"We had lawyers joined at our hips," said one participant. "And they were very helpful at framing the issues. But they never said we couldn't do it."
As another participant put it, "It was a policy and political decision, not a legal decision."
A Wall Street Watershed
The account from the New York Fed officials provides new insight into a dangerous moment in Wall Street history. Countless financial figures — from Wall Street chiefs to government policy makers — have said that allowing Lehman to die the way it did was a misjudgment that inflicted unnecessary pain.
"There is close to universal agreement that the demise of Lehman Brothers was the watershed event of the entire financial crisis and that the decision to allow it to fail was the watershed decision," Alan S. Blinder, an economics professor at Princeton and former vice chairman of the Fed, wrote in his history of the financial crisis, "After the Music Stopped."
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"The Fed has explained the decision as a legal issue," Mr. Blinder said in an interview. "But is that true or valid? Is it enough? Those are important questions."
Whether the Fed should have tried to save Lehman is still a subject of heated debate. And it is unclear whether the firm could have been rescued at all.
What happened that September was the culmination of circumstances reaching back years — of ordinary people too eager to borrow, of banks too eager to lend and of Wall Street financial engineers reaping multimillion-dollar bonuses. Even so, saving Lehman from complete collapse might have shielded the economy from what turned out to be a crippling blow. And as the subsequent rescue of A.I.G., the insurance giant, demonstrated, a rescue could have included substantial protections for taxpayers.
Back in 2008, the Fed possessed broad authority to lend to banks in trouble. Section 13-3 of the Federal Reserve Act provided that "in unusual and exigent circumstances" the Fed could lend to any institution, as long as the loan was "secured to the satisfaction of the Federal Reserve Bank." In the eyes of the Fed, that means a firm must be solvent and have adequate collateral to lend against, and making that determination was the responsibility of the New York Fed, the regional Fed bank that had begun to assume responsibility for Lehman. On that September weekend, teams from the New York Fed were told to assess Lehman's solvency and collateral.
Whether and how much the Fed could lend Lehman depended on those teams' findings, although the final decision rested with Mr. Geithner, Mr. Bernanke and the Federal Reserve Board.
A Question of Valuation
In recent interviews, members of the teams said that Lehman had considerable assets that were liquid and easy to value, like United States Treasury securities. The question was Lehman's illiquid assets — primarily a real estate portfolio that Lehman had recently valued at $50 billion. By Lehman's account, the firm had a surplus of assets over liabilities of $28.4 billion.
Others had already taken a stab at valuing Lehman's troubled assets. Kenneth D. Lewis, then the chief executive of Bank of America — who, with the government's encouragement, was considering a bid for Lehman — asserted that Lehman had a "$66 billion hole" in its balance sheet.
A group of bankers summoned to the Fed by Mr. Paulson, who was hoping they would mount a private rescue, did not accept Lehman's $50 billion valuation for its real estate and could not decide whether Lehman was solvent. But potential private rescuers had a motive to lowball Lehman's value. Fed officials involved in the valuation stressed that the Fed could hold distressed assets for much longer than private parties, allowing time for those assets to recover in value. Also, because the Fed sets monetary policy, it exerts enormous influence over the assets' ultimate value.
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"There can't be any reasonable doubt that had the Fed rescued Lehman, that very act would have pushed up the value of its assets," Mr. Blinder said.
While the Fed team did not come up with a precise value for Lehman's illiquid assets, it provided a range that was far more generous in its valuations than the private sector had been.
"It was close," a member of the Fed team that evaluated the collateral said. "Folks were aware of how ambiguous these values are, especially at a time of crisis. So it becomes a policy question: Do you want to take a chance or not?"
Argument continues today over the value of Lehman's assets. A report compiled by Anton R. Valukas, a Chicago lawyer, at the behest of the bankruptcy court overseeing Lehman concluded in 2010 that nearly all of the firm's real estate valuations were reasonable. It also suggested that Lehman's chaotic bankruptcy caused many of the losses later borne by the firm's creditors. Other analysts have argued that Lehman was deeply insolvent.
Ultimately, the appraisals of the New York Fed teams did not matter. Their preliminary finding was that Lehman was solvent and that what it faced was essentially a bank run, according to members of the group. Researchers working on the value of Lehman's collateral said they thought they would be delivering those findings to Mr. Geithner that September weekend.
But Mr. Geithner had already been diverted to A.I.G., which was facing its own crisis. In the end, the team members said, they delivered their findings orally to other New York Fed officials, including Michael F. Silva, Mr. Geithner's chief of staff.
On Sunday, Mr. Bernanke was in Washington awaiting the New York Fed's verdict. In a phone call, Mr. Geithner said Lehman could not be saved.
The Fed would be lending into a run, Mr. Geithner told Mr. Bernanke, according to both men's accounts. In a recent interview, Mr. Bernanke said, "Knowing the potential consequences of Lehman's failure, I was 100 percent committed to doing whatever could possibly and legally be done to save the company, as were Tim and Hank." Mr. Paulson has concurred, saying, "Although it was Ben and Tim's decision to make, I shared their view that Lehman was insolvent, and I know the marketplace did."