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Second Guessing the Lehman Failure

An extra day? A week or month? Lehman could have lived, but at what cost?



) -- Two years ago today the saga of Lehman Brothers ended abruptly when it filed for bankruptcy protection in the early morning. Despite that ending, many industry professionals, policy makers and economists agree that the firm could have survived past that fateful Monday.

The only question is at what cost.

"The best and the brightest did not understand the cause and effect of a Lehman failure," says Anton Valukas, the court-appointed Lehman bankruptcy examiner and chairman of the New York-based law firm Jenner & Block. "This was different from something we have ever seen. It will change the American economy forever."


filed for bankruptcy on September 15, 2008 after myriad of last minute negotiations fell through and left chairman Richard Fuld no other option. Significant losses on mortgage-based securities, coupled with investors and customers fleeing the bank, created a liquidity crisis that meant Lehman could not meet its debt obligations by the time the markets opened in Europe.

In its final weekend, the

Federal Reserve Board

declined to infuse the firm with much needed capital as it had for

Bear Stearns

in March of that year . Lehman's credit clearing firm,

JPMorgan Chase

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, was allegedly planning to refuse brokering new credit orders unless the failing firm posted billions of collateral it did not have, a point that is currently

the subject of a lawsuit.

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Finally, a last

minute merger between Lehman and


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fell apart after U.S. and UK regulators refused to backstop the deal.

If only a single one of those options was pursued - and Lehman was able to live even a day longer -- it would have been a much better outcome than the reality the markets faced two years ago and still face today, argues Harvey Miller, Lehman's bankruptcy representative and a partner in the law firm of Weil Gotshal & Manges in New York.

Miller says that if there was a government support program Lehman would have met its obligations and kept the market stable for a potential merger. Even if a deal was not available, a support program from the Federal Reserve would have set the stage for an orderly wind up that allowed the market to close out its trades with the doomed firm with limited disruptions.

"There had already been intervention on behalf of Bear Stearns and there was a pattern of involvement by the government in the markets. People did not believe

bankruptcy was going to happen," Miller says. "If

federal intervention had happened, there would have been a more stable and efficient market," Miller says.

That point of view is also held, obviously, by Fuld in testimony before the Financial Crisis Inquiry Commission two weeks ago.

"I believed then, and still do now, that had the Fed opened the financing window to investment banks just before the Bear Stearns problem, that decision might have provided the necessary liquidity to keep Bear Stearns operational and, more importantly, might have lessened the need for additional government intervention," Fuld said in a written statement before the commission. "Still, having acted, the intervention of the federal government set a precedent in the marketplace that impacted liquidity, capital formation and the expectations of creditors and stockholders for at least the next six months."

The cascading effects of Lehman's bankruptcy lasted for months.

Three days after the bankruptcy Boston-based Reserve Primary Fund announced that it had "broken the buck," - or had it net asset value per share fall be $1 - as a result of losses on Lehman bonds. Other money market funds quickly followed with loss announcements until the government stepped into the market. The derivatives market also seized as Lehman-backed contracts began to fall in value.

If Lehman and made it past that Monday, Miller argues, the shock in both the derivatives and money fund markets would never have happened.

But despite the protestations, not everyone is convinced that keeping Lehman on life support would have been the best option for the U.S. economy.

"I think there is a fair amount of revisionist history when it comes to that weekend," says Anil Kashyap, a member of the Federal Reserve Bank of New York's economic advisory panel and professor of economics and finance at the University of Chicago Booth School of Business. "Everyone knew Lehman was weak and policymakers said that it was not their intention to bail it out. "

Even if Lehman had survived with government assistance, Kashyap says, Washington would have been forced to refuse another failing institution government-sponsored liquidity shortly after.

"If it wasn't Lehman, you could pick who it was going to be," he explains. "Morgan Stanley

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(AIG) - Get American International Group, Inc. Report

or any of the other financial institutions that were failing. There was a massive financial crisis and at some point the government had to draw a line in the sand."

Theoretically, the government could have offered enough liquidity for Lehman to last another day or month, but that option had a massive downside, Kashyap explains. Having a dying Lehman on government-backed respirator would have set up the firm's customers to continue their run on Lehman to pull their assets out before the government pulled liquidity.

"If the government was going to play God and say 'Lehman gets to live until October 1,' the customers would have pulled out immediately. The central dynamic was a run on the bank by customers, and they would not be able to change that by delaying it," Kashyap says.

Miller concedes that Lehman brothers, not matter what intervention had occurred, would have been doomed by the markets because of customer and investors reluctance.

"At some point Lehman was going to run out of money," Miller says. "But you could keep it open for a few more days to allow for an orderly wind down. Instead, you had a fire sale of Lehman assets."

Miller points to the sale later that month of Lehman's money management subsidiary, Neuberger Berman, to private equity firms Bain Capital and Hellman & Friedman for $2.15 billion. Prior to the bankruptcy, Neuberger was valued much higher. That deal eventually collapsed after a competing bid from Neuberger management.

Other pieces of the firm, including Lehman's investment Asia division (to Nomura Holdings) and its North American operations to Barclays were sold at deep discounts.

The loss of value to the Lehman franchise, coupled with the seizure of the money markets and credit derivatives contracts, meant that keeping the investment bank as a going concern and alive for some period of time was the best option, Miller contends.

"That week, $700 billion in value was lost when it would have cost $50 billion to keep it alive," Miller says. "The U.S. Treasury came to the conclusion the market was prepared for Lehman to fail. The thought by Monday it would declare bankruptcy, by Tuesday there would be a collateral call and by Wednesday Lehman would be a distant memory They were wrong."

However, despite the fallout Kashyap says the government needed to end Lehman's life in order to save the rest of the economy.

"At some point the government would not be able to stop plugging the holes in the financial system and would have had to choose a bank to fail," Kashyap says. "The Federal Reserve does not have the resources to keep plugging these kinds of holes."

--Written by Christopher Westfall in New York.

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