We're From the Government, and We're Here to Save You Money

We're from the Government, and We're Here to Save You Money

The FDIC released a report today with the amazing claim that, if the Dodd-Frank Wall Street Reform and Consumer Protection Act had been in place in 2008, the FDIC could have prevented the multi-hundred-billion-dollar international Lehman Brothers bankruptcy and saved creditors billions of dollars without costing taxpayers a red cent.

The Lehman bankruptcy was an amazing lawyer-fest, with a whopping $1.2 billion in fees approved by the bankruptcy court to be paid out of the bankruptcy estate's assets. It ending up paying creditors only 21 cents on the dollar. The FDIC claims it could have paid creditors 97 cents on the dollar. One way it would have accomplished this public service is to avoid all the legal fees. That much I probably buy; many of the legal battles would not have been fought at all absent the special bankruptcy context.

The FDIC says it also would have helped things by making its own loan to Lehman for operating funds, thus eliminating Lehman's need to negotiate for debtor-in-possession financing in bankruptcy. I'm not entirely convinced by the FDIC's claim that Lehman would and could have repaid this loan without burdening taxpayers, but OK, maybe.

I'm less convinced about this:

Under Dodd-Frank, the FDIC can require that systemically important investment banks, insurance companies and other companies with large financial services components deemed vital to the global financial system have resolution plans.

Such a “living will” would have required Lehman Brothers to develop early on a plan to dump or restructure some of its toxic real estate and private equity investments before being placed under FDIC receivership. The FDIC and other regulators both inside and outside the U.S. would also have had the ability to study Lehman's living will and work to improve it.

I don't like contemplating the image of FDIC regulators "studying" Lehman's "living will" in order to "work and improve it" -- either quickly, cheaply, or effectively. I doubt they could have been made to understand Lehman's business at all. Then there's this:

One of the key benefits to FDIC resolution authority is the potential speed of the transaction. Title II of Dodd-Frank allows the FDIC to review a financial institution's books, identify a potential buyer and any troubled assets that need to be split off, and quietly conduct bidding prior to taking over as a receiver.

The FDIC does have a track record of pulling off these emergency prebankruptcy sales at great speed, but as you might expect, when the pressure's on, the government regulators get their shirts handed to them. Invariably they find out in a year or two that they cut a horrible deal and some evil capitalist made a lot more money than they intended to allow, and they complain about it loudly -- often suing to renegotiate the deal.

This one, for me, is the real howler:

One of the problems Lehman faced as it skidded into bankruptcy was that potential buyers, including Barclays and Bank of America Corp., identified between $50 billion and $70 billion in assets they did not want to touch. Lehman was in no position to bargain, so the buyers walked, necessitating the bankruptcy filing, according to the report. . . . FDIC receivership would have prevented that, the report said.

As far as I can tell, this just means that the FDIC would have strong-armed some favor-currying insured bank into accepting the toxic assets, which would have ended up some day as a drain on the FDIC insurance system.