Forget that the entire financial system was in crisis, and that lots of other banks had charts similar to this in the 2nd half of 2008, and assume Lehman is the only is the only faltering institution. Consider these questions:
1) What are your goals as you see Lehman’s slide?
2) What are you doing in the period leading up to your decision to take Lehman into bankruptcy?
3) What are the likely actions by market participants, counterparties, and potential investors in Lehman doing while you decide?
4) At what point do you, as Treasury Secretary, make the determination to step in and take Lehman Brothers into bankruptcy?
And finally, Will the availability of resolution authority make it more or less likely that you can achieve your goals?
These are the most important, practical questions in trying to anticipate if resolution authority – however comforting in concept — is a good or bad tool for policymakers.
If you are Treasury Secretary in the months leading up to Lehman’s collapse, you’re goal is to avoid using your resolution authority. Your primary objective is to find some way to encourage the private sector to step up. So you’re doing exactly what Hank Paulson was doing in the summer of 2008 – encouraging Lehman CEO Dick Fuld to either raise capital or find a buyer.
Market participants and potential investors are watching you, looking for signals for your likely answer to question #4. Knowing that you have resolution authority and can come in at any moment to take down the firm, they’re wondering why in their right minds would they ever put a dollar into this failing institution today if the Treasury Secretary can come in tomorrow and wipe them out. (To prevent flight in the case of Fannie Mae and Freddie Mac, recall Secretary Paulson insisting on reassuring investors that the firms would continue “in their current form as shareholder-owned companies”, as he sought authority to deal with the GSEs. It didn’t work.) In fact, the very availability of resolution authority, and the unpredictability of when and under what conditions government would use it -- wiping out equity investors and removing management -- is more likely to speed up investor flight, not encourage them to step in to help. In other words, an outcome precisely opposite of your goal as Treasury Secretary.
Lehman Brothers, it should be noted, may have been salvageable. At the time a Treasury Secretary with resolution authority might be seeking to shutter the firm, the bank’s officials were actively courting large investors and seeking a buyer. They actually found one in Barclays, although it was scuttled by UK authorities. There were lots of reasons why other firms walked away from Lehman – not least were their own precarious positions — but it’s hard to imagine resolution authority making them more likely to step in under similar circumstances.
