive.
...
As a reality check I called Jim Grant, of Grantâs Interest Rate Observer, and the author of the forthcoming âMr Market Miscalculatesâ. He comments: âThe alternative to preserving the value of the GSE preferreds? Prayer? Remember that a lot of that paper is held by the same banks the authorities would love not to fail.â
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So, when the time came, mere days after this column was written, to save Fannie & Freddie, what did Treasury do?
I quote from their release:

The agencies encourage depository institutions to contact their primary federal regulator if they believe that losses on their holdings of Fannie Mae or Freddie Mac common or preferred shares, whether realized or unrealized, are likely to reduce their regulatory capital below "well capitalized." The banking agencies are prepared to work with the affected institutions to develop capital restoration plans consistent with the capital regulations.
Preferred stock investors should recognize that the GSEs are unlike any other financial institutions and consequently GSE preferred stocks are not a good proxy for financial institution preferred stock more broadly.
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Yes, they hung the preferred investors out to dry.
Did the market agree with the Treasury about the idea that "GSE preferred stocks are not a good proxy for financial institution preferred stock more broadly"?
In a word, no:

Fannie, Freddie Takeover Jolts Preferred Stock Market (Update2)
By Caroline Salas

Sept. 10 (Bloomberg) -- Treasury Secretary Henry Paulson's takeover of Fannie Mae and Freddie Mac is roiling the market for preferred securities.

Prices of fixed-rate preferred stock fell an average of 11 cents to 69.8 cents on the dollar this week, including the biggest one-day drop in a decade on Sept. 8, according to Merrill Lynch & Co. index data. The 13 percent decline compares with a 0.8 percent drop in the Standard & Poor's 500 index in the same time.
...
Paulson's ``actions have damaged the preferred market,'' said Thomas Hayden, the investment strategist for Liberty Bankers Life Insurance in Dallas. ``Somebody is going to be looking at an issue of Fannie or Freddie preferred shares that were rated AA up until a few months ago. If that's not money good then what about the small regional bank in some part of the country?''
Hayden, whose $1.5 billion fixed-income portfolio contains preferred shares of Fannie and Freddie, said he's ``not interested'' in buying any more preferred securities.
...
``In the primary market it's going to be much more difficult for financials across the board,'' Hayden said. ``If Lehman Brothers thought they needed to go to the market and had any chance at all of issuing preferred stock to raise capital, it is now three times more difficult than it was last Friday.''
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Fitch lowered Lehman's ratings on Sept 9. This is the only link still not up, but at the time, Fitch lowered Lehman's ratings - and this is the important part - not because they thought it was in imminent danger of going down, but because they thought it would have a hard time raising capital.
The reason why is above, in that Bloomberg article.
Lehman's death spiral was on. Shortly after its death, Paulson saved AIG. Coincidentally - or not - GS had a large exposure to that company, as we all now know.
What happened on Sept 15 happened because of the deliberate decisions made in the months preceding by the Treasury Dept led by Hank Paulson.
The TARP, at a mind-boggling 750 billion, well over even the most pessimistic projections of John Dizard if the preferreds on the GSE's got trashed, back on August 31, in the column quoted above, followed.

Selah.

Renegen · Sep 16, 2009

I heard it in a few places that Lehman was allowed to fail to make the bailout pass and the other extreme legislation like Fed getting more power. When did Goldman Sachs and Morgan Stanley get holding bank status, after Lehman?

I mean for a guy who was against bailouts and helping everyone, remember all the trillions went out after Lehman!

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September 15 and Revisionist History

trefoil

Renegen