Australian economist Paul Sheard was worried about one of his cherished textbooks, a $US150 tome on industrialisation he’d left in his office on the 15th floor of Lehman Brothers’ midtown Manhattan headquarters.
As Sunday dawned that September 15, 10 years ago this weekend, Sheard – then chief economist at the bank’s research department – ducked into work to collect the book and a few other personal items.
Just in case. Just in case the rumours were true, that Lehman had failed to secure a white-knight buyer and would be left to go under – crazy as that notion seemed even at that late stage.
If bankruptcy was declared, everything in the building – everything – would be locked down and handed to the liquidator.
“I lived several blocks away and I thought I’d grab my books … some of those books don’t come cheap.”
Around 11am that morning as he started back down the elevator, Sheard swung by the third floor – home to Lehmans’ sprawling fixed-income trading desk, where the superheroes of the investment bank plied their trade. They were at the epicentre of the market noose that had been tightening around the institution in the preceding week.
If something was up, they would know.
To his mild surprise – and relief – the place was pretty much empty, and he continued home.
Perhaps last-minute negotiations by the heads of the Fed, Treasury and a room full of Wall Street banking chief executives the day before and through to Sunday morning to find a buyer such as Bank of America or Barclays had succeeded.
Sudden and steep
But only three hours later, Sheard got an email from a colleague: get back to the office.
“The first thing I did was go to the third floor and open the doors – I’ll never forget the scene.”
To Sheard, who has spent many years in earthquake-prone Japan, it reminded him of the kind of roiling humanity you see in the aftermath of natural disasters.
“It was like a local high school gymnasium, full of people packing their desk up,” he says. “In those hours, the word had got out that we were going down … It was, in the end, a run of the people. My compelling memory was of how sudden and steep that cliff was in the end.”
Sheard wasn’t alone. The whole world shared that feeling. The speed by which Lehman went under – and the market violence it unleashed – took everyone by surprise. Including the people who were trying to avoid it: Hank Paulson, the then Treasury secretary, and Tim Geithner, who was in charge of the New York Federal Reserve.
The $US600 billion collapse of 158-year-old Lehman remains the biggest bankruptcy in corporate history. Twenty-five thousand people lost their jobs in an instant, already stressed financial markets went into full-scale panic around the world, and economic calamity loomed.
“It was a nightmare,” said Paulson this week, at an extraordinary conference in Washington hosted by the Brookings Institution, the highlight of which was a panel discussion with Paulson, Geithner and the Fed chairman during the crisis, Ben Bernanke.
“I remember that mix of that crushing burden of responsibility; fear of whether we were going to get our arms around it,” said Geithner. “The hardest thing was sitting at the table with my wife in the morning and her reading what we were doing … and seeing on her face that mix of despair and doubt.”
Bernanke, also this week: “Nobody saw how widespread and devastating the crisis itself would be.”
As the Lehman employees cleared their desks that Sunday afternoon, Paulson – who had been battling rolling waves of crises for more than a year by then – admits to succumbing to genuine terror for the first time. It was his darkest moment.
“I stepped out, called my wife Wendy and told her ‘I’m scared’.”
She replied with one of their family’s favourite verses, from Timothy 1:7; For God has not given us a spirit of fear, but of power and of love and of a sound mind.
“I immediately snapped back and I was fine.”
In the months that would follow, as Bernanke, Paulson and Geithner cajoled a reluctant Congress into supporting a rescue package – as the entire system teetered on the brink – Paulson would find himself snapping awake at midnight.
“Little problems seemed big and big problems seemed insurmountable. I’d look into the abyss and see food lines, a second Great Depression … how would we put it all back together?”
The story of how Paulson, Geithner and Bernanke put it back together holds key lessons for today, and has been the focus of debate all week.
While the next crisis is unlikely to be a repeat of the GFC, it will almost certainly echo. The triggers will be different, and are by definition unknowable. But it will be just as scary and just as sudden when it finally bites.
Perhaps even more so because many of the things that came together in 2008 to prevent another Great Depression may not be available next time.
This includes a President at the end of his term, as the crisis struck, willing to give key policymakers the leeway to act fast and unconventionally; there was unprecedented cooperation between the world’s central banks; and – as Paulson notes – China was an ally of the US at a key moment.
While neither Paulson, Geithner nor Bernanke are willing to go there, the elephant in the Brookings conference room this week was whether any of those things are possible now under President Donald Trump.
The relationship between Beijing and Washington is under enormous stress and conflict; Congress is deeply divided; and the current President’s “America first” approach raises serious doubts about whether international cooperation on the scale witnessed a decade ago would happen today.
“The Chinese were quite responsible during the financial crisis,” says Paulson. He recalled a meeting in Beijing in the months leading up to Lehman’s collapse, before it was at all clear how deeply corrosive the subprime mortgage rot had affected the financial system. The Treasury and Fed still didn’t know how bad it was “under the hood”.
Paulson says a “very senior” Chinese official took him aside and told him the Russians were urging them to jointly begin selling US financial assets – in effect, join in with predatory short-sellers to bring down the entire American financial system at its most vulnerable moment in 75 years.
“You talk about scary moments; that was another one.” Paulson says. Making matters worse, he couldn’t pick up the phone and relay the message to Washington because he feared it was bugged.
“My phone call [back] would be all positive things … and I couldn’t talk about the things from the Russians. When I got back, wow, that really gave me an incentive to get moving.”
Another lesson from the crisis was how difficult it was convincing Congress to provide the regulatory and fiscal tools needed to stabilise the financial system and restore the broader economy.
Paulson suggests he effectively bluffed his way through the worst of the storm because Treasury and the Fed had no way of recapitalising teetering banks with government money.
Next in line
At best, they could cajole other buyers into rescues of the troubled banks before panicked investors and counterparties wiped them out.
On the Monday after the Lehmans’ bankruptcy, Paulson says he was tested on this point after receiving a call from Morgan Stanley’s chief executive officer, John Mack, who warned his bank’s liquidity was “bleeding away”. Morgan Stanley was next in line to go down.
“Mack said ‘I don’t know how long we can live, the shorts will be all around us’,” Paulson recalls.
As he stood in the White House briefing room, Paulson was forced to put “as good a face on it as I possibly could”.
“If I [had] said ‘there is not a single power the United States of America has to save a disintegrating bank … Morgan Stanley would have gone down immediately. There was so much dry tinder.”
As the panic spread that week, engulfing AIG, one of the world’s biggest insurers and providers of credit default swaps that were exploding, Paulson was finally able to convince Congress that taxpayers’ funds were needed to stop the crisis wiping out the economy.
“It was a terrible outcome, but one thing [the Lehman’s collapse] did do is it shocked the political system.”
Congress soon after agreed to the troubled asset relief program – or TARP – a $US700 billion facility that helped stabilise the banks. It was the “bazooka” Paulson needed to curb the panic. It injected funds in exchange for collateral such as securitised mortgages. By the time the money was repaid several years later, the US federal government made a $US50 billion profit on the facility.
But a decade on, all three men are concerned that Congress has, if anything, made it more difficult for the Treasury and Fed to act in a future crisis, with the introduction of new rules curbing their power.
“It has to get really terrible for Congress to provide the tools you ultimately need,” Geithner says.
Political will is a vital ingredient.
US economics commentator Greg Ip says George W. Bush’s role merits greater appreciation, as he provided the support the technocrats needed.
“Ten years after the crisis, the financial system is stronger, but the political system is far more fragile,” Ip wrote in the Wall Street Journal this week. “Polarisation, populism and protectionism mean the next crisis will be met with far less political will than the last.”
Geithner says as there is no way to anticipate all the things that can cause the system to break down, policymakers need to be “humble and sceptical”.
“In the end what you want to do is make the system more resilient against the natural failure of people to pre-empt [the things that can go wrong].”
To be sure, Geithner is less pessimistic than most about the future support of Congress.
While there is a lot of “dysfunction in Washington today … I don’t ever want to bet against the USA and our political system in a crisis”, he says.
“A crisis can bring out the best; you’re not going to get me to say we couldn’t do it today. I can’t imagine what would have happened to our country if we hadn’t gotten the TARP.”
Geithner worries about other factors, such as the need to retain and nurture skills within institutions like the Fed and Treasury for the next crisis. Turning over the top four layers of government every time the administration changes doesn’t help either.
“The enemy is forgetting. We’re trying to preserve the body of knowledge about what works and what doesn’t so others have better tools … and narrow the gap between diagnosis and action.”
The next crisis is unlikely to be that distant, even if it happens far from Wall Street.
Donald Kohn, the Fed vice-chairman during the crisis, told AFR Weekend that a key lesson is the need for global action.
“The crisis, and the global nature of the crisis, made it very clear to lots of people that you couldn’t be isolated in a globally financially interdependent world,” he says. “So everybody had to act together.”
As Bernanke puts it: “What we learnt from that particular panic is that we’re all dominoes and we’re all close together.”