Pulling the plug on Lehman

The BBC has been running some special programmes to mark the first anniversary of the collapse of Lehman Brothers. First it showed a fictionalised reconstruction of the events of that extraordinary weekend, then a documentary covering exactly the same period. When I saw this in the TV listings I thought it looked a bit strange, but the two complemented each other quite well. In some ways the fictional piece looked less phoney than the documentary, especially given the latter's hamfisted attempts to put the events into the context of a New York weekend. ("Across the city at Shea Stadium, the home town New York Mets are losing to Atlanta. It's a bad omen". No, I'm not making that up.)

Stylistic questions aside, the stories told in the two programmes were consistent. Much of what happened that weekend is well known now, but there was one element that I hadn't fully picked up on in the past. At the start of the weekend, the CEOs of the major New York financial institutions, minus Dick Fuld of Lehman Brothers, were summoned to meet with Treasury Secretary Hank Paulson at the New York Fed. Two firms, Bank of America and Barclays, were undertaking due diligence on Lehman's books at the time, but Paulson urged the other firms to take steps to ensure that the global financial system would not collapse when markets resumed activity after the weekend.

One of them certainly took action, though probably not the kind that Paulson had in mind. John Thain of Merrill Lynch quickly came to the conclusion that Lehman was going to go bankrupt, and that his own firm might be next. He left the meeting, went out into the street and called Ken Lewis, the CEO of Bank of America, offering a merger betweeen their two companies. Lewis promptly flew to New York, ended the due diligence review of Lehman and put together a deal with Merrill. When Barclays was unable to put together a deal for Lehman, the company's death was assured.

The voiceover of the documentary remarked that this certainly proved the old Wall Street axiom, "eat or be eaten". True, but my reaction was a bit different. Wasn't Thain in a position of conflict of interest? Having been taken into the Government's confidence, might it not have been illegal for him to torpedo the best deal available for Lehman with a view to saving his own company's skin? If Lehman had been through a merger with BofA, it's possible that the short sellers would have turned their baleful attentions on Merrill next; but it's also possible that the deal would have calmed the markets, leaving Merrill independent while saving investors a great deal of grief and taxpayers an immense amount of money.

You can never be certain with counterfactuals, of course. Still, if Hank Paulson saw the heads of the big banks scrambling to grab the best seats in the lifeboat for themselves, it's hard to blame him for refusing to throw them any more Government money.