Dualist Decision Making

Specification of Principle-Guided Political Crisis Management: Decisions are framed in either-or terms (dilemmas)

The U.S. Treasury and the Federal Reserve Bank approached the Lehman case with a strategy that was built on two premises: First, that a buyer for Lehman was needed. Second, that no public money would be provided this time. I argue that this perspective qualifies as principle-guided crisis management by employing the anti-pragmatist concept of dualism. Framing the decision in the dichotomous contrast of buyer or bankruptcy the Federal Reserve Bank and the Treasury limited their scope of possible actions.

From the perspective of this study, this decision therefore qualifies as dualist crisis management since it framed the decision as either-or dilemma: “Either we find a buyer for Lehman Brothers or

we will let the company fail“. As Ben Bernanke recalls Timothy Geithner saying: “Our whole strategy was based on finding a buyer” (Bernanke 2015, 268). The second dilemma, excluding the possibility of public financial support, took the form of: “Either we find a solution that does not require public money or we will let Lehman Brothers fail“.

In highlighting these two dilemmas it is important to note that the decision to let Lehman fail was not the first choice of the Bush administration. But by framing the decisions in the form of two dilemmas (buyer or bankruptcy; solution without public money or bankruptcy) the only outcome that was left after no buyer was found and the commitment to not use public money was made was the bankruptcy of Lehman Brothers. The previous chapter has shown how this strict dualism has transcended with the Bear Stearns decision: First, by providing a limited indirect loan on March, 14 that was intended to allow Bear Stearns to get to the weekend and explore further options. Second, by balancing the two poles of moral hazard and systemic stability by pushing for a low price for Bear Stearns’ shares. For the Lehman decision, however, we find no substantial examples for such anti-dualist decision making.

The Insistence to Find a Buyer as Dualist Crisis Management

The premise that a buyer for Lehman was necessary was developed at the Federal Reserve Bank. In an internal mail from July 12, 2008 James McAndrews from the New York Fed suggested that from the Fed's perspective – similar to the Bear Stearns scenario – a buyer was necessary in order to save

Lehman: “If we think it [Lehman Brothers] can be sold, then proceed as in BS [Bear Stearns]. If not, discuss with the Treasury its appetite for a permanent addition to the government's balance sheet by lending to the distressed firm” (Financial Crisis Inquiry Commission 2010, 69). If the Treasury would not show any “appetite” to help out, Andrews suggested that Lehman would have to file for bankruptcy.

The view that a buyer was needed for Lehman showed up in another internal e-mail of the Federal Reserve Bank from July 20, 2008 with the subject “Our Options in the Event of a Run on LB [Lehman Brothers]“. Written by Patrick Parkinson, director of the Division of Banking Supervision and Regulation of the Federal Reserve Board, it summarized the Fed's position: “But even if we are willing to extend as much as $200 billion of financing to LB [Lehman Brothers], absent an acquirer our action would not ensure LB's survival” (Financial Crisis Inquiry Commission 2008e, 4). An internal Fed analysis from September 10, 2008 reached the same conclusion and found a dilemma that included only two basic options: finding a buyer for Lehman or the failure of the company (Financial Crisis Inquiry Commission 2011, 331). As New York Fed director Geithner summarized the position of the Federal Reserve Bank: “We had no alternative to a merger” (Geithner 2014, 185).

The view at the Treasury was in line with the Fed's assessment stating that a buyer for Lehman was necessary. For political and legal reasons, Treasury Secretary Paulson insisted that the Treasury wasn't willing to help Lehman Brothers (see next section) so he facilitated the negotiations between Lehman and its two potential buyers (Paulson 2010, 178; Sorkin 2009, 131). After these negotiations failed, Treasury's Phillip Swagel emphasized how the absence of a buyer was the chief reason why Lehman couldn't be rescued: “In the end there was no one prepared to buy Lehman with any realistic amount of government assistance as had been the case with Bear Stearns” (Swagel 2009, 40). This was also how Treasury Secretary Paulson explained the decision to president Bush: “There was just no way to save Lehman. We couldn't find a buyer even with the other private firms' help” (Paulson 2010, 216; Bush 2010, 457; Sorkin 2009, 226).

The meeting with leading Wall Street bankers on September 12, 2008 was also structured according to this dilemma. Geithner and Paulson had convened the executives of major financial institutions at the New York Federal Reserve Bank to explore ways in which these financial institutions could help to facilitate the sale of Lehman to one of the two potential buyers: Bank of America and Barclay's (Financial Crisis Inquiry Commission 2011, 334; Sorkin 2009, chap. 13; Stewart 2009).

Geithner divided the bankers into three working groups along the two lines of the dilemma (Mollenkamp et al. 2008). The first two groups prepared a sale of Lehman while the third group prepared for the alternative, a Lehman bankruptcy (Wessel 2009, 17; Stewart 2009; Paulson 2010, 193).

Excluding the Possibility of Financial Support as Dualist Crisis Management

This sense of only two possible options was further increased by Paulson's stance on the question whether public money would be used to rescue Lehman Brothers. While the Federal Reserve Bank, with support from president Bush and the Treasury, had supported the sale of Bear Stearns in March 2008 with $30 billion (see chapter 5) Treasury Secretary Paulson excluded a similar solution for Lehman:

“In a conference call with Bernanke and Geithner, Paulson stated unequivocally that he would not publicly support spending taxpayer's money – the Fed's included – to save Lehman. 'I'm being called Mr. Bailout,' he said. 'I can't do it again'” (Wessel 2009, 14; also see Sorkin 2009, 141).

Without the support from Paulson, Bernanke was reluctant to spend the Fed's money on a Lehman deal as well (Wessel 2009, 14).

The moral hazard-infused stance that no public money would be spent on Lehman Brothers was repeated in internal discussions and public statements. In the meetings with Wall Street bankers on the evening of September 12, 2008 both Paulson and Geithner stressed that “the government would not bail out Lehman and that it was up to Wall Street to solve its problems” (Sorkin 2008; also see Bajaj 2008). The reluctance to rescue Lehman Brothers is also noted in the internal agenda that the Treasury and Fed prepared for the meeting, which lists one of the key elements of Paulson's introductory remarks: “Paulson conveys willingness of the official sector to let Lehman fail” (Financial Crisis Inquiry Commission 2008d, 2). Paulson and Geithner also let the two potential buyers of Lehman Brothers early on know that there would be no public money (Paulson 2010, 184; Stewart 2009). Additionally, Paulson believed “that we should emphasize publicly that there could be no government money for a Lehman deal” (Paulson 2010, 181).

President Bush stayed out of sight during the Lehman weekend and “left most of the details about the crisis to […] Paulson” (Labaton 2008; also see Stolberg 2008; Mann 2015, 132). As Wessel (2009, 11) puts it: “Bush and his team had delegated almost unconditional responsibility for

managing the Great Panic to the Treasury and the Fed“. When Paulson informed Bush on September 14, 2008 that Lehman would have to file for bankruptcy, Bush expressed relief that his government would no longer be associated with government bailouts:

Bush “told Paulson that he was unhappy about the bankruptcy, but that allowing Lehman Brothers to fail would send a strong signal to the market that his administration wasn’t in the business of bailing out Wall Street firms any longer” (Sorkin 2008, 226).

Internally, Timothy Geithner was opposed to Paulson's position that excluded the possibility of any public support. Wessel has described Geithner as “the one most ready to intervene to stop something bad from happening” and the “most 'forward leaning'” compared to Paulson and Bernanke (Wessel 2009, 20). Geithner himself recalls how the days of the Lehman decision were one of the few instances where there were substantial opinion differences between him, Paulson and Bernanke (Geithner 2014, 180). Geithner sensed that Paulson and Bernanke were influenced by political pressure and especially did not agree with Paulson's strategy to publicly state that there would be no financial support for Lehman (Geithner 2014, 179; Paulson 2010, 187; Stewart 2009). Paulson later claimed that his position was part of a negotiation tactic that was meant to prevent that Lehman, its potential buyers and other Wall Street banks would expect that the government would step in again (Paulson 2010, 187; Wessel 2009, 14). There is evidence for this explanation (Financial Crisis Inquiry Commission 2008d, 2011, 332; Valukas 2010, 618) but as the next section will show Paulson's reluctance can also be traced back to increased political pressure against the bailout of another investment bank.

Whatever the exact reasons for Paulson's position were, the internal and public exclusion of the possibility of any financial support for the rescue of Lehman Brothers can be qualified as dualist decision making since it included a dualist account of possible options. As Timothy Geithner, who did not want to exclude the possibility of public financial support, has pointed out this led to a situation where the Treasury and Federal Reserve Bank were not able to “preserve optionality“: “I didn't want us to commit to inaction and box ourselves in” Geithner stated (Geithner 2014, 179). Publicly reinforcing the “no-bailout” position further led to a self-imposed commitments that made it difficult to change course. As the model has outlined, from the perspective of pragmatist political crisis management such self-imposed commitment should be avoided. The Bear Stearns case has provided an important example for the avoidance of self-imposed commitments. Treasury Secretary Paulson advised president Bush not to promise that there would be no further bailouts, which preserved optionality and enabled the Federal Reserve Bank to financially support the deal between

Bear Stearns and JPMorgan two days later (see 5.1.1).

For the Lehman case I found an example of dualist decision making, Decisions are framed in either-or terms (dilemmas). The concluding section will discuss the question why the Bush administration engaged in this principle-guided form of political crisis management, compared to its earlier pragmatist approach in the Bear Stearns case.