More on Lehman Revisionism

I’ve been thinking a bit more about the Lehman Brothers revisionism coming from the likes of Bernanke, Paulson, and Geithner: the fact that although they were quite clear about letting Lehman fail at the time, they subsequently have backtracked on that, and said that although they tried very hard to rescue Lehman, they simply weren’t allowed to do so.

I still think that’s probably bullshit, and that in this crisis, as we’ve seen, where there’s a will, in government, there’s a way. Paulson, for one, was not the type of person to let a bunch of Federal Reserve lawyers stop him from doing what he thought needed to be done. But what if he’s telling the truth, and rescuing Lehman really was illegal? How can that be squared with contemporaneous statements?

I think the answer might lie in market psychology. When Lehman failed, it did so with clear indications from its regulators that they wouldn’t continue with Bear-style bailouts, and that there was no kind of Paulson Put, where failed banks automatically get rescued by Treasury.

If the sun rose the following morning and the world didn’t come to an end, that would be an astonishingly strong signal about market resilience in the face of government inaction, and would help boost sentiment a very great deal.

On the other hand, if Lehman’s failure really was going to have nasty systemic consequences, then a few statements from Treasury were unlikely to make things substantially worse: an apocalyptic meltdown is an apocalyptic meltdown either way.

So I can see why Paulson and Bernanke said what they did in the immediate wake of Lehman’s collapse: there was substantial upside to saying it if markets went up, while if markets went down the downside was so big either way it made very little difference whether they said it or not.