So which theory is it: stunning bureaucratic incompetence, wishful thinking and denial, or a cover up? Or a combination of the above?
No matter which theory or theories you subscribe to, the continuing revelations of how the SEC -- and perhaps more importantly, the New York Fed -- conducted themselves in the months before Lehman's collapse, paint an increasingly damning picture.
The Valukas report shows both regulators were monitoring Lehman on a day-to-day basis shortly after Bear's failure. They recognized that it had a massive hole in its balance sheet, yet took an inertial course of action. They pressured a clearly in-denial Fuld to raise capital (and Andrew Ross Sorkin's accounts of those efforts make it clear they were likely to fail) and did not take steps towards any other remedy until the firm was on the brink of collapse (the effort to force a private sector bailout as part of a good bank/bad bank resolution).
One of the possible excuses for the failure to do more was that the officialdom did not recognize how badly impaired Lehman was until too late in the game to do much more than flail about. But that argument is undercut by a story in tonight's Financial Times.
Merrill warned both the SEC and the Fed in March 2008 that Lehman was engaging in balance sheet window dressing of a serious enough nature for it to put pressure on Merrill (as in it was making Merrill look worse relative to the obviously impaired Lehman).
When a company under stress makes fraudulent statements about its financial condition, it is a sign of desperation, and possibly imminent collapse. The fact that Merrill, with a little digging, could see that Lehman's assertions about its financial health were bogus says other firms were likely to figure it out sooner rather than later. That in turn meant that the Lehman was extremely vulnerable to a run. Bear was brought down in a mere ten days. Having just been through the Bear implosion, the warning should have put the authorities in emergency preparedness overdrive. Instead, they went into "Mission Accomplished" mode.
This Financial Times' story provides yet more confirmation that Geithner is not fit to serve as a regulator and should resign as Treasury Secretary. But it may take Congress forcing a release of the Lehman-related e-mails and other correspondence by the New York Fed to bring about that outcome.
From the Financial Times:
Former Merrill Lynch officials said they contacted regulators about the way Lehman measured its liquidity position for competitive reasons. The Merrill officials said they were coming under pressure from their trading partners and investors, who feared that Merrill was less liquid then Lehman...
In the account given by the Merrill officials, the SEC, the lead regulator, and the New York Federal Reserve were given warnings about Lehman's balance sheet calculations as far back as March 2008.
Former and current Fed officials say even in the competitive world of Wall Street, it is unusual for rival bankers to relay such concerns to the Fed.
The former Merrill officials said they contacted the regulators after Lehman released an estimate of its liquidity position in the first quarter of 2008. Lehman touted its results to its counterparties and its investors as proof that it was sounder than some of its rivals, including Merrill, these people said...
"We started getting calls from our counterparties and investors in our debt. Since we didn't believe the Lehman numbers and thought their calculations were aggressive, we called the regulators," says one former Merrill banker, now at another big bank...
Merrill officials said their calculations led them to believe that Lehman included what is known as regulatory capital in its calculation of excess liquidity. Executives at other banks say that is improper...
Mr Valukas said in his report that the banks interacting with Lehman may have suspected Lehman was incorrectly calculating its liquidity. In September 2008, days before it collapsed, Lehman maintained that it had about $50bn in readily accessible funds, though at the end it had nothing like that amount.