Global market melted because the US Fed have failed

Reprinted from Business Times

October 24, 2008

(NEW YORK) The Federal Reserve could not help investment bank Lehman Brothers even as its default threatened to wreak havoc on financial markets, US Treasury Secretary Henry Paulson told the New York Times in an interview.

Fed could not help Lehman, says Paulson, the Bank did not have enough good assets to serve as collateral for a Fed loan

Mr Paulson and Mr Bernanke have been criticised for allowing Lehman to fail, an event that sent shock waves through the US banking system. 'We didn't have the powers,' Mr Paulson told the paper, explaining the decision to let Lehman go bankrupt, which many have since criticised.

By law, the Federal Reserve could bail out Lehman with a loan only if the bank had enough good assets to serve as collateral, which it did not, Paulson told the paper.

'If someone thinks Hank Paulson could have made the Fed save Lehman Brothers, the answer is, 'No way',' Mr Paulson said.

But that is not the way that many who have scrutinised his actions see it. Bankers involved said they do not recall Mr Paulson talking about Lehman's impaired collateral.

And they said that buyers walked away for one reason: because they could not get the same kind of government backing that facilitated the Bear Stearns deal. In retrospect, they added, it was emblematic of the miscalculations by the government in reacting to the crisis.

The day after Lehman collapsed, the Fed saved AIG with an emergency US$85 billion loan, but the credit markets around the world began freezing up anyway. Mr Paulson defended Treasury's actions, saying that he and his aides had done everything they could, given the deep-rooted problems of financial excess that have built up over the past decade.

'I could have seen the sub-prime problem coming earlier,' he acknowledged in the interview, quickly adding in his own defence, 'but I'm not saying I would have done anything differently.'

History will be the final judge.

In contrast with Mr Paulson's perspective, other government officials and financial executives suggest that Treasury's epic rescue efforts have evolved as chaotically as the crisis itself.

Especially in the past month, as the financial system teetered on the abyss, questions have been raised about the government's - and Mr Paulson's - decisions.

Executives on Wall Street and officials in European financial capitals have criticised Mr Paulson and Fed chairman Ben Bernanke for allowing Lehman to fail, an event that sent shock waves through the banking system, turning a financial tremor into a tsunami.

'For the equilibrium of the world financial system, this was a genuine error,' Christine Lagarde, France's Finance Minister, said recently. Willem Sels, a credit strategist with Dresdner Kleinwort, said that 'it is clear that when Lehman defaulted, that is the date your money markets freaked out. It is difficult to not find a causal relationship.'

In addition, Mr Paulson and Mr Bernanke have been criticised for squandering precious time and political capital with their original US$700 billion bailout plan, which they presented to congressional leaders days after the Lehman bankruptcy.

The two men sold the plan as a vehicle for purchasing toxic mortgage- backed securities from banks and others.

But even after the House finally passed the bill on Oct 3, markets remained in turmoil. It was not until Britain and other European countries moved to put capital directly into their banks, and the United States followed their lead, that some calm returned.

Many complained the worst of the turmoil might have been avoided if it had not been for Mr Paulson sticking with an original bailout plan that they viewed as poorly-conceived and unworkable.

'They were asking the most basic questions,' said one Wall Street executive who spoke to Treasury officials after the bailout bill was passed. 'It was clear they hadn't thought it through.'