Friday, October 24, 2008

Paulson Explains Himself: Calling Frank Drebin!

“I felt like Butch Cassidy…. Who are these guys who just keep coming at us?”

—‘Running a Step Behind as a Crisis Raged’ by Joe Nocera and Edmund L. Andrews, New York Times, October 23, 2008

So began yesterday’s excellent, and profoundly disturbing, inside look at how it was that Lehman Brothers was allowed to file for bankruptcy, essentially by one man: Hank Paulson.

While few of its competitors shed tears for Lehman, the ramifications of that Chapter 11 filing are now making the collapse of Bear Stearns seem like a walk in the park.

Yet, as the article makes clear, the Feds looked on like the bumbling but always successful Lieutenant Frank Drebin in that famous scene in “The Naked Gun,” when, gas tanks exploding and missiles flying, Drebin urges gawking pedestrians to ignore the carnage:

“All right, move on! Nothing to see here!”

The Times article appears to be based largely on the recollections of the man who has been on center stage during the entire credit crisis, Hank Paulson, and the chief inconsistency appears right up front, in the second paragraph.

See if you can spot it:

It was the weekend of Sept. 13, and the moment Treasury Secretary Henry M. Paulson Jr. had feared for months was finally upon him: Lehman Brothers was hurtling toward bankruptcy — fast.

Knowing that Lehman had billions of dollars in bad investments on its books, Mr. Paulson had long urged Lehman’s chief executive, Richard S. Fuld Jr., to find a solution for his firm’s problems. “He was asked to aggressively look for a buyer,” Mr. Paulson recalled in an interview with The New York Times.

The operative word, we think, is 'asked.'

We do not recall the heads of Fannie Mae, or Freddie Mac being “asked” to sell their companies to the Federal Government, thus wiping out shareholders and even preferred shareholders in the process.

We do recall the two men being told what was going to happen, whether they liked it or not.

Nor do we recall the heads of Goldman Sachs, Morgan Stanley, Merrill Lynch, JP Morgan, Citigroup, Bank of New York, Bank of America and Wells Fargo being “asked” sell stakes to the U.S. Government.

We do recall that the men were summoned to the Treasury and handed a single page term sheet, with the expectation that every one of them would sign it.

And sign it they did.

So why the kid gloves with Dick Fuld?

Why, while Lehman was “hurtling towards bankruptcy” as Hank Paulson had “feared for months,” was Dick Fuld being “asked” to do anything at all except get the hell out of the way before his company failed and took so many other banks, hedge funds, commercial paper funds, bond funds, real estate developments and who knows what else with it that a catastrophe would result?

Why, really, did Hank Paulson let Lehman Brothers go under and cause precisely the kind of global shock that he professed to avoid with his $29 billion Treasury bailout of Bear Stearns?

The article provides no clear answers, although the reporters hint that the most obvious—that it was a mistake Paulson profoundly regrets but will not admit—is also the truth.

Like Alan Greenspan absurdly telling Congress yesterday that it was not that he did anything wrong by fueling a housing bubble with 1% money; rather, it was the inability of Wall Street to regulate itself, Hank Paulson seems to be attempting to protect his legacy.

Only in Paulson’s case, he isn’t even off the stage yet.

Where's Frank Drebin when you need him?

Jeff Matthews
I Am Not Making This Up

© 2008 NotMakingThisUp, LLC

The content contained in this blog represents the opinions of Mr. Matthews.
Mr. Matthews also acts as an advisor and clients advised by Mr. Matthews may hold either long or short positions in securities of various companies discussed in the blog based upon Mr. Matthews’ recommendations. This commentary in no way constitutes investment advice. It should never be relied on in making an investment decision, ever. Nor are these comments meant to be a solicitation of business in any way: such inquiries will not be responded to. This content is intended solely for the entertainment of the reader, and the author.


Desiderata said...


I like your writing and all but you are being unnecessarily harsh on Paulson.


Christopher Caputo said...

Interesting post. However, I would note the the banks were demanded to accept the equity injection AFTER Lehman's failure...probably long enough after the fact for Paulson to have figured out he erred in ASKING Lehman to find a buyer.

Blue Wing Capital said...

Since the financial system handled the unwind of the massive Lehman CDS exposure without a complete unraveling, I think Paulson got it right in allowing Lehman to fail. Saving Bear was always much more about saving JPM and their massive counterparty risk to Bear, and set a bad precedent. This served as a proper warning that the Government is not here to bail out every troubled institution (even if that's what it feels like!)

antlord said...

Why does no one bring up the point that Paulson, including stocks and options, has over $100MM in net worth tied up in Goldman Sachs. After Bear went down, after Lehman went down and after Merrill was sold off, only Morgan and Goldman were left. Lo and behold, the Treasury Secretary comes to the rescue. I am not saying he is a criminal or even immoral. He acted perfectly rational.

russell1200 said...

In retrospect I think saving Bear may have been a mistake. But as an attempt to plug the hole in the breach and hope the wall holds the incoming tide it probably had to be done.

The timing of the Fannie and Freddie move was also really odd and appears to have triggered the AIG mess.

It just doesn't seem like trying to save leveraged dollars with real dollars (tax money) is a losing proposition.

But compared to some other this Administrations' operatives, Paulson has been a rocket scientist.

Kid Dynamite said...

it is impossible to be too harsh on Paulson. He and Bernanke were asleep at the wheel - they have the knowledge and ability to have combatted this crisis before it got into "can't help it now" stages... unfortunately, they instead chose to try to TALK their way out of it for 18 months, saying everything was OK.

the way Paulson et all let Lehman fail, and then bailed out AIG the next day was sick.

save 'em all, or kill 'em all...

Anonymous said...

"We do not recall the heads of Fannie Mae, or Freddie Mac being “asked” to sell their companies to the Federal Government, thus wiping out shareholders and even preferred shareholders in the process."

I understand that Fannie Mae and Freddie Mac are government sponsored entities, therefore they would have take it like how they did.

rockpaprscissors said...

Only a Jedi Knight could catch all the shocks thrown at it by that funky and erratic moving sphere that Luke Skywalker trained with on the Millenium Falcon. Paulson is no Jedi Knight, but it seems like his light saber is catching most of the damage. Too bad we don't have John Snow at the helm!!

By the way, whatever happened to the Sith Lord? Ahhh, I miss those days of general silliness.

Mark said...

The irony of that "Butch Cassidy" comment is that those guys were robbing banks, whereas in this case, it's the BANKS that did the robbing. Meanwhile, Paulson says he feels like a latter-day bank robber when, in fact, he's actually robbing the taxpayers. I guess William Goldman was no dummy when he figured out what kind of robbers he could "write likeable".

P.S., Jeff: I notice you omitted the "Sundance" part of Paulson's "Times" quote. It must be because Redford's still alive and thus Paulson definitely now more closely resembles Newman.

Beanieville said...

hey, maybe paulson had an axe to grind with somebody at lehman, like fuld?

Rich L said...

In the interview with Charlie Rose, Paulsen said that the Treasury didn't have the statutory authority to add capital to Lehman, and there were no buyers. He spoke about an antiquated system of regulations that needed to be modernized promptly. After the LEH failure, both MS and GS became bank holding companies, so the statutory problem that LEH faced was eliminated for the others in the future.

Paulsen also said that Congress wouldn't have acted until imminent disaster faced them.

It may be viewed at:

Jeff Matthews said...

"rockpaprscissors": I miss the 'Sith Lord', too, sort of. On the plus side, the IQ of commentators has gone up dramatically since he went underground.

Rich I Said: Thank you for pointing out that Paulson interview on Charlie Rose.

For the record, how did Paulson square his statement that he could not rescue Lehman one day with the fact that, as Kid Dynamite points out, he rescued AIG the very next day?

Thanks one and all for the non-Yahoo Message Board responses!


Tague said...

Q: How confident can we be in identifying…bubbles, and if we can’t be confident, what’s the role of the central bank in dealing with these events?
First, I think that many distortions in asset prices have arisen historically because of various kinds of structural regulatory problems in the underlying markets.  For example, research on historical episodes suggests that large asset price increases are sometimes preceded by credit booms.  In many cases this pattern results from the fact that the country in question deregulated its banking system, giving banks extra powers, but did not enhance the supervisory structure adequately at the same time.  The result is that institutions have an incentive to make economically bad investments, to take advantage of the “put” provided by the government safety net.
So you could have a situation where a badly managed deregulation of some financial market, such as in the case of our own savings and loan crisis or in episodes during the 1980s in Japan and Scandinavia, has the potential to create a one-way bet that generates a destabilizing move in asset prices.  It’s extremely important for central banks, or for financial supervisory agencies in those countries that have them, to ensure that the underlying microeconomic regulatory structure is such that moral hazard and misalignment of incentives are not pervasive in the system.  More often than not, such moral hazard problems are the source of asset prices becoming disconnected from fundamentals.  So good oversight of the banking system and of the broader financial system is one very important way in which central banks or other agencies can prevent these kinds of problems.

Federal Reserve Chairman Bernanke in an Interview with the Federal Reserve Bank of Minneapolis in June 2004
Click here for Interview
Maybe it’s just me, but doesn’t his description fit the subprime crisis to a tee? As lending decisions moved away from regulated banks and credit unions to mortgage underwriters, credit standards evaporated. And now many are trying to take advantage of a government “put” via direct government mandates or lower interest rates. Clearly our Federal Reserve Chairman understands bubbles and markets. My only question is why did he fail to increase regulation on the shadow banking system created by mortgage underwriters and Wall Street?

And Jeff, I am not making this up!!!

Ken Houghton said...

"After the LEH failure, both MS and GS became bank holding companies, so the statutory problem that LEH faced was eliminated for the others in the future."

I note for the record that it doesnt appear to be the "statutory problem" that is eliminated; it is the designation of Investment Bank.

Which means, if Hank Paulson or Bowie Kuhn were alive today, he could have told Fuld, "If all else fails, become a bank."

Anonymous said...

You assume for some reason that everyone agrees with you and that Lehman should have been saved. Why? I think letting it fail was the right option. Too many bailouts...

punchcard said...

Respectfully, I don't like this criticism of Paulson. Roger Federer is possibly the best tennis player ever, but if he is asked to stand at the net and volley against twenty different ball machines aimed at different angles, he is going to look a bit uncoordinated.

Treasury Secretary is a ridiculously hard job right now and Paulson is handling it well. After a long list of terrible hiring mistakes, W finally had the right man in place during a crisis.