The financial covid crash of 2020 came and went in a month as the US government threw every monetary and fiscal trick it had at the government-imposed flash panic. We’ll never know which malivestments would have been cleansed. We live on with goods and labor shortages and with higher prices we’re assured by experts are transient. Supply chain issues, we’re told constantly, with no mention of the Federal Reserve’s balance sheet having doubled since the 2020 crash.

In 2008, Hank Paulson was a less, shall we say, flexible Treasury secretary than today’s person at the Treasury, Janet Yellen. Sure, Paulson oversaw a $700 billion Troubled Assets Relief Program (TARP) bank bailout. But, that amount seemed quaint as I was reminded of it reading A Colossal Failure of Common Sense: The Inside Story of the Collapse of Lehman Brothers.

The book, authored by the vice president of distressed debt and convertible securities trading at Lehman Brothers, Larry McDonald, with Patrick Robinson, provides an eyewitness account of the nation’s largest bankruptcy, a tripped domino which provided some semblance of an Austrian theory–style malinvestment flushing.

McDonald provides no academic theory, just street-level observation of hubris. He describes Lehman as “24,992 people making dough and 8 losing it.” The head man, Dick Fuld, a small man with a big ego, would not take Paulson’s advice to sell Lehman Brothers, overloaded with $120 billion in commercial and residential real estate. The company’s property portfolio was contained in “no fewer than twenty-four hundred line items” all encumbered with debt. The Lehman leverage ratio had grown to 44 to 1, only to be outdone by Fannie Mae and Freddie Mac’s 65 to 1 leverage. 

Fuld never left the thirty-first floor to visit the troops who not only made the firm money trading on the third and fourth floors but who also knew the real estate jig was up as far back as 2006. Meanwhile the boss made the mistake of many real estate lenders who believe, during a boom, that earning interest isn’t enough. Why not be a developer and make easy profits? 

McAllister Ranch was a project, located southwest of Bakersfield, California, owned and to be developed by Lehman. The two thousand–acre site was to eventually contain six thousand homes surrounding a Greg Norman–designed golf course, boating, fishing, and a fancy beach house. McAllister Ranch by June 2008 was three square miles of fenced-off sand dunes, weeds, and a half-finished clubhouse. Lehman had sunk close to $2 billion in this debacle.

And then there were the credit default swaps. “The issue is the credit default swaps,” Pete Hammack told McDonald said as Lehman failed. “There’s $72 trillion of them out there held by seventeen banks, and Lehman must be sitting on $7 trillion of them.”

An especially enlightening episode was Fuld’s meeting with the ex–Goldman Sachs partner Paulson, who had “been one of the driving forces that made that bank the source of so much irrational envy in the mind of Dick Fuld,” McDonald writes. Fuld’s blind need to grow at any cost was his desire to be bigger than Goldman. Paulson was also personally richer. After the two men dined, Fuld “tried to convince himself and others that the meeting had gone his way.” 

The meeting had been anything but friendly, with Paulson telling Fuld to sell the 158-year-old Lehman and its assets. “He wanted the place to deleverage in a big hurry, and he all but accused Fuld of dragging his feet.” Paulson was annoyed that the highly leveraged Lehman was investing in highly leveraged hedge funds. The Korea Development Bank had a deal for Lehman on the table at $23 per share and the Treasury secretary thought Fuld should take it rather than accessing the Fed window for taxpayer cash. 

“I’ve been in my seat a lot longer than you were ever in yours at Goldman,” Fuld told Paulson. “Don’t tell me how to run my company. I’ll play ball, but at my speed.” Lehman’s goose was cooked at that dinner, with Paulson thinking Fuld “demonstrated something between arrogance and disrespect.” 

In the meantime, the Korean Development Bank’s offer per share shrank from $23 to $18 to $6.40, offers that Fuld reportedly never took to his board. McDonald chronicles the real drama as Lehman’s lenders demanded their lines of credit be collateralized with cash, forcing Fuld to look under every seat cushion for something in short supply at Lehman, cash. 

Never one to take responsibility, Fuld “blamed intense public scrutiny for causing significant distractions among Lehman’s clients, counterparties, and employees,” McDonald recalled. 

Ultimately, Bank of America and the bank from Korea looked to the Treasury for support to buy Lehman. For whatever his reasons, Paulson didn’t blink in the case of Lehman. He saved Merrill Lynch, Bear Stearns, Fannie, Freddie, AIG, and others. Government guarantees totaled $314 billion. McDonald wrote that JPMorgan Chase was the fourth branch of government, Bank of America the fifth. I would squeeze Goldman Sachs in ahead of those two. But Paulson had no love for Lehman and Fuld.

At the eleventh hour, Fuld called Paulson over and over to no avail. A call was placed to Tim Geithner at the New York Fed. He was unavailable. A Lehman executive committee member was a cousin to President George W. Bush. A call was reluctantly placed. “I’m sorry, Mr. Walker. The president is not able to take your call at this time.” Fuld’s delusion is further reflected by the firm’s bankruptcy filing. It was a scant fifteen pages, whereas most large bankruptcy filings are hundreds of pages. The law firm of Weil Gotshal was hired at the last minute. 

Lehman wasn’t alone. At the bottom of the financial mess, America only had six companies with debt rated AAA. In 1980 there were ten times as many. 

Colossal Failure was published in 2009, so McDonald’s memories were fresh. He closed with “Wall Street will never be the same. Lehman brought it down, as it brought down half the world. And, I say again, it never should have happened.” 

In April 2020, a wall of money ($865 billion) flowed into banks, with “[m]ore than two-thirds of the gains [going] to the 25 biggest institutions, according to the FDIC. And that was concentrated at the very top of the industry: JPMorgan Chase, Bank of America and Citigroup, the biggest U.S. banks by assets, grew much faster than the rest of the industry in the first quarter, according to company data,” CNBC reported. Citigroup and Bank of America were the primary beneficiaries of the TARP bailout. 

Wall Street banks are bigger and more fragile than ever. Wall Street is not the same only in the sense it’s more dependent on the government. Janet Yellen has no corporate rivals. She will always say yes.

The Lehman lesson is everyone gets bailed out from now on, and what’s left of capitalism is the worse for it.