Dodd-Frank Could Have Resolved Lehman, Regulator Argues
The failure of Lehman Brothers Holdings Inc., which caused financial panic and sent markets into a tailspin, could have been avoided had last year's financial reform law already been in effect.
A Monday report from the Federal Deposit Insurance Corporation says the firm could have been wound down in an orderly manner, maintaining the value of its assets and ongoing operations. Counter-parties would have been prevented from fleeing and financial markets likely would have absorbed the outcome with minimal disruption, the report concludes.
The legislation that forms the basis of the FDIC's report, known as Dodd-Frank for its principal sponsors in Congress, seeks to end the perception that some financial firms are too big to fail. This could prevent future taxpayer-funded bailouts by allowing regulators to wind down large institutions outside the bankruptcy process. It came in response to the extraordinary steps taken by policymakers in 2008-09 to shore up the U.S. financial system after bankers' and traders' outsized risks failed to pay off, necessitating trillions of taxpayer dollars for equity investments in private firms and asset- and debt-guarantees.
FDIC Chairman Sheila Bair hailed the report's findings. Had Dodd-Frank been in place, it says, Lehman’s creditors may have recovered as much as 97 cents on the dollar. By comparison, they're forecast to receive about 21 cents on the dollar.
The optimistic analysis assumes that the FDIC would have fully used its newly-gained powers in the months leading up to Lehman's Sept. 2008 failure to plan for its demise, find a ready buyer and maximize the value of its assets, thus minimizing the effect the failure would have on the broader market and on taxpayers. The report assumes the FDIC would have begun taking action about six months earlier, in March 2008.
But the global investment bank had substantial operations overseas. It also had about 8,000 subsidiaries and affiliates, Harvey R. Miller, one of Lehman's bankruptcy attorneys, said last September before the Financial Crisis Inquiry Commission. And on the day of its bankruptcy filing, the firm was a party to more than 10,000 derivatives contracts worldwide relating to about 1.7 million transactions, Miller said.
Finance experts say regulators will never be able to resolve failing international firms like Lehman in the kind of orderly manner envisioned by policymakers.
"We need a cross-border resolution authority, but we're not going to get one," said Simon Johnson, a former chief economist of the International Monetary Fund and a professor at MIT’s Sloan School of Management. "The disruption in the U.S. was due to what happened in Europe and the U.K., and unless you have a cross-border regime you can't deal with that going forward."
"And that's not something anyone is working on," he added.
Policymakers in office at the time, including Federal Reserve Chairman Ben Bernanke and current Treasury Secretary Timothy Geithner, argue the government was forced to bail out firms and their creditors because they lacked a legal mechanism to resolve so-called “nonbanks,” whose size and reach prevented them from undergoing an orderly wind-down in bankruptcy.
But Lehman was not bailed out and panic ensued as markets were caught unprepared. Commentators and Wall Street figures point to the government's decision to let the firm fail as the biggest mistake of the crisis, one that led to such widespread panic that investors fled and asset prices plunged, making bailouts of multiple other banks inevitable.
Dodd-Frank would have helped if Lehman were purely a domestic outfit, Johnson said, but if that were the case, bankruptcy should have been used to "let the market sort out the winners and losers.”
Lehman entered bankruptcy claiming $639 billion in assets. It's the largest bankruptcy in U.S. history. Fees associated with the filing have already topped $1 billion and continue to grow.
The agency's new powers "give us the tools to end Too Big to Fail and eliminate future bailouts," Bair said in a statement. But, she noted, "much work remains to be done."