How the Fed Reached Out to Lehman By ANDREW ROSS SORKIN

The New York Times
Printer Friendly Format Sponsored By

December 16, 2008
DealBook Column
How the Fed Reached Out to Lehman By ANDREW ROSS SORKIN

It’s a $138 billion mystery.

In the early hours of Sept. 15, after the government refused to rescue the foundering Lehman Brothers, something odd happened. The Federal Reserve lent tens of billions of dollars to a subsidiary of the newly bankrupt bank.

In other words, government officials who had refused to risk taxpayers’ money on Lehman before it collapsed did just that after it collapsed.

On Monday the Fed lent the Lehman unit $87 billion through JPMorgan Chase. After being repaid on Tuesday, it lent another $51 billion — putting the bailout, arguably, in the same league as the initial $85 billion bailout for the American International Group.

This mystery loan is just one piece of the larger Lehman puzzle. Who lost Lehman? Why, and how? Three months later, those questions still nag.

A series of court documents that detail the Fed’s loan have dribbled out in recent weeks, but they raise more questions than they answer.

Lehman might seem like ancient history by now, some ghost of a crisis past. Lehman — that was before A.I.G., before the Big Three, before Madoff Securities. But no one, least of all government officials, has fully explained why Lehman, one of the grand old names of Wall Street, was allowed to fail while so many others were rescued.

Many people, at least on Wall Street, have come to view the decision to let Lehman die as one of the biggest blunders in this whole financial crisis. Christine Lagarde, France’s finance minister, called the decision “a genuine error.”

Judge James Peck, who approved the sale of Lehman’s carcass to Barclays, the British bank, said it was a shame that Lehman had failed.

“Lehman Brothers became a victim,” Judge Peck said in bankruptcy court when he approved the sale. “In effect, the only true icon to fall in the tsunami that has befallen the credit markets. And it saddens me.”

The authorities are investigating whether Lehman executives misled investors about the firm’s financial condition before the firm failed. But the authorities might be asking similar questions about executives at other banks if, like Lehman, those institutions had been allowed to go under.

The recently disclosed documents detailing the Fed’s loan to Lehman’s subsidiary cast some light on a failed effort to prevent Lehman’s implosion from cascading through the financial system.

The loan, according to these documents, was a “carefully thought-out decision” to stabilize the market by propping up Lehman’s broker-dealer business, called LBI New York, so it could stay afloat long enough to “facilitate an orderly wind-down” of tens of thousands of trades with the other Wall Street firms. The unit was kept out of the Lehman bankruptcy.

That might seem like a reasonable explanation. But Henry M. Paulson Jr., the Treasury secretary, and Ben S. Bernanke, the chairman of the Fed, have said that they did not have legal authority to lend any money to Lehman. The firm, officials said, did not have enough collateral.

“We didn’t have the powers,” Mr. Paulson insisted. He also said Lehman’s bad assets created “a huge hole” on its balance sheet, adding that he had actually tried to find a way for the government to provide money to help support a deal between Lehman and Barclays, but legally could not. His explanation has evolved over time, however. He told reporters the day after Lehman went bankrupt: “I never once considered that it was appropriate to put taxpayer money on the line in resolving Lehman Brothers.”

Whatever the case, the Fed’s loan to the Lehman subsidiary makes all these explanations increasingly hard to square. Mr. Paulson said Lehman had lacked the collateral for the government to backstop a deal between Lehman and Barclays. But then the Fed turned around and lent a Lehman subsidiary billions, based on that same collateral.

People involved in the process said that the Fed only lent the money as part of “an orderly wind-down,” which would have been different from lending money to an ongoing, or in this case, insolvent concern.

Fed officials are not talking much about the loan. Mr. Bernanke and Timothy F. Geithner, the president of the Federal Reserve Bank of New York and the Treasury secretary nominee, have kept quiet on the topic. A spokesman for the New York Fed, which orchestrated the loan, declined to comment.

The Fed’s loans were made through JPMorgan Chase, which, as a clearing bank, acted as a conduit for the money. JPMorgan, if you recall, was the bank that bought Bear Stearns, with the government’s help, as that firm was collapsing last spring.

If there’s a silver lining in this mysterious cloud, it is that Lehman paid the Fed back. Taxpayers did not lose a dime. As part of Barclay’s deal to buy Lehman out of bankruptcy, Barclays agreed to take over the Fed’s lending role and “step into the shoes of the Fed.” (The Depository Trust and Clearing Corporation ended up staying open late to make the transfer.)

Still, Barclays and JPMorgan had a brief fight over the collateral posted for the loan, according to court documents. They eventually reached an agreement. The values of the collateral and the specifics are part of a confidential sealed agreement, making it difficult to determine exactly what happened.

Maybe the Fed’s belated loan to Lehman helped avoid an even deeper crisis. As Representative Barney Frank, chairman of the House Financial Services Committee said on “60 Minutes” on Sunday: “The problem in politics is this: you don’t get any credit for disaster averted.” But until officials explain what happened, it will remain a mystery.

The latest news on mergers and acquisitions can be found at nytimes.com/dealbook